As a seasoned professional with extensive experience in traditional finance and now delving into the exciting world of cryptocurrencies, I find the emergence of Single Manager Accounts (SMAs) particularly intriguing. Having joined Algoz Technologies late last year, I’ve had the privilege to be part of pioneering an SMA structure for an off-exchange settlement product called Quant Pro, using Zodia Custody and Bitfinex.
Earlier this year, come January, I observed a significant shift as 11 prominent global asset management firms ventured into the cryptocurrency realm, primarily through Bitcoin (BTC) exchange-traded funds. This move signified an influx of billions of dollars from institutional investors who had previously been reluctant to invest. As these asset managers delved into the crypto world, they discovered that their established strategies, honed in traditional markets, weren’t as effective in this dynamic environment.
How hedge funds work
With their regulated offshore structures and established auditing procedures, hedge funds work for traditional assets. They provide investors with a sophisticated and secure framework to generate alpha (returns above the market) through various strategies. However, when applied to the crypto markets, several fundamental issues arise.
To begin with, offshore structures for financial entities don’t align well with the regulatory landscape of cryptocurrencies. Typically, conventional hedge funds are established offshore, where regulatory oversight is less stringent, enabling greater freedom in investment approaches. Nevertheless, when it comes to the crypto market, assets managed by these funds are often transferred to unregulated exchanges, posing a significant risk. This is because funds are moved into environments with minimal or no regulation, similar to traditional markets. Essentially, the hedge fund structure serves more as a decorative element than a functional one in the crypto world; it provides only a thin layer of protection.
Another problem with hedge funds is their lack of timely reporting. Most hedge funds provide performance data only after their monthly or quarterly audits are completed, which is 45 days after the fact. In the fast-paced crypto markets where prices can move 10% in hours, this is unacceptable.
As an analyst, I find myself grappling with the reality that by the time investors receive the outcome of a trade, the market conditions that led to those results might have undergone a radical transformation. To put it simply, if we were to transpose this delay onto traditional markets like Nasdaq, we’re looking at a wait time of roughly five months for performance results. In a dynamic and volatile market, such a prolonged lag is simply unfeasible.
In contrast to conventional markets that operate within set trading hours, the cryptocurrency market is a non-stop arena, available around the clock. This constant activity necessitates continuous monitoring and prompt decision-making. Given their slower tempo and regular reporting schedules, hedge funds are not ideally suited for this kind of environment. On the other hand, traders who have grown accustomed to the dynamic nature of the crypto market can swiftly adapt to changes. Unfortunately, traditional hedge fund managers may find it challenging to keep pace with the more volatile and quick-moving cryptocurrency market.
The SMA solution: Custom, clear, and timely
Instead of investing in hedge funds, separately managed accounts (SMAs) might be a better choice for cryptocurrency investments. Unlike hedge funds, SMAs provide users with direct ownership of assets, real-time updates, and a tailored investment management strategy that is more in line with the dynamic nature of the crypto market.
One advantage of Separately Managed Accounts (SMAs) is that they allow you to own the underlying assets individually, which contrasts with hedge funds where assets are combined. In SMAs, each account functions independently, meaning your money can be tracked and its performance monitored specifically for your account, providing you with clarity about where your investment stands at any given moment. This high level of transparency is particularly valuable in the cryptocurrency market, as it helps mitigate potential risks like fraud and mismanagement that are prevalent within this sector.
Furthermore, Self-Managed Accounts (SMAs) provide immediate reporting. Given that each account operates independently, investors can access up-to-the-minute data regarding their portfolio’s progress. This feature sets SMAs apart from hedge funds, where performance reports are sometimes delayed by weeks or even months compared to the real-time market activity.
One advantage of Structured Managed Accounts (SMAs) is their capacity to offer tailored investment strategies. In contrast to hedge funds that employ a one-size-fits-all approach, SMAs enable investment managers to personalize strategies according to each client’s unique requirements and risk tolerance. This flexibility is particularly crucial in the dynamic and unpredictable crypto market, where the capacity to swiftly modify strategies can determine whether gains are realized or losses are incurred.
