(Click image to play) In this episode of the Manager Profiles series, I spoke with Edward Chin and Thejas Nalval about their multi-strategy approach in the digital asset sector and how their experience and structure appeals to a growing base of institutional investors.
In this episode, I spoke with Edward Chin and Thejas Nalval, co-founders of Parataxis Capital Management. We talked about:
How timing is critical and how it affected the creation of Parataxis back in 2019.
The importance of having traditional trading and risk management experience in forming an institutional-grade investment program.
How the firm’s multi-strategy approach allows them to take advantage of inefficiencies in the nascent digital asset space and respond to macro events.
How institutional participation in the digital asset space has evolved.
Lessons learned from 2022.
Parataxis’ focus for 2023.
5:06 | “We all come from a background where risk management mattered. We were trained to think about things the right way. So the way in which we structured our company, the way in which we structured our culture, was with that mindset at the forefront.”
11:34 | “In our view, the only way to really manifest and secure longevity, as a fund, as a company, in the space is to really lead with this multi-strategy approach. ”
15:42 | “We’ve used 2022 to not only survive, but to map out the next stage of our growth. We’ve been able to expand and hire on our team.”
25:10 | “I think folks have moved beyond ‘will Bitcoin disappear?’ to ‘this is here to stay, but we need to be able to manage volatility and get the right type of exposure’.”
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Jennifer Bruno 00:06
Welcome to Hedge Interview. This episode is part of the Manager Profiles series, which features distinguished asset managers with a unique approach in their strategy space. My guests today are Edward Chin and Thejas Nalval of Parataxis Capital Management, a multi-strategy investment firm focused on the digital asset sector.
Ed is the CEO of Parataxis. And prior to co-founding the firm with Thejas, he was an investment banker at two digital asset merchant banks: Galaxy Digital and Element Group. Ed began his career at Lehman Brothers and he spent 10 years as an investment banker executing mergers and acquisitions, and financing transactions across the Tech, Media and Telecom sectors.
Thejas is the Chief Investment Officer of Parataxis. And prior to co-founding the firm, he was a portfolio manager at digital asset hedge fund LedgerPrime. And he was head of asset management at the Element Group. Prior to joining the digital asset space, Thejas spent eight years at Goldman Sachs, most recently as a trader within the firm’s macro trading group.
Thank you both for joining me today.
Edward Chin 01:29
Thanks, Jen, for having us.
Thejas Nalval 01:31
Thanks for having us.
Jennifer Bruno 01:32
So first, tell me about Parataxis and why you decided to develop your specific investment program.
Edward Chin 01:39
Yeah, we started Parataxis in late 2019. Coming out of the bear market of 2018, one of the things that we realized was that there was increasing interest and appetite from large, sophisticated investors across the institutional investment community looking to gain exposure to the sector. But what became clear was that a lot of the vehicles and wrappers for them to express that view weren’t appropriate from a risk management perspective.
And so the goal when we launched in late 2019, was to provide a risk-managed institutional product that would apply traditional investment in trading strategies to what we thought was still a nascent and growing market. I would say one of the things that has evolved since then, especially between 2019 and 2021, is the discussions with our prospective allocator base, and this includes not just high net worth family offices, who’ve traditionally dabbled in digital assets, but increasingly pension funds, both private and public, endowments and foundations, was that the asset class was no longer not investable.
Instead of debating whether or not the asset class would be sustainable, continue to see growth and evolution, the discussions clearly changed to one of finding the appropriate type of vehicle to gain exposure to the space and to figure out how to size and manage that allocation.
And so what we realized, with that change in tone, was that asset managers that were crypto-native that understood how to find opportunities across the space, were going to be very, very important, but increasingly, individuals that had come from traditional backgrounds that think about risk management, I would say from a traditional perspective, were going to be absolutely necessary, given the operational complexities and the plethora of idiosyncratic risks as it relates to this specific asset class. And so we had decided at that point to launch the firm and develop vehicles to allow allocators to gain that type of exposure.
Jennifer Bruno 04:19
It’s great that you understood that because it’s been really difficult, or challenging, I think, for a lot of digital asset fund managers that want to attract institutional capital, but struggled to because of the risk management element and, and the resistance that typically comes up from institutional managers, so the fact that you developed a program that appeals to that group, to the institutional world is a real feather in your cap. What would you attribute that to? How did you know how to get it right for that investor base?
