David Fauchier from Nickel Digital Asset Management discusses the evolution and fragmentation of crypto markets, highlighting differences in rules and opportunities. He explores why traditional high-frequency funds may not dominate crypto. The conversation also delves into managing a fund in the crypto space, addressing risks in asset exchange and custody, due diligence red flags, institutional interest in cryptocurrencies, and the emergence of decentralized finance (DeFi).
Cryptocurrency markets are fragmented with diverse exchange rules, presenting both risks and opportunities.
Successful crypto traders combine human intuition and systematic execution to navigate market dynamics effectively.
Determining fair value of crypto assets is a challenge due to price variations, requiring stringent risk management and valuation practices.
Deep dives
Fragmentation and Opportunities in the Crypto Market
The discussion with David Fauchié of Nickel Digital Asset Management sheds light on the fragmented nature of crypto markets, with various exchanges having different rules and models for trading. This fragmentation presents both risks and opportunities, as different regulatory regimes and market structures create complexities. Despite the evolution of crypto markets, they remain divided, making it challenging for traditional high-frequency trading firms to enter and dominate the space.
Paranoid Cowboys and Quantitative Strategies in Crypto Trading
Successful traders in the crypto market exhibit traits of 'paranoid cowboys,' combining human intuition with systematic execution to navigate the rapidly changing landscape of the market. These traders are meticulous about risk management and constantly adapt to the dynamic nature of crypto trading. Additionally, some traders focus on building models that generate models, creating a swarm of strategies that can rapidly respond to market shifts, especially in the highly quantitative and statistically oriented approaches.
Valuation Challenges and Asset Management in Crypto Funds
Determining the fair value of crypto assets poses a challenge due to price discrepancies across various exchanges. Fund accounting and asset management require establishing a reference point amidst price variations. Fund managers often rely on independent custodians or use a weighted average of prices to mitigate valuation concerns. Additionally, managing exchange and custody risks is crucial, necessitating stringent protocols to safeguard assets in a volatile and susceptible market environment.
Enhanced Security Practices at Crypto Exchanges
Cryptocurrency exchanges have significantly improved their security practices over time. This involves storing a large portion of assets in cold storage, with the majority of funds being held securely. Exchanges like Coinbase have reported around 97% of assets held in cold storage, reducing the risk associated with hot wallets. Additionally, users can enhance security by whitelisting withdrawal addresses, setting up two-factor authentication, and implementing time locks. Furthermore, exchanges have established sizable insurance funds to mitigate losses in case of insolvency, ensuring clients' funds are protected.
Opportunities and Challenges in Decentralized Finance (DeFi)
The rise of Decentralized Finance (DeFi) represents a significant shift in the financial landscape. Offering innovative solutions on blockchain platforms like Ethereum, DeFi enables decentralized exchanges through automated market makers. Liquidity pools allow users to trade assets without relying on traditional order books, opening up new avenues for arbitrage opportunities. Transactions on DeFi platforms operate in a deterministic manner, impacting computations, transaction fees, and trading dynamics. The increasing popularity of DeFi introduces challenges such as gas bidding wars and complex arbitrage strategies, reshaping the trading landscape in the crypto industry.
In this episode I chat with David Fauchier of Nickel Digital Asset Management. At Nickel, David manages the Factors Fund, a multi-strategy, multi-manager fund for cryptocurrencies.
We leave the philosophical discussions about crypto aside to dive into the features of this universe that make it rife with opportunity. What struck me most about this conversation was not just how much crypto markets have evolved in the past several years, but how fragmented they still remain.
Different exchange rules, regulatory regimes, margining rules, derivative contract definitions, and even order book models represent both risk and opportunity. And in exploring these idea, David helps me better understand why traditional high-frequency funds like Citadel, Jump, or Jane Street don’t simply come in and eat everyone’s lunch.
In the latter part of the conversation, we pivot to David’s role as a manager-of-managers, and explore issues such as exchange and custody risk, due diligence, and the types of questions an allocator should be asking.
Finally, David leaves us with a teaser about the new opportunities emerging in the DeFi space. But we’ll have to save that for another conversation.
Please enjoy my conversation with David Fauchier.
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