Investors working within institutions gain significant advantages from the adaptability offered by Separately Managed Accounts (SMAs). For instance, SMAs provide options for tax management techniques such as tax-loss harvesting, which are particularly valuable considering the volatile nature of cryptocurrencies. Furthermore, SMAs enable investors to create custom portfolios within the crypto market, allowing them to tailor their investments according to their broader financial objectives and diversify their assets effectively.
The advantage of being able to trade whenever you want and ensuring your assets remain secure without relying on third parties makes a compelling argument for utilizing SMAs (Smart Multi-Asset Accounts). These accounts are particularly beneficial in the crypto trading market, providing institutional investors with the agility and swiftness they require to maneuver within this 24/7 trading environment. This is quite distinct from conventional finance hedge funds that are confined by business hours and the delays connected with quarterly audits and reports.
Off-exchange settlements are another reason to like SMAs in crypto. Eighteen months ago, off-exchange settlements didn’t exist. Now, companies like BitGo, Zodia, Fireblocks, and Copper.co are filling this gap. Copper.co was the first to offer a secure off-exchange settlement service, which allows institutions to trade without exposing their assets to unregulated exchanges. These services add an extra layer of security so assets remain in cold storage with regulated custodians.
It’s worth noting that each of these companies operates uniquely. Copper.co prioritizes trust within their platform, ensuring that clients’ assets are held in trust, thus reducing counterparty risk substantially. In contrast, Zodia focuses on a trust-based custody approach, which means all assets are kept in trust for the client. However, Fireblocks has faced criticism due to its practice of pooling client funds into a single account, making it challenging to trace individual assets. The growing trend towards off-exchange settlements underscores the significance of transparency and security in cryptocurrencies—two key elements that form the basis of the SMA model.
SMAs are the future of institutional crypto investments
The trend in regulations appears to be leaning towards Self-Managed Accounts (SMAs) over hedge funds. For instance, Singapore’s Monetary Authority has enacted new rules, such as requiring crypto exchanges to keep customer assets in a trust, following the downfall of FTX. This is aimed at safeguarding assets and investors. Moreover, MAS has prohibited staking and lending for retail investors while allowing it for institutional ones. This shift towards stricter regulations and investor protection aligns with the SMA model, which emphasizes transparency, security, and personalized management.
In 2022, when FTX faced collapse, investors worldwide were thrown into a panic, but the situation unfolded differently in Japan. Unlike other regions, users of FTX Japan have been able to recover their funds. This is due to a unique regulation in Japan that mandates crypto exchanges to maintain customer assets in separate accounts—a practice strikingly similar to how we manage Safety-Margined Accounts (SMAs). As an analyst, I find it reassuring to see such regulations in place, as they serve as a vital safeguard for investors.
In Japan, exchanges were required to keep customer deposits separate from business funds, by storing them in a third-party bank or trust. This was done to prevent the mixing of customer and company finances, an issue that significantly played a role in the collapse of FTX in other regions. The concept is similar to Self-Managed Accounts (SMAs), where investors retain full ownership of their assets without pooling them with others, thus reducing the risk of any underhanded or careless activities.
Although global FTX investors are yet to recoup their investments, Japanese investors have already received their funds back. This isn’t just a fluke—it underscores how regulations like SMAs can provide significant safeguards. If more regions were to adopt this strategy, we might be able to prevent future incidents similar to the FTX crisis.
Hedge fund structures may have worked for traditional assets but are increasingly out of sync with crypto. Delayed reporting, offshore structures, and 24/7 trading make hedge funds a bad fit for crypto. SMAs offer a bespoke, transparent, and timely solution for modern institutional investors. SMAs will soon be the investment vehicle of choice for institutions looking to acquire digital assets. Direct ownership, real-time reporting, and bespoke strategies.
Stephen Wundke serves as the Strategy and Income Manager at Algoz Technologies, having joined the company towards the end of 2022. He was instrumental in devising a distinctive Structured Market Agreement (SMA) structure for an off-exchange settlement product named Quant Pro, leveraging Zodia Custody and Bitfinex platforms.
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2024-10-29 14:12