Thejas Nalval 05:06
I think it’s a function of the backgrounds we all come from. For myself, I spent most of my early career on a trading floor at an investment bank that focuses heavily on operations and risk management. I interacted with on a daily basis with the largest endowments and sovereign wealth funds in the world. So you build up an understanding over time of what really matters to the largest and most sophisticated investors over time. And I can say the same story for each of us on the team. We all come from a background where risk management mattered. We were trained to think about things the right way. So the way in which we structured our company, the way in which we structured our culture, was with that mindset at the forefront.
Jennifer Bruno 06:05
And tell me about how you guys met? How did Parataxis come together? How did you meet?
Edward Chin 06:11
Yeah, so I’ll give you my version, and hopefully, it lines up with Thejas’ version as well. We met at the Element Group. The Element Group was an early merchant bank, focused on the space, tremendous growth and market share at the time. I was on the private side running the advisory business at the time, identifying early-stage, disruptive technologies across web3, and crypto, raising capital for these businesses and oftentimes investing alongside.
On the other side of the Chinese wall, facing the public markets, in the firm’s asset management business was Thejas. We were the two folks that were in the New York satellite office at the time, the headquarters was based out of Southern California. And so managing that office and teams here, although there was a separation as related to the types of capital and investors and opportunities that we were looking at, we were more or less in contact on a daily basis and realized that we had the shared interest and perspective on the market and the opportunities that the lied before us. But the market itself, and the products had to evolve, in order to meet demand from as Thejas described, a much more sophisticated investor base.
Jennifer Bruno 07:37
How did you decide you’re ready to pull that together?
Thejas Nalval 07:43
I think timing is everything, especially with this asset class. When we met, the crypto markets were experiencing its first real major bear market in 2018. Timing wasn’t exactly right to launch a fund. I think we, like Ed said, we both come from very similar backgrounds, we both are about the same age, have young families have similar experiences, before joining the digital asset space. So we both have more of an entrepreneur bug, we wanted to launch something in the space. I knew, for me, where my strengths were, where my weaknesses were, and I knew I needed to partner up with somebody who complimented my skill set, and hopefully vice versa for Ed.
So we both knew we wanted to do something, but timing was everything. And at the end of 2019, the timing was much better. And it was at that point we decided to launch the company.
Edward Chin 08:57
Yeah, that being said, folks thought we were crazy launching into the start of the global pandemic. And so there are obviously a number of challenges, but in hindsight, it was, it was probably the best time to be launching.
Jennifer Bruno 09:10
Definitely! 2018 was definitely a bear market. So that’s a great time to get it together and figure out what exactly, you know, it’s a good time to plan while things are not great, and then come out when the market starts expanding. So that definitely was really great timing. Tell me about your investment program and your approach. What are your focus areas within the digital asset space?
Thejas Nalval 09:40
Sure. So I think we, even though we come from backgrounds, where personally I’ve interacted with, with products and asset classes that have been very mature, we recognize that crypto, digital assets, it’s still a very nascent asset class. The market is inefficient, the market structure is still being architected, and therefore, in our view, there are multiple ways to earn a return, multiple ways to create value in this asset class. So that’s one of our core beliefs as a company.
What that translates to within Parataxis is, we look at opportunities that rely on trend-following, for instance, both directionally long and short, maybe relative-value, pairing one name against another. We look for opportunities that may require some more fundamental, bottoms-up type of research, in this space, involving tokens, involving the equity of early-stage projects. We look at statistical arbitrage opportunities. Again, this market is very inefficient. As a result, there are patterns we can recognize intraday, that we can capitalize on, and again, earn as a source of return. We look at event-driven strategies. We also look at our own version of smart beta strategies. Again, in our core, we’re a multi-strategy type of organization.
Jennifer Bruno 11:31
That really is a multi-strategy approach!
