A guide on crypto hedge funds
What are traditional hedge funds?
A traditional hedge fund refers to a limited partnership of private investors whose money is managed by professional fund managers. The name of this investment vehicle stems from the fact that such funds were designed to hedge against market volatility and minimise risks of price fluctuations.
Hedge funds have developed over the years into a more complex structure; fund managers use a wide array of investment strategies to produce high returns for their investors such as leverage and the trading of non-traditional assets.
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Traditional hedge funds are usually available to high-net-worth investors and are not subjected to the same rules as traditional investment funds. They include higher levels of risk and more flexible investment strategies.
Are hedge funds regulated?
Hedge funds are regulated, but keep in mind that laws may differ among various jurisdictions. Always do your due diligence and inform yourself about the laws in your jurisdiction.
We are going to explain the regulation of hedge funds in the United States as an example.
In the U.S., hedge funds are regulated on two levels – at the issuer level and the adviser level. At the issuer level, the Securities and Exchange Commission (SEC) governs hedge funds, including digital asset funds. Fund managers can be regulated by either the SEC or the Commodity Futures Trading Commission (CFTC), depending on the categorisation of the fund’s portfolio assets.
As mentioned above, hedge funds are associated with high-net-worth investors. Therefore, in the U.S., hedge funds can include only accredited investors with a capital of $5 million or more. Off-shore funds can have different thresholds though. The capital threshold is put in place to safeguard retail investors from the high-risk nature of hedge fund investments.
Why are hedge funds using crypto?
While traditional assets provide a high degree of market efficiency, investors have been looking at the volatile crypto market to earn excess returns.
Hedge funds are turning to crypto assets due to two reasons; primarily, they are trying to diversify portfolios by investing in innovative assets. Extending portfolio diversity can diminish unpredictable risks. Secondly, hedge funds are attracted by arbitrage possibilities within the crypto space.
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Institutional crypto adoption is currently driven by a growing number of crypto hedge funds entering the market. If these funds prove themselves to be successful and generate returns, more institutional investors may feel comfortable investing in crypto assets.
What is a crypto hedge fund?
As the name suggests, a crypto hedge fund refers to a type of hedge fund that invests in crypto assets. Some of these funds invest only in digital assets, while others combine cryptocurrency investments with investing in traditional types of assets such as stocks and bonds.
Crypto hedge funds have been created to pool funds from investors and strategically trade cryptocurrencies to generate returns.
Unlike traditional hedge funds, crypto hedge funds are specialised in cryptocurrency fund management and investing in crypto assets by utilising various strategies to generate returns. For example, they buy and sell crypto assets and trade futures.
It is not unusual that crypto hedge funds also invest in venture capital and private equity for blockchain and crypto start-ups to provide a more diversified pool of assets for involved investors. These funds are usually managed by experienced professionals that employ various risk management techniques to generate returns.
Are crypto hedge funds popular?
Crypto hedge funds have experienced a growth in traditional hedge funds investing in cryptocurrencies, indicating a broader adoption of digital assets and blockchain technology. In recent years, the crypto industry has witnessed rapid growth, and investors are turning now to crypto hedge funds for exposure to this emerging asset class.
A 2023 Global Crypto Hedge Fund Report, jointly produced by PwC, the Alternative Investment Management Association (AIMA) and CoinShares, found that the average allocation to cryptocurrency assets managed by traditional hedge funds increased from 4% to 7%, along with more than one-third of traditional hedge funds stating that they are thinking of investing in crypto assets.
Hedge funds’ curiosity was sparked by the tokenisation of funds which can be used to increase efficiency and enable faster settlement times and lower operating costs. The popularity of cryptocurrency hedge funds or traditional hedge funds investing in crypto assets expanded due to the need for general portfolio diversification and the possibility of long-term outperformance of these emerging assets.
The future of the crypto hedge fund industry seems promising. As cryptocurrencies continue gaining acceptance and the infrastructure supporting digital assets matures, the demand for crypto hedge funds could surge.
How do crypto hedge funds work?
