Risk Factors – General

The following risk factors describe a sample of risks inherent to any private fund of the type we may offer, many of which derive from risks inherent to Bitcoin funds in general. This list is not intended to be exhaustive.

Systemic Risks

While the fund may hedge against risk specific to businesses in which they invest, it does do not intend to hedge against systemic risk. This means that any event which could negatively impact the Bitcoin economy as a whole should be assumed to impact the fund itself. Such events might include, but clearly are not limited to, the possession or transmission of Bitcoin being outlawed; pathological failure of the Bitcoin network due to intrinsic software or design faults or extrinsic attack or interference; or sustained loss of confidence in Bitcoin as a currency or store of value.

Currency Exchange Risks

The fund will not, in the general case, hedge against changes in the exchange rate of Bitcoin relative to the dollar or other fiat currencies, except to the extent that doing so may form part of activities designed to hedge against risk inherent to a portfolio business which is itself exposed to changes in the exchange rate, or activities specifically designed to profit from movements in the exchange rate. Participants should not use the fund as any form of hedge against changes in exchange rates. As an illustrative example, if the fund were to gain 20% per annum in Bitcoin terms, but Bitcoin itself were to fall by 20% against the participant’s native fiat currency during the same period, then relative to the participant’s native fiat currency, the participant would have lost 4%. (If 1 bitcoin added to the fund were to grow to 1.2 bitcoins, but 1 bitcoin were to fall to .8 times its original value in fiat, this would yield 1.2 multiplied by .8, or .96 times original fiat value.)

Exchange Platform Risks

Exchanges introduce their own type of risk which cannot easily be hedged against, except via diversification. Participants should be aware that the failure of one or more exchange platforms used by the fund — including but not limited to those providing forex derivatives — may significantly adversely impact the value of the fund.

As a point of interest, one recent study of 40 different Bitcoin currency exchanges found a failure rate of 45% and a median life expectancy of just 381 days.

Exchange Rule Change Risks

Exchanges may in the future — and have in the past — introduced sudden changes to margin requirements (thereby altering available leverage) or to other aspects of trading rules which can have an immediate and unforeseeable impact on the value of existing positions and the attractiveness of potential positions.

Counterparty Risks

As of this writing, Bitcoin-denominated exchanges generally operate as trading networks, meaning that they broker transactions between third parties, rather than acting as counterparties to the trades themselves. In the absence of a central exchange acting as counterparty, only exchange software platform features protect exchange participants from counterparty risk. During times of high market volatility, exchange software platform features may in the future be — and have in the past been — inadequate to protect market participants fully from counterparty risk. (Many people continue to believe that a non-centralized currency is somehow incompatible with a centralized exchange or, for that matter, a centralized options clearinghouse in the case of options on equities, even though comparing these meanings of ‘centralized’ is like comparing apples and The Jetsons.) Where appropriate, the fund will attempt to mitigate risk due to the absence of an identifiable exchange or market maker acting as counterparty, but participants should be aware that in many cases it is essentially impossible to hedge such risks at all, save for in the very limited sense made possible by diversification.

Anonymous Operator Risks

As a special case of counterparty risk, participants in Bitcoin markets should be aware that many operators of exchanges and of individual assets insist on conducting business anonymously. In the fund manager’s view, this insistence on anonymity has very little to do with supporting the ethos of privacy (for individuals, not for profit-making institutions) or the libertarian spirit of Bitcoin itself and rather more to do with avoiding accountability. In addition to making it all but impossible for market participants to corroborate via independent sources these operators’ claims of competence or their offerings’ fitness for purpose or even to evaluate reliably their general trustworthiness, operators who refuse to reveal their own identities insulate themselves against civil liability and any general sense of accountability. This means that should something go wrong — and many, many things have gone wrong, over and over, during Bitcoin’s brief childhood — market participants, including creditors and customers of those operators, may have little or no recourse. The fund’s interactions with operators who insist on remaining anonymous place the fund at a significant disadvantage in terms of risk management.

The fund manager has written separately about the topic in the article In the Bitcoin Economy, Anonymity and Privacy are Not the Same Thing.

Liquidity Maintenance and Underperformance Risks

The liquidity necessary to support even a limited redemption facility does not come without cost in terms of performance: capital held in cash or very short dated debt so as to be available to support redemptions will be unavailable for deployment into other activities potentially offering significantly higher returns.

Volatility Management and Underperformance Risks

Attempting to reduce portfolio risk via diversification and explicit hedging may reduce the impact of adverse price moves, but such risk management may also reduce the ‘risk’ of advantageous price moves. In other words, successfully reducing portfolio risk may reduce returns.

Fund Management Competence and Experience Risks

While the fund manager offers significant experience managing portfolios of equities, commodities and listed derivatives, and has successfully invested in the Bitcoin economy for a time, including operating the original BTC Growth hedge fund-style offering as a service to the now-defunct BTC Trading Company’s virtual exchange, it is entirely possible that his experience will not translate fully into successful management of any other fund of any type. In particular, the relatively primitive nature and limited liquidity of derivatives available in the Bitcoin space do not currently support the same array of strategies that can be constructed with standardized derivatives. Without recourse to other than the most primitive of strategies, it is entirely possible that the fund manager will be unable to construct suitably hedged and profitable positions.

Regulatory Risks

As a United Kingdom registered company, the issuer is subject to any and all legislation which might be introduced by the UK government to regulate, limit, or even prohibit activities of this type. While the company will make commercially reasonable best efforts to continue the operation of the fund while complying with unforeseen new legislation, it is possible that new legislation may make this impossible. As of this writing, our understanding is that the UK government has indicated that Bitcoin investment gains are not subject to tax until the point at which they are converted to fiat currency. We believe that this situation affords significant leeway to operate a Bitcoin-denominated fund without incurring the overheads of taxation that would otherwise become due as a result of our current structure as an ordinary limited company rather than as a passthrough investment company. As a point of interest, the UK government has also reportedly indicated in direct correspondence with an exchange operator that the operation of an exchange itself does not at this time require registration as a money transmitter:

We hope and believe that this provides an early indication of the UK government’s intention to pursue policies which will not unduly constrain growth in the Bitcoin economy.

Data Loss, Death and Disability Risks

For many years, the company has had an encryption recovery policy and continuity procedure in place to help ensure the ongoing operation or, if necessary, the smooth winding down of the company, should death or other unplanned circumstances such as sudden disability compromise the ability of the company’s Managing Director to continue in his role.

Although steps have been taken to mitigate the risk, it remains possible for the company to suffer catastrophic data loss. Should both sets of encryption keys for our doubly-encrypted, geographically distributed backup system be lost, the company’s electronic assets would in effect be digitally shredded, significantly impairing the company’s capacity to function.

In addition, should the fund manager die or become otherwise unable to continue in his role, a significant gap may occur in the management of open positions before the fund’s activities can be gracefully wound down. This may adversely impact the fund’s value.

Personal Risk Tolerance and Diversification

Generally speaking, Bitcoin-denominated private funds of the type we may offer include very significant and broad risks. It is essential that prospective participants consider carefully whether their own personal risk tolerance and personal approach to portfolio management are consistent with the levels of risk involved with such funds, and whether involvement in such funds would be appropriate within the broader context of their personal portfolio. Prospective participants who are in any doubt whatsoever as to the suitability of any fund we may offer should not participate.

No warranty or representation, either expressed or implied, is given with respect to the accuracy, completeness, or suitability for purpose of any view or statement expressed on this site. This article was originally published by on and was last reviewed or updated by Dr Greg Mulhauser on .

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