How a Crypto Quant Firm Shook Off the Bear Market – and FTX Exposure

Crypto quantitative trading firm Pythagoras Investment Management LLC made it through the turmoil of 2022 in a rare position. The firm’s funds were up 8% for the year even with exposure to the implosion of crypto exchange FTX. However, the market turbulence halved the company's assets under management to less than $40 million as wary investors stepped to the sidelines.

In a chat with CoinDesk, Pythagoras founder and CEO Mitchell Dong discussed the firm’s market-topping strategies, how risk mitigation has changed post-FTX, and why there’s still hope for the future of crypto.

The market neutral Pythagoras Arbitrage Fund was up a slight 0.1% in December but ended the year with a net gain of 8.8%, according to an investor letter shared with CoinDesk.

“We just look for spreads,” said Dong, who has more than 25 years experience operating hedge funds. “We look for opportunities to buy low and sell high simultaneously whenever the software detects an opportunity to do so.”

The trend-following Momentum Fund declined 0.4% in December but still ended the year with a net gain of 8.1% The fund takes both long and short positions based on what technical indicators show.

The principal threat to Pythagoras’ Arbitrage Fund is counterparty risk. In order to make instant trades, the firm has to keep money on exchanges. Pythagoras diversifies its assets across at least a dozen exchanges with no more than 10% of its funds with any one brokerage, Dong said. Prior to the FTX collapse, Pythagoras did have 10% of its assets with that exchange.

Dong and team immediately requested a full withdrawal from FTX, but only 7% was recovered before the exchange suspended withdrawals. The remaining 3% loss was hedged or offset, first by shorting FTT tokens – the native token of the FTX exchange – and then by taking advantage of a temporary discount in bitcoin and ether futures on the Chicago Mercantile Exchange (CME) that were 3% to 5%, respectively, lower than comparable prices on Binance.

Pythagoras has since tightened up its exposure to exchanges, now favoring those found to have the best technology and credit rating and lowest counterparty risks.

Dong has spoken to the firm’s largest investors who requested redemptions and who had wanted to step aside until the dust settles. These investors have a long history with Pythagoras and indicated plans to return to the crypto fold in the future.

“The bad news is that we had redemptions,” said Dong. “The good news is that there’s less competition, more price dislocations and trading opportunities. Previous trades which had been [arbitraged] out are back again.”

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