Starting a Crypto Hedge Fund

Episode Summary

Executive Summary: Lee Drogon of Starkiller Capital argues crypto remains an early, highly volatile but investable asset class where momentum and trend-following can outperform because valuation anchors are weak and adoption cycles create repeated bubbles. He explains a risk-managed, long-biased strategy using momentum, trend, and stablecoin yield, while defending crypto’s infrastructure and DeFi utility despite skepticism about maximalist narratives.

Main Topics: Why crypto momentum works (Priority: 5/5): Drogon says crypto lacks stable intrinsic valuation, so prices move in adoption-driven bubbles that make cross-sectional momentum and trend-following unusually effective. Starkiller Capital’s strategy and risk management (Priority: 5/5): The fund is long-biased and strategic-beta, aiming to cut typical crypto drawdowns via momentum, trend, mean reversion, and active position sizing. LP appetite and institutional adoption (Priority: 4/5): Early investors include crypto-rich individuals and family offices; institutions are warming to liquid, risk-managed crypto but remain cautious about volatility and bucket placement. DeFi, stablecoins, and financial efficiency (Priority: 5/5): Drogon sees DeFi and stablecoins as core crypto use cases because they remove middlemen, improve leverage efficiency, and generate high yields through lending and liquidity provision. Fraud, security, and due diligence (Priority: 4/5): He describes how the fund screens for rugs and counterparty risk by reading code, audits, and protocol structures, and trusting stronger CeFi counterparties to absorb hacks. Crypto beta, index construction, and portfolio design (Priority: 4/5): He explains that crypto correlations are ecosystem-based rather than sector-based, making indexing difficult and requiring active, momentum-like management. Long-term thesis for crypto (Priority: 4/5): Beyond trading, Drogon believes crypto will rewrite value transfer and network incentives across industries, not just finance.

Key Arguments: Crypto is best traded as an asset class with weak valuation anchors and extreme reflexivity, making momentum and trend models especially powerful. The market is still in an early, venture-like phase, but unlike venture, the assets are liquid, so price discovery and founder sell pressure matter more. A long-biased crypto strategy can aim to limit drawdowns to around 30% even though the market historically suffers about 75% drawdowns. Stablecoins are not just a bridge into crypto; they may be one of crypto’s ultimate products because they let anyone globally hold US dollars and earn yield. DeFi can reduce borrowing costs by removing intermediaries that take roughly 300 bps, improving economic efficiency. Crypto fundamentals are not best understood through traditional sector groupings because assets correlate more by chain ecosystem than by theme. Institutions are gradually becoming comfortable with liquid crypto exposure, but many still struggle with where strategic beta belongs in portfolio buckets. Security and counterparties matter: protocols should be vetted through code audits, and stronger CeFi firms would be expected to recapitalize after hacks.

Data Points: Crypto market growth rate: ~200% CAGR - Drogon describes current overall crypto growth as extremely fast and unsustainable long term. Potential window for strategy: 5-7 years - He calls this a “fat pitch” period for strategic beta crypto long bias. Typical crypto drawdown cycle: ~75% - He says historical crypto markets often experience very deep drawdowns. Target drawdown for Starkiller book: 30% - He wants to preserve capital and emotional bandwidth with risk management. Stablecoin farming APR: 20-35% - He says holding cash in crypto can still earn significant yield through stablecoin strategies. Current APR on their book: ~36% - He cites the fund’s current stablecoin yield environment. Bitcoin volatility then vs now: 130 vol to 80 vol - He argues Bitcoin has already become less volatile over time. Bank intermediary fee: 300 bps - He says banks take about 300 basis points for sitting in the middle of transactions. ETH gas fees: $200 - He cites high Ethereum transaction costs as evidence of current scaling limitations. Wormhole hack hole: $350 million - He references the ETH-Solana Wormhole exploit and Jump’s recapitalization. Jump Capital crypto book profits: $6-8 billion - He mentions Jump’s large crypto gains as evidence of strong counterparty support. Crypto allocation committees: 3%-4% - He says some institutions have decided to allocate this amount to crypto in some form. Top 10 coin turnover: Only 2 remain from 2017 - He uses this to show why index construction in crypto is difficult.

Pivotal Quotes: "There is no intrinsic value to any of these assets." — Lee Drogon: He explains why crypto is unusually suited to momentum and trend models. "Stable coins might be the ultimate feature of crypto at the end of the day." — Lee Drogon: He frames stablecoins as a major real-world use case, not just a crypto on-ramp. "We’re basically investing in experiments at this point." — Lee Drogon: He describes crypto chains and protocols as early-stage but liquid venture-like bets.

Implications: For listeners, the takeaway is that crypto may be more tradable than “value-investable,” with success depending on risk management, liquidity awareness, and protocol diligence. For the industry, institutional adoption may grow around liquid beta, stablecoins, and DeFi rather than maximalist narratives.