ZK Series: Generating returns in a downward market

Key takeaways

• A falling market does not have to mean that returns are impossible.
• Strategies with less dependence on market direction can still capture opportunities during risk-off periods.
• Capital preservation and drawdown control are essential for long-term wealth creation.

Why downward markets are so challenging

A downward market puts pressure on almost everything. Sentiment deteriorates, liquidity declines, volatility rises, and many investors become more defensive. In these phases, assets that once behaved very differently during a bull market often start moving down together. Correlations rise, and risk assets are broadly sold off.

For directional investors, this is problematic. Those who depend entirely on rising markets not only see returns dry up, but often watch their accumulated capital decline as well. That second point is especially important, because a large loss always requires a disproportionately larger recovery.

A loss of:

• 10% requires an 11.1% recovery
• 20% requires a 25% recovery
• 50% requires a 100% recovery

That is why, in falling markets, it is not only important to identify opportunities, but above all to limit major drawdowns.

Why long-only is often not enough

The most traditional form of investing is simple: you buy an asset with the expectation that it will rise in value. In upward markets, that often works well. But in a downward or sideways market, that same simplicity becomes a limitation.

A long-only strategy has one defining characteristic: it depends on beta, meaning the broad direction of the market. If the market declines structurally, the probability increases that even a well-diversified portfolio will be pulled down with it.

That is exactly why more and more investors are looking at strategies that are less dependent on market direction and more focused on alpha: returns that come from skill, structure, and inefficiencies, rather than from a rising market alone.

How can you generate returns in a falling market?

Returns in a downward market usually do not come from simply “riding the trend,” but from a different approach. For example:

1. Short exposure

By shorting an asset, a strategy can benefit from falling prices. This is the most direct way to generate returns in a declining market, but it also requires strong timing and risk management. Shorting is not accessible for most retail investors and comes with its own risks.

2. Market-neutral strategies

Market-neutral strategies seek to hedge broad market exposure and focus on price differences, funding rates, spreads, or arbitrage. The return does not come from “the market goes up,” but from inefficiencies within market structure.

3. Relative value and arbitrage

In volatile or stressed markets, especially in crypto, mispricings often arise between spot and futures, between exchanges, or between related assets. These differences can create opportunities for strategies that are able to trade quickly and in a controlled way.

4. High-Sharpe strategies

Some strategies do take risk, but only when the expected return clearly outweighs that risk. Think of asymmetric opportunities, funding dislocations, or data-driven setups with a strong risk-reward profile.

5. Active risk management

Sometimes the real edge lies not only in “more opportunities,” but in fewer losses. Smaller position sizes, faster hedging, lower directional exposure, and a strong focus on capital preservation can make a meaningful difference in difficult markets.

Why market-neutral strategies become especially interesting

In downward markets, market-neutral strategies are often particularly attractive because they are not dependent on rising prices. By combining long and short positions intelligently, they aim to remove market direction from the equation as much as possible.

The goal is not to predict what Bitcoin, Ethereum, or the broader market will do, but to generate returns from:

• price differences between instruments
• funding rate opportunities
• spreads between spot and futures
• differences between centralized and decentralized exchanges
• temporary mispricings in a fragmented market

During periods of high volatility, inefficiencies often increase. A good example is the market crash of October 10, 2025, when prices in some parts of the market diverged by several percentage points. During these events, liquidity shifts and spreads widen. Some markets react quickly, while others respond more slowly. For strategies designed to capture these dynamics, this can be a fertile environment. You can read more about market-neutral strategies here.

The value of high-Sharpe in a risk-off market

A downward market does not only call for protection, but also for efficiency. When returns become harder to find, it becomes even more important that every unit of risk is used as effectively as possible.

That is where the value of high-Sharpe strategies becomes clear. Not every opportunity is attractive simply because it can generate returns. The more important question is: how much return do you get for the risk you take?

In risk-off environments, that distinction becomes sharper. Investors who only chase upside can be hit hard. Strategies that target a high Sharpe ratio are specifically designed to generate returns with controlled volatility, limited drawdowns, and a better balance between risk and reward. You can read more about high-Sharpe strategies here.

Why stability becomes even more powerful

Stable returns are always valuable, but in a downward market they take on even greater significance. Not only psychologically, but mathematically as well. Investors who protect capital more effectively during difficult periods have a much stronger base from which to grow again in the next cycle.

This ties directly into the principle of returns on returns. Compounding only works optimally if major interruptions are avoided. A strategy that remains stable or even positive in a declining market can therefore contribute disproportionately to long-term wealth creation.

That is exactly why market-independent strategies can play an important role within a broader portfolio. Not to remove all risk, but to make the overall return stream more robust. You can read more about the power of compounding returns here.

The role of the ZK Fund

The Hodl ZK Fund was specifically developed with this type of market environment in mind. The fund combines market-neutral and high-Sharpe strategies to generate returns with limited dependence on market direction. Rather than relying on a bull market, the focus is on capturing inefficiencies, funding opportunities, spreads, and other structural opportunities within the digital asset market.

This makes the fund particularly valuable in risk-off or sideways markets. Not as a replacement for every other strategy, but as a more stable building block within a broader multi-strategy approach. This is also why the Dutch Hodl funds may allocate part of their portfolios to the Hodl ZK Fund.

Conclusion

Generating returns in a downward market requires a different mindset. Less focus on “the market must go up,” and more focus on structure, inefficiency, risk management, and stability. In these phases, the limitations of purely directional investing become visible, while market-independent strategies can prove their value.

For investors, this means that a good strategy should not only work in bull markets. The true quality of a fund or portfolio often reveals itself when markets come under pressure. And that is exactly where the relevance of market-neutral and high-Sharpe approaches emerges: seeking returns where others mainly see risk.

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