The Thermodynamics of Crypto Investing

Many risks still remain, of course, which is why investors still have the chance for outsized returns – though as each risk falls, returns become incrementally smaller.

So, if this risk-return energy is not destroyed, what does it become? As regulatory risk takes center stage, we see a continually transforming landscape for digital alpha investing. Consider:

• Offshore market makers are decreasing volume, which affects quantitative market-making and high-frequency arbitrage trading strategies.
• Government lawsuits that target altcoins as potential unregistered securities affect the viable universe of token selection alpha for fundamental investors.
• Rules around qualified custody affect all on-chain strategies, where today’s cutting edge of financial engineering and market structure innovation live.

In other words, while each incremental return opportunity for crypto beta is less significant than the prior, the opposite is happening for crypto alpha: The reduction of these later-stage risks is paving the way for extraordinary financialization and institutional adoption. Yet, this transformation creates an “allocator’s dilemma.” You can’t just offhandedly invest with the largest funds as a sure-fire path to success. Instead, we are currently in an exceptional era for capacity-constrained smaller funds, which have a unique opportunity to outperform. But, of course, that won’t last forever as the thermodynamics of crypto investing continue to transform. Astute institutional investors would be well-served to consider what kind of stake they want to have in this moment of transition.