Thejas Nalval 11:34
It stems from the fact that the market is inefficient. It will remain inefficient for some time. And unlike the equities market, I think the crypto markets tend to evolve and reinvent themselves every 18 months or so. So in our view, if you really, if you just pigeonhole yourself into one term source of return profile, because there’s an arbitrage opportunity, chances are in 18 months, 24 months, that arbitrage opportunity will cease to exist. And it’ll be very difficult to exist as a fund. In our view, the only way to really manifest and secure longevity, as a fund, as a company, in the space is to really lead with this multi-strategy approach.
Jennifer Bruno 12:20
So that plays nicely into risk management, as well, I would think.
Thejas Nalval 12:26
It does. And I’d be remiss, if I said there was no risk in this asset class. There is. And risk is a function of it being a brand new asset class. Effectively, the whole financial ecosystem that we’ve known and interacted with for decades is being architected within blockchain and digital assets. So a lot of the strategies, a lot of the ways of looking at this world are a very novel. And with that comes risk. Our job as a fund manager is to manage that risk, to mitigate that risk where we can and how we do that, you know, we tend to categorize risks based on market risk and portfolio risk.
That’s the easy part, you know, we use some very similar risk management techniques that any traditional fund manager would use in terms of how we construct our portfolio, the level of volatility that we’re comfortable with, given a certain sub-strategy, how we manage our long and short exposures, our delta positions when we hedge.
But then we have to pay special attention to more of the operational risks that exist. This involves how we trade where we trade, who our counterparties are, where we have exposure to, and I think we pay special attention to that part of the risk management category only because it’s very clear that who you traded with and where you have exposure to in a year, like 2022, it really mattered. And I think, because we paid special attention to where we traded and how we traded, you know, we were able to survive and not expose our investors to a lot of the pitfalls that some of our peers, unfortunately had access, had exposure to.
Jennifer Bruno 14:43
That’s so important. You know, institutional investors I interview and speak with have said over and over again, it’s great if you make me money, but above all, you have to preserve capital. You have to know how to do that. So in going through a tough year like 2022, or any challenging period is just a feather in your cap that shows that you weathered the storm, you know how to get through because there’s been so much attrition in your space, right? And you’re still standing. So that’s extremely important. And given the breadth of the tools and the tactics that you apply, tell me about your team and your organization. How big, how many people are involved in the Parataxis operation?
Edward Chin 15:42
Yeah, given the multi-strat approach, it does require a combination of different skill sets. I think the overarching requirements are that the folks have to be crypto native.
It’s not just looking at the price of a digital asset and trading that, but to have an understanding of the fundamental drivers. Because at the end of the day, price should, at some point, reflect fundamentals, whether that’s growth or adoption, or some other metric.
And then the second requirement is the traditional background, so that we are all on the same page as it relates to thinking about building an institutional product and thinking about risk the right way. We have a team of seven today: four investment professionals, two non-investment professionals. And we have a separate Bitcoin mining business, so we have a Bitcoin mining operations lead there. That business is interesting because it allows us to delve into the other parts of the ecosystem, whether it relates to infrastructure stack, or understanding how mining pools operate, the effect of hash rates, difficulty and what that would mean for price and frankly, it does impact how we think about our strategies at times as well.
Outside of Thejas, myself, we have a third partner, Julian Gropp, also from a traditional background, much more tech, banking and private equity focused. He spent time at KKR and Lazard before joining us.
And I would say we’ve used 2022 to not only survive, but to map out the next stage of our growth. We’ve been able to expand and hire on our team. We’ve brought on a quant researcher, who’s spent a large part of his time at various quant hedge funds, including AQR who’s building out a lot of the quant systematic strategies for us. And then given the non-investment-related workload as it relates to managing an asset management business, a controller, head of ops, and somebody that’s dedicated to the IR function.
That allows us to have a team that can be pretty much dedicated to managing our LP’s assets the right way, and to find new and interesting opportunities, but also kind of manage and run all the other parts of managing a business in this space.
Jennifer Bruno 18:33
So speaking of 2022, all asset managers evolve. Everybody has lessons learned no matter what strategy space you’re in. What would you say are some of the key lessons learned that you’re taking with you into, or hurdles you’ve overcome, as we move further into this year?
Thejas Nalval 18:57
I can kick that off with a few. I think one thing we knew going into a year like 2022, that it was very demonstrated it was valuable was just communicating with investors and communicating with stakeholders, especially when there is when there are events that are occurring in the marketplace and information is getting disseminated in real time, over social media, over Twitter. You know, it’s clear that all of our investors are seeing certain headlines and how they interpret that is important and providing some context is important.
