The mainstream discourse surrounding digital assets often gravitates towards the dramatic price fluctuations of bitcoin and ether. For years, both retail and institutional investors have primarily sought beta exposure, aiming for returns that align with the broader cryptocurrency market. However, with the introduction of products like bitcoin exchange-traded funds (ETFs) and exchange-traded products (ETPs), achieving beta has become more accessible than ever, attracting over $100 billion in institutional capital.
As the asset class matures, the focus is now shifting. Increasingly, institutions are pursuing alpha, or returns that exceed the market, by employing actively managed strategies.
The Role of Uncorrelated Returns in Diversification
Digital assets, given their low correlation to traditional assets, significantly enhance diversification within investment portfolios. Since 2015, bitcoin’s daily correlation with the Russell 1000 Index has remained at a modest 0.231, indicating that its daily returns only weakly align with traditional equity markets. Similarly low correlations are observed with gold and emerging markets. Notably, allocating just 5% of a traditional 60/40 portfolio (60% equities, 40% fixed income) to bitcoin can elevate the Sharpe ratio—indicative of risk-adjusted return—from 1.03 to 1.43. Furthermore, the varying correlations within the crypto space itself allow for intra-asset diversification, reinforcing the position of digital assets as crucial tools for enhancing risk-adjusted returns [see exhibit 1].
Digital Assets Enter the Active Era
Much like traditional markets were transformed by hedge funds and private equity, the landscape of digital assets is now evolving beyond mere index-style investing. In traditional finance, active management constitutes over 60% of global assets. The presence of informational asymmetries, fragmented structures, and inconsistent pricing within digital assets creates unique opportunities for alpha generation.
This transition reflects the early evolution of the alternatives industry, where hedge funds and private equity harnessed market inefficiencies long before such strategies became mainstream.
Market Inefficiencies
Despite bitcoin’s annualized volatility dropping below 40% in 2024, it remains more than twice as volatile as the S&P 500 index. Pricing discrepancies across various exchanges, regulatory fragmentation, and the influence of retail investors create ample opportunities for active managers to exploit. These market inefficiencies—coupled with limited competition in the realm of institutional-grade alpha strategies—strengthen the argument for adopting specialized investment approaches.
- Arbitrage strategies: Utilizing concepts like cash and carry, which captures spreads between spot and futures prices, or basis trading (long positions in discounted assets and shorts in premium ones) can effectively generate alpha by leveraging market inefficiencies within the digital asset sector.
- Market making strategies: By placing bid/ask quotes, market makers capture spreads, but their success depends on managing risks such as inventory exposure and slippage in volatile markets.
- Yield farming: This emerging approach exploits Layer 2 scaling solutions, DeFi platforms, and cross-chain bridges, allowing investors to earn yields through lending protocols or by providing liquidity on decentralized exchanges (DEXs), with an added incentive of earning trading fees and tokens.
- Volatility arbitrage strategy: Targeting the gap between implied and realized volatility in the crypto options market, this strategy aims to achieve market-neutral alpha through expert forecasting and risk management.
High Upside and an Expanding Universe
The digital asset ecosystem continues to expand with new opportunities. The tokenization of real-world assets (RWAs) is projected to exceed $10.9 trillion by 2030, while DeFi protocols—boasting 17,000 unique tokens and business models—are anticipated to surpass $500 billion in value by 2027. This ever-evolving digital asset landscape presents an increasingly legitimate avenue for investors seeking to tap into alpha-generating strategies.
Bitcoin’s price has surged over the years, while its long-term realized volatility has steadily declined, showcasing a maturing market.