Crypto hedge funds act as an intermediary between traders who set up the crypto fund and the investors who invest in the fund. Crypto hedge funds represent a novel segment of the investment industry which is gaining a lot of popularity.
Crypto hedge funds utilise two approaches to investing – discretionary and systematic. The discretionary approach means that the crypto hedge fund manager decides on all important investment matters while the systematic approach is based on computer transaction processing models.
The second approach is deemed less risky because the whole process is automated, yet the first approach is still praised as an efficient one.
Most crypto hedge funds employ a conservative policy regarding dealing with investors’ funds. For example, approximately 80% of funds belonging to private and institutional investors are invested in mining cryptocurrency to provide a small yet stable income. The remaining 20% is for speculative activities regarding cryptocurrency trading.
Crypto hedge funds produce revenue through an annual management fee that ranges from 1% to 4% of the invested amount. Additionally, investors can be required to pay a percentage of earned profit as performance fees for crypto hedge fund services.
Advantages of crypto hedge funds
Crypto hedge funds bring to the table several benefits for investors. Let's check them out.
Portfolio diversification
Crypto hedge funds provide a higher level of diversification by offering exposure to digital assets and managing risks associated with cryptocurrencies. A successful investment strategy involves diversification and many investors consider it as a significant element of their investment activities.
A successful crypto hedge fund carefully selects a diversified portfolio of digital assets and utilises active trading strategies to maximise returns and manage risk effectively while taking into account investor protection and overall transparency.
Additionally, a crypto hedge fund may have access to emerging crypto projects or private investment deals that are not yet available to private investors. Therefore, they present a good alternative that enables investors to diversify their investments and try out a new asset class.
High return potential
Hedge funds pursue active trading strategies to buy and sell crypto assets with the aim of profiting from price fluctuations and market inefficiencies. Crypto hedge funds can yield higher returns due to investment strategies typically employed by such funds.
Crypto hedge funds can increase liquidity by employing more accessible positions compared to traditional finance. The volatility of the cryptocurrency market opens a possibility for significant returns.
Professional management
As investment vehicles that pool capital from multiple investors to invest in cryptocurrencies and related assets, crypto hedge funds are managed by professional portfolio managers that employ various risk management strategies to generate returns in the volatile crypto market.
Assets in hedge funds, either traditional or cryptocurrency hedge funds, are typically managed by highly qualified fund managers with a deep understanding of finance and the crypto market. This is important when it comes to the crypto space since inexperienced personnel may fall victim to scams.
Therefore, qualified crypto hedge fund managers often encompass robust financial backgrounds, a deep understanding of blockchain technology as well as a proven track record of managing digital assets, investment volatility and complicated risk profiles which helps investors make more informed investment decisions.
Drawbacks of crypto hedge funds
Crypto hedge funds are not flawless; there are several disadvantages that must be taken into account. Let's explain them briefly.
Crypto hedge funds' risky nature
Considering the cryptocurrency market’s high volatility, lack of regulation compared to traditional markets and concerns regarding fraud presents a significant challenge for investors. Risk management can be affected by operational risks as well, such as security breaches.
The nature of cryptocurrency products is risky and therefore, investment activities related to the purchase or sale of these digital assets can bring a broad income but significant losses as well. An incorrectly chosen investment strategy can increase these risks.
High fees
Typical fee structures of crypto hedge funds include a fee for management and returns. Annual management fees range approximately from 1% to 4% of a hedge fund’s net worth, along with income fees that amount to approximately 20$ of annual results.
Thereby, high fees for management and performance can impact overall returns. The crypto market’s tendency for unpredictable changes based on market sentiment adds more uncertainty.
The income may be also impacted by the previous year’s losses since funds primarily recoup past losses and then distribute profits. With this in mind, investors should be cautious when choosing a crypto hedge fund.
High barriers to entry
The access to hedge funds and regulated crypto hedge funds are mainly available only to qualified investors in relation to a broad entry threshold. Therefore, crypto hedge funds exclude a broader investor demographic.