We did a lot of communication last year, especially last summer, especially during the debacle of FTX in November. And it was largely just to set investors at ease. There were weeks at a time, it seemed like we were just putting out a brand new investor email, just to tell everybody we’d had an exposure to XYZ counter-party, this is how we’re thinking about the world.
In a normal market environment, that type of communication may be overkill at times, but especially in a world like we lived in last year, I think, it allowed us to really demonstrate how we thought about the world when things are bad. But I think it gave a lot of our largest investors, you know, more confidence in us.
Edward Chin 20:42
I’d only add that as it relates to the markets, you can’t be an ideologue in this space. The notion that, you should sell everything and just go into digital assets, because it’s going to take over the world, it’s not the right way to be thinking about this space. And unfortunately, a lot of stakeholders in this ecosystem, their decision-making is binary.
I’d say the thing that we took away from 2022, specifically, is that macro matters, and the macro environment, macro volatility matters. I feel like 2022 was a year where, you know, high-yield was down 15, 20, 25% at one point. Equities, obviously had to draw down as well. And we’re starting to see cracks in commercial real estate and other parts of the credit system. That’s a function of the macro environment. It obviously had an impact on digital assets as well.
Although we always have a view towards the fundamental drivers in the crypto-native narratives that we think will lead to growth and adoption and allow these persistent arbitrage trading opportunities to exist, we have to take a step back and understand the asset class in light of the wider macro picture as well.
Jennifer Bruno 22:19
I think that’s really important for every strategy. You just can’t ignore the big picture of what’s going on, and even your investors, they want to know what you’re thinking during those periods and understand like, what your approach is, so it’s definitely important. And Thejas, your background, being a part of the Goldman Sachs, macro trading group, particularly, obviously that experience lends itself to what you’re doing now, and paying attention to all of those things, I would think.
Thejas Nalval 22:58
Absolutely. Just to piggyback on what Ed said, when we entered the crypto space in 2017, there really weren’t any institutional investors in the space at large. There were a few funds. But the space was largely invested by high net worth individuals, maybe some family offices. There were no pension funds, there were no corporates buying bitcoin or buying really any digital assets, and even the players that were the market participants were largely crypto-native.
This is the first cycle where you saw a bit of a transition of traditional investors coming into the space, pretty meaningfully. You saw traditional market participants, market makers, brokers, actually entering the digital asset space either largely through the futures market, which does have a correlated effect on spot volumes.
And so, you know, the macro having an impact on the digital asset space, it shouldn’t have come as a shock to anyone. I think, especially when you have an overlap in market participants that now view digital assets as part of a multi-asset portfolio. So there’s going to be some causality between asset classes, and when we see macro headlines, we always try to understand what the impact could be short-term and long-term for our asset class and also within our funds.
Jennifer Bruno 24:50
And how have things changed in terms of institutional money participation in the digital asset space since last year into this year? What are you witnessing, as far as you know, their interest in digital assets, the digital asset space?
Edward Chin 25:10
Yeah, I think going back two years, a number of institutional allocators that identified this asset class, one, that they need exposure. I think folks have moved beyond ‘will Bitcoin disappear?’ to ‘this is here to stay, but we need to be able to manage volatility and get the right type of exposure.’ So 2022, I felt like was going to be one of the greatest fundraising years, at least for our fund. But all that was kind of put on pause when FTX happened.
I think FTX was one of the largest exchanges in the world. If you look at their equity cap table, and the number of prominent individuals that had vetted that opportunity and still weren’t able to identify certain risks. For a lot of institutional allocators that had already vetted the sector, figured out the type of exposure that they wanted, they had to go pencils down. I think that’s changing right now.
We’re seeing a thaw, and conversations have gone back towards identifying, the survivors from last year, and trying to sift through the best way to get exposure to an ecosystem that has over 20,000 cryptocurrencies available out there. And that requires working with managers that breathe this, day in and day out.
But one thing that has changed is a move away from just gaining passive exposure, given the volatility, and more towards managed strategies, whether it be low vol, high Sharpe type of strategy, something that may have directional or quantitative components to it.
