Jeff Dorman, a partner at crypto asset management firm Arca Funds, spent 18 years on Wall Street and in fintech before turning his focus to developing crypto asset strategies and products.
This article originally appeared in ‘Institutional Crypto,’ a weekly CoinDesk newsletter focused on the institutional investors interested in crypto assets. The opinions expressed in this article are the author’s.
After 365 days of running a crypto fund, one thing is certain: it’s exhausting. And yet, at the same time, I’m more energized than ever.
Arca just completed its first full year managing LP capital in its flagship Digital Assets Fund. As chief investment officer, I experienced first-hand the trials and tribulations of building, launching and managing capital in the newest, most misunderstood and potentially most lucrative asset class available to institutional investors today.
Let’s take stock of the last year, reflect and see where we go from here.
Building a team and a strategy
Starting a crypto fund is a lot like trying to build Uber while the car is being invented.
We’re working with an incomplete deck and everything is brand new, from the service providers and the systems/tools, to even the valuation techniques. This past year was just as much about business development as it was investment process. Running a crypto fund is an all-encompassing 24/7 job, and there are no shortcuts when trying to build long-lasting client trust.
In the traditional world, you wouldn’t even try to start a fund with less than $150 million in assets. At a 1.5 percent management fee, that’s $2.25 million/year to spend on salaries and infrastructure needed to employ top talent and ensure operationally sound practices. So how do you build the same caliber team when the median assets under management (AUM) for crypto funds is under $5 million?
For starters, there is no waste. Everyone wears multiple hats. The qualities we look for include flexibility as much as niche specialization. Perhaps, more importantly, passion is a must, as employee motivation has to come from more than just expected compensation.
The investing strategy is just as important as the team, because employees and investors understand that our investment process and capabilities will remain consistent and be scalable. Even in a constantly changing industry, the processes and procedures in place have to be enforced consistently to ensure repeatability as the sector and our fund grow. To do this correctly, we need help from the service providers.
Perhaps the most startling and time-consuming aspect is managing the sheer volume of service providers, which dwarfs the number of funds in crypto.
In traditional asset management, incumbents reign supreme, and you’d only evaluate new service providers 3x per year. In crypto, we’re evaluating new service providers 3x per week. As there is no regulation, no incumbents that dominate and an unlimited amount of VC funding, the barriers to entry as a service provider are near zero. On one hand, this is refreshing because we get to start from scratch without relying on inefficient legacy tools; but, on the other hand, many of the service providers don’t have much experience servicing asset management clients.
In 2011, after 10 years working on the sell-side at traditional investment banks, I moved to the buy-side for the first time. It was immediately clear how little I understood about how my old clients performed their jobs until I was in their shoes. I used to joke that everyone on the sell-side should be forced to have a three-month internship on the buy-side, and vice versa, to understand how the other side operates.
This advice applies equally to crypto. Many of the service providers are building tools they think funds and investors should need, instead of working with their clients to try to understand what our needs are. For example, there are at least 50 new exchanges that want me to trade bitcoin with them, but very few have been able to articulate in three sentences why I should.
That said, it’s impossible to dismiss any firm until doing proper due diligence, because getting these solutions right is essential towards building long-lasting institutional investor trust. And we have slowly moved forward with some of the best new startups in crypto. My job as CIO is to help these firms build the best solution, but also to wait until they solve a need for my fund and my investors before moving forward.
Managing 24/7 risk
Once we’ve established the team and systems, we have to actually make money on our investments.
As everyone in this industry knows, the crypto markets never sleep. Even while writing this, I’ve taken six breaks to check our risk and the price movements of our investments. However, contrary to popular belief, this space doesn’t require "round the clock" trading. It requires disciplined risk management procedures, constant communication between team members with trading authority, and the willingness to step away from the screens to allow you to think clearly enough to see the forest for the trees.
While 24/7 trading is a feature and not a bug of crypto investing, there are some benefits to the legacy financial system’s trading hours. Even the worst weeks come to an end, allowing the market to collectively reset. In crypto, there is no reset (unless forced upon participants manually), so momentum has no natural off switch.
Managing volatility is hard enough during work hours. Doing it from home while cooking dinner for two starving toddlers is nearly impossible. As such, process and planning trumps even the best traders and algorithms. While we always have someone available to trade if needed, it has benefited us tremendously not forcing investments just because the market is open.
Of course, having a strong team and a scalable strategy doesn’t mean investors will throw money at you.
As new as this industry is for all of the asset managers, it’s even more foreign for investors looking to allocate to this space. Traditional hedge funds often pretend it’s still 1982, when it was important to be secretive so the other nine hedge funds didn’t steal their best ideas. Yet in today’s world of constant communication and interconnectivity, not to mention high competition amongst funds, transparency is the key to earning investor trust.
We spend an enormous amount of time educating our investors and our prospects. This is necessary for this asset class, especially when your investor base is sophisticated and has a different level of risk tolerance than the current set of crypto investors.
While potentially a longer process than more established areas of finance, you have a chance to forge lasting relationships built on education and not a transactional commoditized sale.
Comparing crypto to traditional funds
While many crypto investors come from tech backgrounds and are now trying to learn how to manage outside capital for the first time, we take the opposite approach.
We believe understanding how to manage risk is the critical skill, and everything else can be learned. Would you look to your mechanic to manage your automobile stocks? Does your doctor manage your healthcare stocks? In the same vein, your developer shouldn’t manage your crypto assets. In my 20-year finance career, it took me two months to learn how to analyze companies, two years to learn how to trade, and two decades (and counting) to learn how to manage risk. There is no short-cut.
Our backgrounds in traditional finance come in handy every day, from modeling to risk management to marketing. While I wish I had learned to program at age 12 because it would have made my adult life easier; at the same time, I don’t believe it would make me a better crypto fund manager. There is a reason “two guys and a Bloomberg” hasn’t been a very successful hedge fund strategy in the traditional world, as it has become impossible for one or two people to do everything well. The roles of CIO, PM, Research Analyst, Trader and back-office are very different and require specialized skill sets to do the job properly.
Having a balanced approach and different viewpoints across the portfolio team allows us to think more objectively about the real risks and opportunities in this asset class.
The reality is, crypto is both a technology and a financial product, and having collective knowledge in both creates a winning formula. Once those roles and differentiations are established, managing a crypto fund is no different than managing an equity, fixed income or managed futures fund. Portfolio managers manage risk, analysts analyze, traders trade, and the CIO pulls it all together.
I started this by saying I’m both exhausted and energized. While these may seem mutually exclusive, in crypto it makes sense. The speed, growth and promise of this industry light a fire under me and my team every minute of every day.
There is so much to learn, read and talk about, but that also means there is little time to do anything else. The risk of burning out is real.
Recently, we instituted mandatory days off and often turn the screens off in the middle of the day for short periods of time just so we can think without price factoring into the thought process. We’ve begun to realize that any small short-term moves in price that we don’t capture in real-time are often offset by our ability to think clearly enough to capture the larger, more sustainable ones.
I’ve spent my entire career investing or building businesses. Now I get to do both at the same time. The most rewarding part of being CIO is knowing that we’re at the dawn of the next big global technological advancement. We have a global platform where we can recruit new people to this industry, and shepherd others into this asset class as investors. We write and speak constantly, which is as much a part of our internal investment process as it is our external education process.
As this space evolves further, my job will inevitably morph as well. And that excites me, enough to fight through the exhaustion.
The leader in news and information on cryptocurrency, digital assets and the future of money, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.