Effective risk management of cryptocurrency

Risk management

Effective risk management of cryptocurrency

Effective risk management of cryptocurrency 800 426 cryptonews@arxnovum.com

The management of risk is important in the administration of any investment strategy on any asset class, but never more so than on a highly volatile asset like cryptocurrency. But how does a manager ensure effective risk management oversight when implementing an index strategy?  

Today we will address the various screens built into the index construction that helps minimize the loss of capital, including :

  • starting universe exclusions, 
  • legal and regulatory exclusions,
  • minimum listing and safekeeping requirements and 
  • liquidity parameters.

Starting universe exclusions:

The index starts with a focus on cryptocurrencies but excludes any digital assets that are linked to another asset including fiat currency (stablecoins), physical commodity or digital asset. This simple exclusion eliminated the exposure to the recent collapse of Terra/Luna. Thus allowing the index to remain focused solely on the economic drivers behind investing in cryptocurrency by eliminating the financial engineering that underpins stablecoins. 

Legal and regulatory exclusions:

The index then removes any cryptocurrency whose status is ambiguous or has been questioned by regulatory authorities from a developed market. While this risk mitigation seems fairly straightforward, it’s also important to note that the index also has the flexibility to, in exceptional circumstances, remove a constituent if there are any regulatory or legal actions that questions the legitimacy of the digital asset. 

Minimum listing and safekeeping requirements:

In order to create a benchmark that accurately reflects the market, an index must include securities that investors can reliably access, trade and store. In order to achieve this goal the benchmark employs two selection criteria:

  • an asset safekeeping test that states that a cryptocurrency must be eligible for custody at 2 or more regulated custodians, and 
  • a trading venue test that states that a cryptocurrency must be eligible for trading against the currency of the index on 2 or more recognized constituent exchanges. 

Liquidity parameters:

Finally in order to ensure that the benchmark is investible, an index should screen for eligible constituents that meet minimum liquidity or asset turnover requirements. The liquidity screen requires the constituents to have a liquidity ratio of greater than 0.5% relative to the remaining constituents in the index. The turnover screen requires that greater than 2% of the outstanding float is trading throughout the year. 

Each of the steps described here are designed to 1) minimize loss through the exclusion of asset linked cryptocurrencies and cryptocurrencies whose status is legally ambiguous or questions by regulators, or, 2) increase tradability by insuring minimum listing and safekeeping requirements or meeting liquidity and asset turnover requirements.

Tomorrow, we will close this week’s series of blog posts by tying together all the topics in a succinct recap of reasons to consider adding the Arxnovum Multi Crypto Index Fund to your portfolio.

The products and services offered by Arxnovum are available to qualified investors in certain provinces and territories of Canada. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
All investments contain risk and may lose value. Investing in the cryptocurrency market is subject to risks.  Cryptocurrency, often referred to as “virtual currency” or “digital currency”, operates as a decentralized, peer-to-peer financial exchange and value storage that is used like money. Cryptocurrency operates without the oversight of a central authority or the banks and is not backed by any government. Even indirectly, cryptocurrencies such as bitcoin may experience high volatility, and related investment vehicles may be affected by such volatility. Cryptocurrency is not legal tender. Federal, state, provincial, territorial or foreign governments may restrict the use and exchange of cryptocurrency, and regulation in North America is still developing. Cryptocurrency trading platforms may stop operating or permanently shut down due to fraud, technical glitches, hackers or malware, which could have an adverse impact on the net asset value per unit of the Fund. Please consult the Funds Term Sheet for a complete list of risks.
Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “intend,” “plan,” “believe,” or “estimate,” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what Arxnovum Investments Inc. and the portfolio manager believe to be reasonable assumptions, neither Arxnovum Investments Inc. nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.