Excitement around crypto is reaching fever pitch. The buzz has driven prices higher and forced mass acceptance and accumulation.
During the early part of the existence of altcoin, traders basically fell into four primary groups: IT nerds, anarchists, bandits and speculators.
Normal investors, already staggering under the weight of FinTech innovation, faced a daunting challenge. Building wallets, opening accounts with sketchy exchanges, stories of widespread hacks, rumours of tulip bubbles, criminal activity, doom-and-gloom predictions of ‘forks’, old-fashioned Ponzi schemes… Even if investors safely navigated these perils when purchasing cryptocurrencies, they still had to deal with unprecedented volatility.
The Darwinist nature of financial innovation kicked in. The prospect of massive gains prompted many investors to power ahead. As participation increased, user-friendly ecosystems emerged, making it easier to trade cryptocurrencies. As we approach the beginning of 2018, the ease of opening a trading account, transparency of coin information, and user-friendly trading front ends are almost on a par with systems available in the forex market.
What took fifteen years of development in forex has taken only two years in crypto-trading. The trading technology surrounding altcoin is predictable and user-friendly. Meanwhile, liquidity in primary coins has increased significantly, allowing for seamless buy and sell transactions with low spreads and stable prices. Decentralized trading venues still have issues, as highlighted by the Bitfinex hack, but the evolutionary process suggests that these bugs will be fixed. Demand for crypto-assets has shifted away from the fringe and is now almost, although not completely, mainstream.
With trading issues in the process of being resolved, the actual strategies used by investors in altcoin will likely also evolve. Currently, the most widely used strategy is simple long-only: investors pick one or more currencies to invest in, and hold them until a certain threshold return is reached. Riding out extreme volatility is just part of the play. To continue attracting new investors from the fiat world, more conventional investment vehicles will be essential. However, Darwinism in financial innovation indicates that, as with stocks, those investors who will ultimately shift into more complex strategies will most likely move into smart beta strategies first.
A quick recap: smart beta strategies aim to improve returns, reduce risk and enhance diversification. Smart beta strategies are active investments that attempt to enhance risk-adjusted returns through exposure to demonstrated drivers of returns. Such strategies are transparent, systematic and rule-based. Deploying smart beta allows an investor to maximize the potential opportunities offered by cryptocurrencies.
Using ‘smart contracts’, or traditional vehicles such as ETF or certificates, investors will be able to participate in market-directional investments, arbitrage, systematic trend-following and short-term mean reversion, to name just a few simple but effective trading strategies. These well established non-discretionary strategies are easy to model and execute.
In addition, shifting investors’ cyprocurrency strategies away from ‘buy and hold’ and into active strategies removes the emphasis on picking the winner in a very crowded space. Finally, we suspect more traditional vehicles such as funds and certificates will be used as wrappers for smart beta products, since this type of approach bridges the divide between crypto and real investments. Investors should watch out for this new breed of innovative financial product, which will open the world up to trading in cryptocurrency, providing another way to diversify traditional portfolios.
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