That’s a bit exciting, because we get to help allocators figure out and create products that are bespoke to the specific type of exposure that they’re looking for. And to the extent that we can apply traditional investment strategies and risk management practices to provide that exposure, we think it’s a great opportunity on both sides.
Jennifer Bruno 27:34
And what are you focused on right now in terms of the macro environment?
Thejas Nalval 27:41
One of the views that we had, at the start of the year, or at the end of last year, closely was that there would be a meaningful amount of supply pressure in the digital asset market, both from folks, likely it’s more of a year-end dynamic, where you see some rebalancing occur across the space, both within crypto-native funds and also within traditional funds that may have some crypto exposure.
Our view was that we would see a sharp mean reversion to start the year, just given that anytime there’s a disproportionate amount of buying or selling, usually there is a nice reversion to the mean, especially with something as inefficient as crypto. And we’ve seen that evidenced already in Q1. Most of the market was up anywhere from 50, to sometimes even 150% for Q1 itself. And that’s just purely a market structural dynamic that existed. Our view now is that a lot of the forced selling that took place is behind us, forced selling from either leverage that existed in the ecosystem, exposure to the Block5’s, the Celcius’, the FTX’s of the world.
And so the market is behaving a bit more rational today. We are paying attention to what’s happening, say less on the macro side, but more on the regulatory side, both here in the US and globally. It’s something that we’re paying attention to in real-time, because obviously a lot of it has an effect on perceived behaviors of different participants in the ecosystem. As it relates back to the macro space, and we’re not a macro fund, but we are paying attention to, you know, what the Fed is doing and what we think the Fed will, where they’ll land at the end of the year, and how that’s going to impact traditional risk assets, and what impact that’s going to naturally have on Bitcoin, and really the rest of the ecosystem.
There is a bit of a cycle. It is our view that if the Fed does pivot, eventually, if there is a shift in language, that it will likely trigger capital to flow back into what traditionally hasn’t had the highest beta, and that’s been digital assets, been Bitcoin and Ethereum. We should see a little bit of a sharp uptick right off the back of any sort of language that would be sign of a pivot. It’s not gonna happen anytime soon, but it’s likely at some point, either later this year or early next year, where we see a bit of an inflection point. I think it lines up very nicely with the halving schedule that Bitcoin has. Every four years, the amount of bitcoin mined in a block, it’s cut in half. And historically, that has always been the start of a secular bull run for crypto. So a lot of the a lot of the forces are lining up for the end of this year and early next year to be a much more constructive market environment for this asset.
Jennifer Bruno 31:35
And hopefully, the worst is behind us as far as interest rate hikes, because a bunch, all in the Fall of last year, had a really strong impact on the markets and everybody contracted, everything contracted. My observation is, if the Fed looks back and is like, oh, I guess we need to approach this a little more gently so that the markets don’t get crushed like they did last Fall, or the whole economy. I don’t mean just the capital markets, but you know, it had such a harsh effect that hopefully the worst is behind us and even future hikes will be staggered.
Edward Chin 32:20
Yeah, yeah. I think the other thing that’s really important as it relates to macro is it’s always evolving, because the narratives surrounding the macro picture, and I would say, separate asset classes, are always evolving.
If you think about the narrative surrounding digital assets, and specifically Bitcoin last year, it revolved around BTC being somewhat like gold and serving as an inflation hedge, and that narrative was clearly invalidated. And I think part of the resurgence and interest in the asset class is BTC as a source of, having a hedge against monetary debasement.
That’s going to definitely impact the macro. We have a macro overlay, as Thejas described, always have a view towards, you know, what the Fed may be doing. What is the money supply doing, what are interest rates? What does the outlook look like for rates? But that’s an overlay, at the end of the day, we do still have a bottoms-up approach, and that’s a crypto-native part of this asset class. It’s not just the fund flows in the market. Microstructure, those are really important for a number of our stat arb strategies, and trend-following, relative value strategies.
But there’s just tremendous growth that still exists in space, and disruption, and so, by taking a bottoms-up approach, it does allow us to kind of sift through the landscape of, as I described, 20,000 digital assets, to find the best ways to kind of gain that type of exposure once growth resumes.
