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Crypto Hedge Funds and Indices

Investors you are invested in investing in cryptocurrencies through vehicles such as hedge funds should be aware that there is no dominant or established valuation model for cryptocurrencies. But there are three valuation models which have gained popularity in the recent years:

1. Network to Transaction Ratio (NVT Ratio)

This is was derived from Metcalfe’s law, which values telecommunication networks by taking the square of the number of users on the network. It is calculated by dividing the market cap of a cryptocurrency by its daily transaction volume. Historically, the relationship between the NVT ratio and bitcoin prices have displayed little correlation.(1) This is could be due to the challenges in obtaining the relevant data i.e. transaction volume. Even in calculating the market cap of bitcoin, it is hard to accurately determine the number of bitcoin in circulation as many bitcoin have been lost due to owners misplacing their private keys. Such bitcoin should arguably be left out in the calculation.

2. Bitcoin as Gold 2.0

This is one of the most popular narratives, one which has been popularized by the Winklevoss twins (2) and Mike Novogratz(3), the former macro hedge fund manager of Fortress Investment Group. This model assumes that bitcoin will eventually capture a percentage of the gold market or the global money supply. Ari Paul, the former portfolio manager at the Chicago endowment fund, has also highlighted bitcoin’s utility as an alternative to offshore accounts for corporations, given its censorship resistant attributes.(4)

3. Cost of Mining Multiple

This model values cryptocurrencies by dividing spot price of a cryptocurrency by the cost of mining one unit of the cryptocurrency. This is best used with an average bitcoin price over a period of time as mining difficulty adjusts every two weeks. In other words, even if bitcoin prices fall and miners scale down on their mining operations, the amount of computation power required to mine bitcoin will remain the same throughout the two-week period. Tom Lee, the former Chief Equity Strategist of J.P. Morgan, asserts that the cost of mining creates a lower-bound support for the price of bitcoin.(5)

However, none of these valuation models have worked particularly well in the past. A joint report on crypto hedge funds conducted by PwC and Elwood Asset Management found that fundamental and discretionary crypto funds have performed poorly in 2018, with median returns reportedly being -53% and -63% respectively.(6) The report also found that, in contrast to fundamental and discretionary cryptocurrency funds, quant funds have performed well, returning 8%, which is impressive considering that Bitcoin dropped -72% in value through the year. Some quant funds base their strategies on technical analysis, which was found to be relevant in the crypto market due to the high level of speculation in a study by J.P. Morgan.(7) Quant funds also use live data from social platforms such as Twitter and Github, tracking activities online and making trades off the data in the crypto market which never closes.

The performance across the different types of crypto hedge funds implies that investments in crypto is best managed actively to some degree. In fact, a study by Bitwise Asset Management concluded based on historical back testing that tolerance-based rebalancing resulted in a strong risk-adjusted return.(8) They also compared risk and return measures in a traditional 60/40 portfolio (60% equities, 40% bonds) to the same portfolio with bitcoin allocation ranging from 1% to 10%.

Accredited investors based in the U.S. can invest in cryptocurrency indices through asset managers like Crescent Crypto Asset Management and Bitwise Asset Management, which offers a range of funds varying in diversification within the crypto market on their website.



Joseph Lee

Research Analyst

Table of Contents

  • Network to Transaction Ratio (NVT Ratio)

  • Bitcoin as Gold 2.0

  • Cost of Mining Multiple


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