Cryptocurrency market volatility has been viewed negatively by a number of people, many of whom consider crypto to be a bubble about to burst. However, volatility can actually result in greater profits for cryptocurrency traders. Crypto’s high volatility, strong correlations, multiple markets, and developing derivatives can serve as excellent instruments for quantitative trading.
Dr. Changhe Qiao has years of experience trading cryptocurrencies and views the high volatility of the crypto markets as an opportunity for the development of “decentralized hedge funds.”
“High volatility is an enemy to individual investors, but a friend to hedge funds,” Dr. Qiao told me.
Dr. Qiao is the co-founder of Alpha Protocol, a cryptocurrency startup based in Singapore headed by a team of quantitative researchers and mathematicians who are developing strategies to generate excess returns from the cryptocurrency markets. Alpha Protocol is a decentralized hedge fund that uses digital assets to generate returns. Profits are then shared with the Alpha Protocol community.
How a Decentralized Hedge Fund Works
Unlike traditional hedge funds that are typically managed by fund managers within one single enclosed entity, decentralized hedge funds offer an open platform allowing many more crypto investors and strategists to participate. Decentralized hedge funds also create a strong sense of community within their networks.
Alpha Protocol serves as an agreement between strategists and investors, connecting these two communities together. The network consists of crypto investors, who hold digital assets, and quantitative strategists, who apply math and other techniques to generate returns from these assets.
In order to participate in the Alpha Protocol network, users must hold ALP (Alpha Protocol Tokens). Investors on the Alpha Protocol network are called “ALP Holders”, and strategists are called “Alpha Producers”. Exchanges take place using the ALP tokens in a digital currency pool called the “Alpha Pool”. The ALP token facilitates the entire implementation of the Alpha Protocol network.
The overall mission of Alpha Protocol is to develop a decentralized community of crypto investors and quantitative strategists. Once this community is developed, Alpha Protocol will encourage strategists to contribute low-risk strategies and tools to the crypto markets for gaining excess returns.
This will provide crypto investors with a low-risk crypto fund, encouraging institutional investors and others to enter the crypto markets. The Alpha Protocol community will then coordinate with all participants to generate economic growth. This growth will later be returned to the community via the ALP token.
Benefits of Blockchain Technology
In a way, decentralized hedge funds are similar to traditional hedge funds, yet they come with the benefits of blockchain technology.
By utilizing blockchain technology, decentralized hedge funds are able to bring together a large number of people within a network to cast bets/votes based on their market research. Once a trading period is over, bets are evaluated based on the returns made. Participants are then rewarded.
Traditional hedge funds are different, as these platforms receive investment from investors and rely on a limited amount of strategists to generate excess returns. Traditional hedge funds also have drawbacks such as high fees, low liquidity of assets invested, and the fact that sometimes the interests of the hedge fund and those of investors are not aligned.
Decentralized hedge funds solve these problems using blockchain technology. For instance, the use of smart contracts creates digital trust and full transparency between strategists, crypto investors, and the fund itself.
Also, the volatile nature of crypto markets provides many fleeting shorting opportunities. The blockchain allows for instant, peer-to-peer exchanges between crypto investors and strategists to ensure that trades are quickly facilitated.
Additionally, blockchain technology enables hedge funds to remain decentralized. This means that the risks and benefits involved for both investors and strategists are equal. For example, black swan events are known to occur frequently in the crypto markets. The community envisioned by Alpha Protocol aims to diversify digital asset holdings for each individual. This allows individual investors to better withstand risk from market events and gain the highest possible level of stability.
Why The Crypto Community Needs Decentralized Hedge Funds
As the cryptocurrency markets continue to gain traction, a bridge is being formed between traditional financial models and the world of crypto. Just as hedge funds are used in the traditional financial world, crypto investors and traders require a platform to benefit from the volatile nature of the crypto markets.
Decentralized hedge funds provide a protocol for connecting crypto investors and traders to hedge funds that benefit the entire community. As blockchain technology continues to advance, traditional hedge funds may just start transforming into protocol-based commonwealths exhibiting decentralized models.