Jennifer Bruno 34:10
And so lastly, what developments are you looking forward to in terms of your growth at Parataxis, or macro developments, or things on the horizon that you’re positively looking forward to?
Edward Chin 34:26
We’re excited because we have a multi-strat approach. And what that means is that, as Thejas described, depending upon what the market is doing, or what the macro environment looks like, we can overweight or underweight different types of exposures in order to get a composite risk-adjusted, return profile, attractive risk-adjusted return profile. What’s exciting for us is there are a lot of allocators that are doing a lot of work on the space. And the way that we know that is that, instead of just digging into the sector, at a high level, they’re trying to understand specifically how some of these arbs work and different ways to gain exposure that replicate strategies in TradFi, but have higher returns oftentimes just given that the market is more nascent, it is more inefficient.
So that’s a bit exciting for us to explore because we can parcel out specific exposures and provide that through different types of structures that are most relevant and help for prospective allocators. The one other thing I would say is, the market does feel like 2019. Almost four years ago, going into halving year, back then it was in 2020. Obviously, we were blindsided by the pandemic. But 2018 was one of the worst bear markets on record for the sector, and had anybody taking the time to look underneath the hood, they would have seen that there was still tremendous technological innovation, adoption taking place. And 2019 felt like the year of consolidation before growth resumed. Our view is that, to the extent that that is a similar cycle that we’re in, hopefully 2024 will have a much more accommodative macro backdrop. Because it’s clear that the innovators in the space are building, and at some point, that building and adoption should be reflected in the price of digital assets
Jennifer Bruno 36:45
And it’s pretty good allocators as well are expanding their understanding of the digital asset space, and they’re more open-minded going forward. I think that also helps. Because, again, weathering this period and seeing that digital assets aren’t just going away, because of a difficult period, probably helps bolster the whole digital asset sector, as far as being a real meaningful place to consider allocating, given how that sector behaves, and that it’s here to stay and that there’s so much opportunity yet to discover. It’s just definitely under-allocated to and will be for a while.
Thejas Nalval 37:37
Yeah. And to add to that, Jennifer, I think a few years ago, when allocators were researching the space, usually, the dynamic was, there was usually a junior person on the team that understood the space and they were given ownership of, ‘hey, just figure out if this is, you know, this is something we should pay attention to’. And this was, you know, four or five years ago.
It’s clear that allocators have a very strong thesis on the space. It just goes back to timing. I think there will be a timing component, where the opportunity cost of not being involved is actually greater than just you know, sitting on the sidelines. And so, I think we’re excited for when that timing element does shift.
Those junior people have now been promoted. And usually now what we’re seeing is that they’re in a decision-maker seat. And when we speak to allocators, the conversation isn’t, you know, what is Bitcoin? What is blockchain? It is very crypto-native as we’re getting deep into the weeds and whether it be DeFi, whether it be NFTs, whether it be infrastructure plays, and these are very, very interesting conversations for us too. Because we’re speaking intelligently about areas of that ecosystem that sometimes goes underserved in traditional media.
And I think for us as a company too. When we started Parataxis, it was just Ed and myself and it was largely, our thinking was you know, let’s build this, and it was a very Field of Dreams, you know, let’s build it they will come. Whereas now, we have a very strong team. We have a very capable team. There are folks on our team that are smarter than Ed and myself. We have the right people and that’s almost a force multiplier as it relates to being a company in this space.
And so now, when we do transition to that moment where allocators start entering the space in a meaningful way, the day will come and we can build it, we can build whatever product or vehicle they’d like. And we couldn’t do that three years ago, and it’s because we have the right team. So I’m really excited for that.
Jennifer Bruno 40:26
Fantastic. Well, that’s really exciting. And it’s great that those conversations have evolved, and the market, the digital asset space has evolved. So even though the environment might still be a little challenging, the fact that so many other things have evolved, just speaks to the opportunity in the sector.
Thank you both so much for participating today and being here to tell us about Parataxis.
For folks that want more information about Parataxis Capital, you can visit their website at parataxis.io.
And again, thanks so much, guys. It’s been great having you here.
Edward Chin 41:07
Thejas Nalval 41:08
Jennifer Bruno 41:10