The rise of the crypto robo-advisors

The long-standing battle between passive and active management is heating up again in robo-advice with new fintechs pushing the boundaries of digital investing, but this time, they're blending traditional stocks with more volatile cryptocurrencies.

Even after the recent sell-off that cut the value of Bitcoin in half, retail investors are flocking to gain exposure to the explosive world of cryptocurrency, and digital investment platforms are looking to cash in on the increased interest.

According to InvestmentNews Research, about a third of all advisors expect to increase their clients’ exposure to digital assets in the coming year. While only 10% of advisors were using crypto last year, 44% believed they would be managing it within five years.

Humans managing a robo-advisor sounds like an oxymoron, but recent market turbulence is making crypto robo-advisors much more appealing to rich, younger clients looking for diversification in the traditionally passive world of digital advice.

“With market volatility coming back, I think that an actively managed robo-advisor may be a good alternative,” said Erik Baskin, founder of Baskin Financial Planning in Cheyenne, Wyoming. “The data does not support humans being good at active trading, so there may be some advantages to utilizing technology during times of volatility to produce higher returns for active investors.”

The stock and crypto investing platform Domain Money uses a team of portfolio managers to maintain strategies that offer both stocks and crypto investing to customers in the same portfolio. Adam Dell, former head of product at Marcus by Goldman Sachs, launched the company last week and brought in managers from Goldman Sachs Group Inc., Morgan Stanley & Co. and Bridgewater Associates, according to a release.

“We saw a gap in the market for a platform that offers both stocks and crypto to a serious, sophisticated investor,” Dell said in an email. “We believe investors are increasingly looking for a broad offering … but they also need someone to demystify crypto for Main Street America.”

The digital investing company differs from more traditional robo-advice by adding tools and analytics to specifically manage cryptocurrencies. Along with the actively managed strategies, the platform also offers real-time market data, a proprietary social sentiment tool and live customer agents.

The company’s website shows strong performance, with its core all-stock offering returning 22.8% over a 12-month period beginning in November 2020. However, those results are back-tested, and during the performance period cited, the S&P 500 returned 27.9%, said David Goldstone, manager of research and analytics at the consulting firm Backend Benchmarking. 

“There has always been consumer demand for active strategies, but strong performance is critical to success,” he said.

Daniel Yerger, president at My Wealth Partners, said it’s noteworthy that the advertised performance omits the “absolute devastation” in the cryptocurrency markets during the start of the year.

“Statistically, active management, particularly in the space of equities, doesn’t work in the long term,” Yerger said. “The underlying risk here, of course, is that crypto is extremely speculative, so it would be a stretch for any fiduciary financial planner to say it’s a ‘good product’ for clients.”

One actively managed robo-advisor, Titan Invest, however, actually outperformed the markets during the worst of the pandemic-fueled downturn in March 2020. The robo-advisor purchased an inverse ETF that actually shorted the S&P 500. From the date the fund was purchased, the investment returned 8% when the S&P 500 was down almost 14%, according to the research from Backend Benchmarking.

The holding, in fact, was something the researchers had never before seen on an automated platform.

Titan has increased its assets under management to more than $500 million since launching in 2018, and closed its second funding round of $58 million in July.

“We are big believers in portfolio theory and asset allocation, and diversification is a core tenet of our investment philosophy,” Dell said. “For someone interested in investing in crypto, we would encourage them to think carefully about what portion of their investible assets is appropriate given their financial circumstances and tolerance for risk.”

There are also massive risks. The track record for active robo-advisors has been less than encouraging in recent years. A handful have already shuttered their doors, most notably Hedgeable in 2018, and including QPlum in 2019.

That’s not stopping companies from launching crypto-based platforms. In April, Seattle-based Makara, a registered investment adviser with the Securities and Exchange Commission, launched, offering customers cryptocurrency-only funds through passive investment baskets for 1% on assets under management plus an annual fee.

Given the complexity and chaos of speculation in the crypto markets, Yerger said newly launched platforms like Domain Money and Titan could become popular with young retail investors who want to get into the cryptocurrency market, but don’t have enough time to do the necessary research.

Whether actively managing crypto will prove profitable is, as of yet, still largely an untested question. Considering that there aren’t many established cryptocurrency benchmarks with histories long enough to be useful, it could take years, or even decades, before analysts can use the empirical data to come to an informed conclusion.

“Most active managers do not successfully beat their benchmark,” Goldstone said.