Digital Assets on the Buy Side
With Thejas Nalval, Co-Founder and Chief Investment Officer, Parataxis Capital
Briefly describe Parataxis Capital, including its trading operations and capabilities. Who are your end-user investors?
Parataxis Capital is a US-based hedge fund focused entirely on the digital asset space. We currently manage three funds, with our flagship multi-strategy fund having an absolute return mandate. Across our funds, we actively trade liquid digital assets in the public markets, and also make private investments in early-stage digital asset protocols. We are also a Service-Disabled Veteran Owned Small Business, with headquarters in New Jersey.
Our investors are largely high net worth individuals, family offices and, increasingly, institutions. Most of our LPs have a small passive allocation to the space but are generally looking to increase their exposure to the sector and are most comfortable doing so in a risk-managed way with an institutional-grade team.
Discuss your own career trajectory — from traditional capital markets roles into digital assets?
I am a trader by background and spent my early years on the equity trading floor at Goldman Sachs. I was most recently on the program trading desk on a team that facilitated index rebalances for the largest index fund managers in the world. Notwithstanding the training I received on the trading floor, GS was the perfect place to launch my career coming out of college. In my time there, I managed to develop an incredible network of peers and mentors, many of whom I remain close with today.
Ironically enough, it was during my years at GS that I was introduced to the world of digital assets. In 2012, some of my colleagues were mining and trading bitcoin. It was during that time that I bought bitcoin and began going down the crypto rabbit hole personally before deciding to jump into the space full time. For me, the attraction was the ability to create something of value in what felt like a brand new and emerging asset class. In 2017, I joined an LA-based startup that was looking to create the first US-based digital asset merchant bank. I helped build and launch a hedge fund with that team and managed a fundamentally driven long-short strategy for the fund. I took that strategy to another crypto hedge fund in 2019 before leaving to launch Parataxis Capital with my partner, Ed Chin (another former Wall Streeter turned crypto professional) in 2020. I currently serve as a Co-Founder and Chief Investment Officer for Parataxis Capital.
Buy-side firms typically own securities such as stocks and bonds, for which there are tangible underlying assets. How does a buy-side firm such as Parataxis Capital manage digital assets?
This may come as a shock to those that are not crypto native, but we as a fund interact mainly with the actual digital assets themselves. There is an entire ecosystem that looks like Wall Street that is being built to service funds like ours. There are exchanges, brokers, lenders, custodians, etc. So we’re able to deploy sophisticated, traditional investment strategies to this nascent and growing asset class.
Our portfolio construction process begins with a thoughtful assessment of the market risk and what that could mean for digital asset prices over the next quarter. We analyze fundamental indicators, supply & demand dynamics, behavior of other market participants, liquidity on exchanges, product developments, market microstructure, regulatory climate and include an overlay of the larger macro environment surrounding traditional risk assets. Based on continual discussion, challenging of assumptions and debate among the investment team, we determine levels of risk that we are comfortable having on in the portfolio and set aside cash for any opportunistic investments. We do not use leverage and rebalance the fund as new data and opportunities are presented.
At the center of our process is risk management. We believe risk management within a digital asset fund is paramount to the protection of capital and generation of positive returns over multiple market cycles and across different market environments. Our risk management process leads us to identify and manage risks that fall into one of the following categories: (i) portfolio risk, (ii) operational risk, (iii) counterparty risk, (iv) regulatory risk and (v) force majeure risk. We manage risk the same way a fund manager would operating across traditional assets, albeit adjusted for the risk profile of crypto.
What makes your fund unique?
First and foremost, we are not idealogues. We recognize that this market is capable of producing both parabolic returns but also the potential for significant drawdowns. Therefore we maintain a constant focus on risk management, which helps us navigate volatile periods like the one we just experienced. After risk management, we spend significant time on portfolio construction. The goal is to provide our investors risk-managed exposure to the most attractive opportunities at any given time. Finally, I believe we have some of the smartest folks in the industry on our team. Each one of us brings a unique breadth and depth of knowledge from both traditional and digital asset markets, allowing us to routinely identify new investment opportunities and consistently stay in front of a marketplace that is constantly evolving.
Will the SEC approve a bitcoin ETF? How important is it for the development of digital asset markets?
We believe that the SEC will eventually approve a bitcoin ETF, but it is likely to be at some point next year. An ETF won’t have a direct impact on the bitcoin blockchain (or other digital assets for that matter), but having one solves a major problem for many investors looking to gain exposure to the asset class. We believe that an important marginal buyer over the next few years will be sophisticated retail investors and RIAs that aim to add digital assets to their current portfolios. All of which is custodied at a traditional broker dealer or other retail platform. Providing access to a bitcoin ETF, once approved, is an easy task for these brokers and platforms, especially if they can generate a fee or charge a commission for that access. So as much as crypto native folks will preach that true ownership requires one to own the private keys, the truth is that the ETF model has 30 years of infrastructure and distribution already built around it. The level of new marginal capital that will be driven into the space from this channel will likely be an order of magnitude larger than what we’ve seen over the past few years. That is incredibly bullish for the growth of this industry.
The recent spikes in bitcoin price volatility — what are your thoughts, and what (if anything) does it mean for Parataxis Capital and its business model?
We believe that the digital asset space will grow to become an asset class worth several trillion dollars over the next decade. However, we also understand that the market is still nascent and capable of periods of outsized volatility, as we witnessed over the past quarter. Our firm view has always been that investment managers should attempt to capture most of the upside, while managing risk and protecting against potential losses. Our active funds performed quite over the past quarter and managed to outperform not only the market, but also many of our peers. We’re exceptionally proud of those results because they validate our business model and open up this asset class to those institutional investors looking to deploy meaningful capital but are often hesitant from doing so because of the volatility in the sector.
What is the future of digital assets, from the perspective of the institutional asset management business? In 10 years will most or all institutional managers have digital asset offerings?
One thing we’ve observed with our space is that it tends to evolve at a much faster rate versus traditional asset classes. We’ve found that the digital asset market reinvents itself every six months or so. Therefore a single strategy or product offering that made sense in the past may not work, or may be obsolete in the future. The only way to stay on top of this evolving super-cycle of growth is to consistently maintain depth of understanding of where the opportunities for investment returns reside and to maintain the tactical freedom to pivot to strategies that produce the highest risk-adjusted returns. In other words, the key to generating alpha over time is to identify and skate to where the puck is going. Constantly. We like to think that we do that well because we live and breathe these markets. It’d be difficult for a new entrant to replicate this. So we think the asset management business will bifurcate into folks distributing beta products and funds focused on generating alpha. There will be those that have meaningful distribution capabilities that will win the asset gathering exercise and direct capital to passive vehicles. And then there will be those like us that aim to allocate to the pockets of the market that offer the most upside, remain tactical to avoid market drawdowns and compound returns in a way that will always beat a straight buy-and-hold approach.