Cryptocurrency hedge fund BKCoin Capital’s evolving arbitrage strategy soars amid bitcoin surge

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Since launching in late 2018, BKCoin Capital, a New York-based digital asset-focused hedge fund firm, has built an impressive track record with its market neutral, arbitrage-based approach to cryptocurrency trading.

Established by founding principals Carlos Betancourt and Kevin Kang, the BKCoin Digital Asset Fund aims to capitalise on price inefficiency and volatility within cryptocurrencies using an algorithm-based trading model that fuses elements of statistical arbitrage and multi-strategy long/short investing.

Reflecting on the firm’s origins, Betancourt and Kang recall how investors were initially cautious on what they saw as the speculative, volatile nature of cryptocurrencies. BKCoin Capital sought to develop a strategy tailored towards institutional clients, even though few such allocators were looking at cryptocurrencies seriously at that point.

Opportunity

“Around four years ago, when we first started conceptualising what we wanted to do, most firms at that time that were popping up in the US were led by two people in San Francisco that had an algorithm. Kevin and I saw a huge opportunity,” Betancourt tells Hedgeweek.

“For us, the key was building a strategy that would minimise the volatility of bitcoin so that traditional allocators would pay attention to it. So we came up with a market neutral strategy.”

Previously a founder and managing director of commodities brokerage and consulting firm Yorkville Commodities, Betancourt began his career as a research analyst, later working at KCM Asset Management as an equity analyst and at AMCI Group as a commodities manager.

“Things shifted drastically last year,” he says of crypto’s stratospheric surge. “We started the year managing roughly USD10 million and ended the year managing close to USD35 million. We’re now managing about USD50 million today, and our aim is to get to USD100 by the end of 2021. That growth, and the amount of appetite from traditional investors towards us, has been tremendous.”

Initially, the firm’s focus was on inter-exchange arbitrage and triangular currency pair arbitrage trades.

Kang – who was an assistant portfolio manager at Alliance Bernstein focused on US equities, and later a portfolio manager and trader at an NY-based fund managing more than USD4 billion in US equities and fixed income prior to BKCoin – describes how digital currencies’ mispricing and inefficiency proved pivotal in the firm’s early investment approach.

“Until two years ago, inter-exchange arbitrage and currency pair arbitrage was huge. Buying on one exchange and selling on the other for more than 50 per cent arbitrage – that kind of alpha is something you can’t find in any other asset class,” he says.

“That’s what drew us, from a trading perspective, to this asset class – seizing on those arbitrage opportunities, with minimum risk, knowing that arb will be gone once more people enter into this space.”

Parameters

As more investors have entered the crypto space, and the market has matured, such arbitrage trades have become less interesting over time, Kang explains.  With the strategy continuously evolving in line with the opportunity set – the BKCoin vehicle now consists of four trading algorithms – it has gradually switched its focus from exchange arb to mispricings in the futures market.

“In futures spot basis trades, we’re going long spot and short futures, so we’re capturing that premium in the futures market,” Kang says. “A lot of players are doing cash carry trades and waiting until the expiry. So their returns are locked in at, say, 3 or 4 per cent, until the quarter’s future expiry, whereas we are constantly going in and out of positions.”

He continues: “There are different parameters we look at, which are built into our algos. As the futures and spot basis contracts and expands throughout the day, or throughout the week, we’re constantly going in and out of positions. So rather than locking in that 3 per cent return in a three-month frame, we’re trying to eke out gains on a daily basis – trying to build that out to a 7 per cent or 10 per cent return in a month.”

In terms of performance, this progression has paid off: the strategy made an eye-catching 71.5 per cent annual return last year, and since its inception it has generated a 127.4 per cent return, having suffered just one down month.

While the fund’s main strategy is dollar-denominated, the firm also offers a bitcoin-denominated shelf for certain investors who want to hedge their dollar exposures and accumulate more bitcoin.

“On this side we run a momentum, trend-following and mean reversion strategy on different exchanges,” explains Kang. “We’re getting more traction and more interest on that strategy. Let’s say a client invests BTC100 with us – here we aim to grow that 20 to 30 per cent within a one-year timeframe.”

Elsewhere, the strategy has generated profits in futures basis trades across bitcoin, ether and litecoin.

“We’re not taking any directional bets – we’re looking at the arbitrage opportunities, and building our positions,” he notes. “Our average holding period is only three days, so we’re just constantly going in and out of positions to try to maximise our returns.”

Pivot

Just as opportunities in the firm’s original inter-exchange arb focus have receded as the market has expanded, both Bentancourt and Kang expect a similar decline in its current algorithms, and are developing their strategy accordingly.

“We have a long-term view on this space, with minimum volatility. We’re thinking two to three years ahead, and how our algorithms can stay consistent as the market grows,” Betancourt notes.

“We started with just two algorithms at the beginning and we quickly had to pivot. I think it’s a testament to us that from inception, we had the ability to move quickly and be nimble enough as a company to continue enhancing our algorithms, and build new ones and be able to still generate a return profile that’s still very attractive to our clients.”

Later this year, the firm is also preparing to launch a new strategy focused on DeFi, a rapidly-growing corner of the digital asset sphere.

DeFi – or decentralised finance – describes the financial universe built around smart contracts on blockchains such as Ethereum, rather than the traditional centralised intermediaries such brokerages, banks and exchanges. BKCoin Capital’s DeFi strategy will take a deep-dive, bottom-up, fundamental approach using research expertise focused on revenues generated on platforms.

“If you look at the landscape right now in DeFi, there are maybe no more than 10 crypto hedge funds that are participating in it, and most of what they're doing is very passive,” says Betancourt.

“We always want to have an actively managed approach, to differentiate ourselves from our competitors. So aside from doing all the fundamental research, we also want to have a hedging component, where we’re thoroughly hedged as we go in and out of trades.”

As more institutions are getting comfortable allocating capital into solely bitcoin or ether, they are also starting to look at active strategies, which is where Kang sees opportunities for further growth.

“They’re asking how they can go from just holding bitcoin, and storing it safely, to generating alpha from holding it; how they can turn their BTC1 into BTC1.2 or BTC2,” he adds.

“That’s where active managers will come in and educate these traditional allocators. You’ll see growth not only in ETF and passive strategies, but also active strategies like what we’re doing.”

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Hugh Leask
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