By Nedina Stevens
Nedina Stevens, head of ALTS content with Markets Group, sits down with Zoe Cruz, founder and CEO of Menai Financial Group, a leading provider of institutional-grade digital asset investment products and trading services. Zoe will be speaking at our ALTSCHI event July 20-21 in Chicago, where she will share even more insights into how to make smart investments in the digital asset space.
Markets Group: Zoe, you have spent decades at the forefront of the financial services industry. How has the landscape changed during the course of your career?
Zoe Cruz: When I began my career at Morgan Stanley, finance was just beginning to globalize. Financial intermediaries put users of capital together with providers of capital in the global arena. Globalization led to changes in many financial intermediary business models. I see many parallels from those early days of my career to the innovations happening today in the crypto-blockchain ecosystem. Think about what crypto represents: programmable value across trustless networks. This development, with all its efficiency and scalability, is a real paradigm shift, the kind we haven’t experienced since the dotcom era of the late-1990s. It’s a very exciting time to be on the forefront of this digital innovation.
Markets Group: At Menai, you provide your clients with opportunities to participate in the emerging digital assets space. What should allocators looking to enter the market be aware of?
ZC: As with any new emerging asset class, investors face a number of challenges that they need to address when allocating to digital assets. First, you can lose all your money in any highly risky investment; and while I don’t believe that will be a likely and permanent outcome in digital assets, investors need to understand that is a possibility. So, how do allocators address that risk? By only targeting a small portion of risk capital within your strategic allocation.
From Menai’s conversations with investors, strategic targets generally range from 0% to 5%, but I believe 0% is not the right number. The asymmetric return potential of crypto-blockchain is something we haven’t seen in 20-plus years – it’s effectively liquid VC and it’s accessible to all investors. It warrants some target weight in strategic allocations of institutional investors, and it provides an opportunity to harvest volatility through active rebalancing, unlike traditional illiquid VC investments.
Two other important considerations for allocators that I’d mention are diversification of idiosyncratic risk and operational diligence – don’t put all your eggs in one basket and make sure your manager has built institutional infrastructure, risk management processes and security protocols.
MG: On that note, how can investors build operational frameworks that help them reduce risk when investing in crypto?
ZC: Well, operational alpha is critical at every step of the process to secure your digital investments. However, it’s a massive undertaking to build out the operational framework across multiple jurisdictions and in a way that safeguards our clients’ assets. While investors can take on that effort in-house, I think most allocators recognize the value of operational alpha that a truly institutional manager delivers, which is why operational due diligence (ODD) is critical for investors. We have active dialogues with two institutional investment consultants that are really top-notch on the digital ODD effort, very impressive. At Menai, I’m fortunate to have attracted some of top operators in traditional finance and technology. While you cannot eliminate operational risk, you can go to painstaking lengths to mitigate it to manageable levels. We do this every day for our clients’ assets, as well as for our own capital committed to Menai Markets, our proprietary market-making business.
MG: How are you working with allocators to help them make smart investments in the digital space?
ZC: We approach our relationships with allocators with a philosophy of partnership and knowledge sharing. We want investors to view Menai’s investment team as an extension of their internal teams. A core tenet of Menai’s investment philosophy that we always talk about is diversification. The thesis isn’t “buy Bitcoin and you will get rich” – it’s about professional portfolio management backed by deep fundamental research.
When I started Menai almost two years ago, we intentionally designed diversified products to mitigate idiosyncratic risk and provide investors with strategic exposure to a rapidly developing crypto ecosystem. Like in the dotcom days, where there were winners and a lot of losers, the true winners in crypto will reveal themselves over decades. So, allocators must manage strategic exposure actively as use-case applications shift throughout cycles. To do this, Menai has a team of five crypto-native analysts that have culled the universe of approximately 18,000 tokens down to 15 to 30 that we invest in at any given time. Making our team’s intellectual capital available to allocators is part of that partnership mentality that we value at Menai.
MG: How are you working with your clients to help them understand the metrics behind valuations in the cryptocurrency space?
ZC: Valuation is one of the biggest challenges for investors – how do you assign value to speculative technologies? Well, building on the partnership focus, we take a consultative, educational approach to helping clients understand the underlying use cases of crypto-blockchain technology. Real-world examples help to guide the conversation. It’s not as simple as applying a discounted cash flow (DCF) model, even to protocols that generate token fees. We have to think like venture capitalists and active portfolio managers, which is why I’ve hired experienced traditional investors, crypto natives and technologists to help identify winning protocols and potential for value creation.
When you bring to life real-world examples of how crypto is disrupting in positive ways, such as Uniswap in decentralized cryptocurrency trading, that really resonates with investors. And the value of liquidity and flexibility from investing in liquid crypto alongside traditional VC deals is something investors are beginning to see.
MG: What are the biggest operational risks and challenges investors should be mindful of in the digital asset space?
ZC: Custody and exchange risk are at the top of the list – all of which fall under operational alpha I mentioned earlier, which an institutional-quality manager should be providing to investors. We at Menai spent the majority of our time during the first 18 months of our existence on these efforts. It cannot be underscored enough: pursuing best-in-class, institutional-grade operational rigor is just as critical to the investment outcome as token selection.
When allocators decide to take market risk in the digital asset class, they don’t want to take uncompensated operational risks. Investments should be made in building operational excellence, a robust tech stack and focus on compliance. Managers that can solve for operational security and technological redundancy will be successful when the institutional allocation cycle begins in a real way.
MG: Looking into your crystal ball, what will the digital asset space look like in 5-10 years?
ZC: Had you asked me this a year ago, my answer would still come to the same conclusion – the future will be bright over the next decade. Yet we cannot ignore the current challenges that all risk assets are facing with a new regime of monetary tightening. Deleveraging and cleansing of failed businesses or protocols are part of every cycle, which may continue in the near term. But I believe that the digital asset class will be stronger over the next decade as the strongest protocols become time-tested. When I see the efficiency, scalability and accessibility of crypto-blockchain technology today, the potential to transform business models and economies is tremendous, especially in financial services. This is what makes me excited about the future of digital asset and the potential value creation on the horizon.