Larry Newhook, a veteran investor with more than 20 years of experience, is taking his second swing at the surging market for bitcoin and other cryptocurrencies. DigitalArray, his new asset management firm which launched in June, offers to handle wealthy individuals' crypto portfolios — a growing specialty.
Newhook abandoned his first attempt three years ago after his team ran into a problem: They couldn't find enough people with the investing chops to take on the unpredictable, volatile industry based on a still largely misunderstood blockchain technology.
There were crypto investors who had "great success just being long" on digital assets, but "knew very little about fundamental analysis, quantitative investing, risk management, etc.," Newhook, CEO of asset management firm Alpha Innovations, said.
"It was a bunch of amateurs," he told Protocol. "You had a lot of individuals who made a lot of money speculating in bitcoin, thinking they were now hedge fund managers. The reality is it's a different ballgame."
But the game is changing. The crypto market, though still notorious for wild swings underscored by the recent decline in bitcoin's value, is becoming increasingly attractive to investors and the wealth managers who cater to them, including Wall Street giants like JPMorgan and Goldman Sachs and longtime professionals like Newhook.
The total value of digital assets under professional management was roughly $40 billion this month, compared to $7.5 billion in October 2020, according to CoinShares.
Newhook cited a key reason for that growth: the melding of talent and expertise from traditional finance and the crypto world. "You're seeing a lot of analysts and portfolio managers from the hedge fund world moving into the crypto world," said Newhook, who is DigitalArray's president. "You're seeing some of that cross-pollination."
DigitalArray President Larry NewhookPhoto: DigitalArray
Technology entrepreneur Jesse Proudman said he has seen the trend pick up in the last 18 months. "Another week, another asset manager joins the fun," he said in a recent LinkedIn post, referring to a report that hedge fund firm Marshall Wace was looking to invest in digital assets.
Proudman's own crypto career began in 2018 when he co-founded the digital asset investment management company Strix Leviathan, which his team envisioned as a Bloomberg terminal for crypto investors. In June, his team launched a spinoff, Makara, the first crypto roboadvisor service registered with the SEC.
Makara's technology is based on algorithms built to "identify repeated patterns" in crypto investing that could be used to "provide a better risk-adjusted return" instead of just "passively buying and holding an asset," Proudman said.
He said a key to his venture's success has been the ability to attract talent from the finance world. "I am a technologist. I was not an asset manager," he said. "We started the firm with technologists, and we were able to bring in asset management help."
One of them is Makara's chief investment officer Nico Cordeiro, who has a deep understanding of the finance world, Proudman said.
"It's been a great pairing," he said, explaining how Cordeiro is able to use his finance expertise to "tell what we need from a technology perspective" to take on the challenges of crypto investing.
The new rules of crypto
Proudman said the crypto markets are "a beast unto themselves," with hurdles that are unheard of in traditional investing.
Newhook cited the issue of digital asset custody, which he said is still a major concern for institutional investors. "If I'm the CIO of a pension fund, I need to tell my board that there's 0% chance our money can get stolen," he said. That's not always possible in crypto, he said.
Proudman also cited that as a critical issue, although one that has "changed dramatically" with the emergence of some "legally qualified custodians." "That's been one of the things we've been most excited about," he said.
Regulation is another concern. Traditional investors are "used to being regulated," Enzo Villani told Protocol. A veteran investor, Villani recently ventured into blockchain and crypto investing through Alpha Sigma Capital, which he co-founded in January. DigitalArray is operating the Alpha Sigma fund, providing corporate governance and other services. "Folks like us from the traditional side who are in crypto now, we like a sandbox [where] you just learn to function in it," Villani said.
But that's not easy to do in crypto where key rules are still being defined and debated. For example, there is still a raging dispute on whether cryptocurrencies should be classified as currencies or securities.
That lack of clarity on the regulatory front has led to hefty legal fees, Proudman said. "If you start a hedge fund in the traditional equities world, you'd write a $40,000 check and away you go," he said. It's been different in the crypto market where Proudman said his team has already spent "into seven figures in legal expenses."
Then there's the extreme volatility in crypto markets.
Traditional markets historically go through jolts caused by major events, such as the events that led to the financial crisis in 2008 and 2009, but these are generally rare, Proudman said.
Makara co-founder and CEO Jesse ProudmanPhoto: Makara
"They happen all the time" in crypto, he said, noting with a laugh how crypto prices can be jolted by an Elon Musk tweet. "And they happen outside of traditional banking hours. It's the Wild West."
But the Wild West of crypto became such a massive market in just a short time that the mainstream investment community can no longer afford to ignore it. Bitcoin's market cap has soared from roughly $250 billion at the beginning of 2018 to about $625 billion this week.
"Regardless of what an investor's view of crypto is, it has become a highly liquid market, and has many inefficiencies to capitalize on," Newhook said. "There is the fear of missing out so that's why you're seeing some institutions dabbling."
Christine Parlour, a finance and accounting professor at the UC Berkeley Haas School of Business, said the collection of "pretty accurate, high-frequency pricing data" in the crypto market has made it easier for institutions "to figure out portfolios and trading strategies."
Rob Siegel, a Silicon Valley investor and management lecturer at the Stanford Graduate School of Business, also cited a "massive increase of investor speculation given a world of zero percent interest rates, more parties are familiar with the technology and the issues around blockchains, tokens in general."
Proudman said Makara's target client is "the working professional: the doctor, the lawyer, the banker" who is curious about crypto, "and that curiosity component is leading them to invest."
"Our objective is not to say these are safer markets or our approach makes it any less risky," he said. "Educating clients about the volatility that exists in these markets is a significant part of our job."
But that volatility and uncertain future of crypto itself means institutional investors will approach that market with extreme caution, Newhook said. "Some of these cryptos, including bitcoin, five, 10 years from now are either going to be multiples of where they are now, or it could be a goose egg," he said.
"That's why I think institutional investors are going to be tiptoeing into cryptos and it's going to be at the margin," he added. "Because if you're the CIO of a pension fund, your first job, frankly, is to keep your job."
Newhook himself embraces a prudent approach to crypto. He doesn't own any cryptocurrencies and said he has no immediate plans of investing in the space, even for long-term gain.
"It's also why I don't buy lottery tickets," he quipped. "Yeah, people have been very successful just buying and holding. That works, until it doesn't."
But "there's money to be made" for clients, he said. That's why I'm working with [portfolio managers] that know more than I do and can extract those returns."