Exchanges, Strategy, and Whose Data to Trust: An Interview with Crypto Hedge Fund ProChain Capital
Crypto market data has taken center stage, after increasing evidence of false trade volume being reported by many exchanges. Within days of each other, independent analyses by Bitwise Asset Management and crypto data platform The TIE were published concluding there were serious problems with the trade volume reported by exchanges and made prominent on sites like CoinMarketCap.
For most investors, good data is the foundation of any investing strategy. Without it, it becomes difficult to accurately evaluate pricing, markets, and opportunities. We spoke with Justin Litchfield, Chief Technology Officer and Portfolio Manager at ProChain Capital, about their firm’s approach to crypto investing, challenges they see in the market, and spotting bad data.
Litchfield has been in the crypto space on the technical side for the better part of half-a-decade. While he’s done some speculating on the silver market, he very much considers himself a crypto native. With his partners David Tawil, Steven Azarbad, and Nehemia Kramer, he co-founded ProChain Capital, a New York-based crypto asset hedge fund. ProChain is approaching the traditional financial markets from a crypto perspective:
“As it becomes more apparent that these big players are going to adopt crypto, we need to learn to speak their language. They have all the money. Some crypto enthusiasts think that money will flee to better solutions, but we recognize that the efficiency benefits from crypto will happen at those existing institutions,” said Litchfield.
ProChain tends to target higher-quality assets with lower risk because these investments are closer to being accepted by the mainstream. The hedge fund takes a two-pronged approach by investing in underlying crypto assets as well as public companies that are doing interesting things. For instance, Square and Facebook are stocks the fund could take positions on based on the companies’ adoption and promotion of the blockchain technology, Litchfield explained. As for direct exposure to crypto:
“Otherwise, we have assets that we have long-term opinions on, assets like bitcoin (BTC), Ethereum (ETH), and Stellar (XLM). We think they have a good shot at adoption. We track those [coins] and balance them in our portfolio based on the development toward their long-term eventual use in the world. Peer-to-peer trading involving holding for a day or two is less important.”
ProChain’s AUM is in the millions of dollars. The firm, which is seeing institutional capital coming off the sidelines, counts big investors including hedge funds, family offices, and foundations as clients. “They’re all talking and thinking about it. We’re working our way up as they become more comfortable,” said Litchfield.
The thing making big investors uncomfortable at the moment is mostly reputational risk, though similar to the crypto winter those fears are beginning to thaw. “It’s a lot less strong of an objection than it was. They’re ready to see some stability and they will come on board,” he said.
Market transparency will play a big part in that, and this is where Litchfield is ProChain’s own secret weapon. “When you can spot algorithms that are doing weird things, if you’re tech [savvy] and used to looking at it, you can spot suspicious behavior. My inclination is let’s take money out of it. If I can predict what this algorithm is going to do, if I think it’s wash trading to create volatility-driven interest, I can go in and design a system off that,” he said, adding that he’s also seen exchanges where orders were absolutely 100 percent fake, explaining:
“I’d put in a bid and trades would cross on the other side, or I could predict an offer would be made, try to take that offer, and then it would mysteriously cancel itself in response to my order. If I did not take that offer, I knew that it would be taken by some other buyer 3.4 seconds later. So it was not just printing inflated volume numbers. They were literally running fraudulent trading systems with their insight into customer orders, which is definitely illegal. That’s when you realize the risk on the shadier exchanges is even worse than you can imagine. Not just flight risk, which is definitely real, but also ripping you off while you’re trading. Bad exchanges are so bad.”
With investing, he suggests the best offense is often a good defense. “Once we have enough good data on systems, the more and more fraudulent data that pops up, the more you don’t have to pay attention to it. If you ignore most of the places that are all suspect, you can get enough information about price discovery and how it’s being worked out to be able to make good predictions,” he said.
On the side of platforms doing it right, Litchfield pointed to GDAX and Gemini as examples of great exchanges. “You’ve really got to think of the investment that the more stable players have put into what they’re building. Reputation is going to be everything.”