An ex-Goldman Sachs and JPMorgan exec breaks down why his market-neutral arbitrage fund

• Anatoly Crachilov is the founding partner and CEO of Nickel Digital Asset Management.
• The exec says that the markets will remain under pressure until “the reversal of Fed hawkishness.”
• Nickel’s Digital Asset Arbitrage Fund is down about 0.4% this year, while bitcoin is down 39%.

Amid

volatility

in crypto and other markets, there have been major laggards in hedge funds, VCs, and investment firms.

Chase Coleman’s Tiger Global Management is down over 44% this year, sources familiar with the matter told Bloomberg. Last month, SoftBank Group’s investment arm reported a $26.2 billion loss from bets on high-growth tech stocks. 

Markets haven’t been able to shrug off investor woes over the Fed’s hawkish monetary policies, Omicron subvariants, and the collapse of algorithmic stablecoin TerraUSD. These have left both capital allocators and retail to identify systemic risks, leaving investors to retreat from risky bets in both crypto and traditional markets. 

Crypto’s

market cap

is down to $1.24 trillion, according to crypto data dashboard Messari, dropping 60% from all-time highs in November. Meanwhile, the S&P 500 and the Nasdaq Composite have declined 16.88% and 27.14% in the past six months, respectively.

“We do not think the market has fully bottomed yet, and I would expect the crypto market to remain under pressure until the reversal of Fed hawkishness,” Anatoly Crachilov, founding partner and CEO of UK fund manager Nickel Digital Asset Management, told Insider.

Crachilov’s Nickel, however, has been faring the bearish storm better than others. The $300 million hedge fund has had little losses for its market-neutral arbitrage fund, which trades around 12 different cryptocurrencies. 

Amid the bearish cycle, its flagship fund is down about 0.4% this year, Crachilov said. This is compared to bitcoin’s price drop of about 39% this year. Since its inception, the three-year-old arbitrage fund has reported returns of 31.3% net of all fees. 

How to trade in a bear market

Market volatility is a friend to Nickel’s arbitrage fund, Crachilov said. 

Nickel has been able to achieve returns with its arbitrage fund, per Crachilov, because it doesn’t take “directional views on the market,” meaning it is market neutral. Instead, it’s focused on market dislocation between spot and derivatives positions. Nickel manages risks by being “fully hedged.” This means any derivatives position is hedged with an offsetting position to remove the market exposure, according to Crachilov. 

“In periods of low market volatility this method builds large positions, which can then be severely impacted when volatility spikes,” Crachilov said. “For trades that are hedged but are path-dependent, such as futures basis trades, we control the risk by ensuring that the position sizes are proportional to the opportunity.” 

In layman’s terms, whether a token’s price increases 40% or declines 17%, the firm is trying to capture arbitrage opportunities from its dislocations and trades, irrespective of directionality. 

Besides its arbitrage fund, Nickel has three other funds including its Diversified Alpha Fund, DeFi Liquid Venture Fund, and Digital Gold Institutional Fund. These have varying exposure to blockchains like Bitcoin, Solana, Ethereum, and Algorand, along with decentralized finance protocols.

“We are seeking to actively protect capital against losses from any hyped protocols with flawed designs like Luna,” he said of the firm’s DeFi Liquid Venture Fund. “Essentially, we are searching for future Amazons and Googles of DeFi, while avoiding Pets.com and other economically unsustainable concepts.” 

The DeFi Liquid Venture Fund, however, is down over 50% since the start of the year.

While there are not many market-neutral arbitrage funds focused on crypto, he said, the typical equities arbitrage fund posts roughly 8% – 10% in annualized returns. Last year, Nickel’s arbitrage fund posted 15%.

Other crypto investment firms may, however, be facing headwinds following the collapse of LunaUST. Nickel previously invested in Luna, but exited its position prior to its crash, sparing LPs from its “death spiral.”

Arca, a crypto hedge fund started by Wisdom Tree cofounder Ryan Steinberg, was not as lucky. The firm tried to play the stable coin’s de-pegging to its advantage and doubled down on its investments. Arca hasn’t disclosed how much was lost on its bet, but the firm said in a note to investors that Luna was a “core holding” in its Digital Assets Fund.

When asked about a potential crypto winter and the market’s selloff in recent months, the former Goldman Sachs exec said that are no clear indicator that the market would recover soon. 

“In our view, investors may wish to consider a strategic allocation of the initial 25% of their overall crypto budget now with the view of allocation the rest over the next 9 months,” Crachilov said. “This would allow the investors to capture the lows of the market, while already having certain exposure whenever the market trend reverts. “