Limited track record
Crypto hedge funds are relatively new, so it is hard to assess their long-term performance based on past data. It is considered that they employ a controversial investment strategy that balances between maximisation for profit and risk management. Crypto hedge funds’ returns are tied to their yield; trade-offs between positive returns and associated risks are yet to be assessed.
Crypto hedge funds' security
To decrease market-related risks and safeguard investors from cyber threats such as fraud and hacking, crypto hedge funds need to utilise strict risk management and robust security measures.
Since investing in crypto hedge funds includes broader amounts of funds laid down by qualified investors as well as market fluctuations and risks related to regulatory developments, crypto hedge funds tend to implement robust fund operations and cybersecurity strategies.
Beyond the protection provided by crypto hedge funds, individual investors can increase their security by adopting recommended security practices and doing their own research on various occurrences on the market.
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Strategies of crypto hedge funds
According to several reports on crypto hedge funds’ performance, they employ divergent investment strategies to navigate the dynamic cryptocurrency market.
Funds tend to implement quantitative approaches which mostly have either a directional or market-neutral strategy to trading. Such hedge fund strategies are, for example, arbitrage, high-frequency trading and arbitrage.
Secondly, crypto hedge funds combine a wide array of investment strategies such as long/short, relative-value, event-driven as well as crypto mining strategies. Reports suggested that the multi-strategy used to perform well.
Some funds characterise themselves as discretionary long only which means that they aim for a longer investment time period. Reports suggested that such funds had a good return rate on investment back in 2019.
Popular crypto hedge funds
With the development of blockchain technology and the crypto space, the hedge fund industry is growing and providing new possibilities for managing capital. Let's take a look at several top crypto hedge funds on the market.
Pantera Capital
Pantera Capital presents a crypto investment fund that offers investors a wide range of capital allocation possibilities within the crypto sector. This American hedge fund launched the first crypto fund in 2013.
As explained by the company itself, its liquid token fund is driven by a discretionary strategy that focuses on decentralised finance (DeFi).
The Liquid Token Fund launched back in 2017. It encompasses a minimum investment threshold of $100,000 as well as a 2% management fee and a 20% performance fee.
Pantera’s Blockchain Fund deals with investing in early-stage tokens, venture equity and liquid tokens with a minimum investment of $1 million.
Morgan Creek Capital Management
This crypto hedge fund, based in North Carolina, became one of the most popular hedge funds providing clients with diverse options. The company introduced Morgan Creek Digital as a cryptocurrency hedge fund extension.
Morgan Creek Capital Management stated many times that their investment strategy is centred around portfolio diversification and the integration of alternative investments.
Morgan Creek Digital invests in seed and early-stage blockchain and AI companies as well as various digital assets. The company partnered with Bitwise Asset Management to provide their clients exposure to various cryptocurrencies.
It includes a 2% management fee and a minimum investment threshold of $50,000.
Galaxy Digital
Galaxy Digital, a New York-based company launched in 2018, is another popular crypto hedge fund.
The company invests in cryptocurrency and crypto projects; so far, Galaxy Digital has invested in approximately 20 cryptocurrency projects such as Ripple, Bitstamp and BlockFi.
Galaxy Digital’s average management fee moved from 1.71% to 1.69% over the years but the median management fee remained at the 2% standard.
The company stated in its 2024 report that the average and median performance fee for crypto hedge funds fluctuated between 21.7% and 20%, adding that it is common for more experienced managers to ask for a higher performance fee.
Multicoin Capital
The company Multicoin Capital was founded in 2017 and became one of the leading crypto hedge funds that invests in project tokens and shares of blockchain companies.
As stated by the company, it utilises an unorthodox investment strategy based on research, analytics and scientific data.
The company maintained a 2% management fee and a 20% performance, including a minimum investment of $100,000.
BH Digital
Brevan Howard Asset Management is a crypto hedge fund that manages assets on a global scale for institutional investors in relation to diverse asset categories such as equities, commodities, and foreign exchange.
In 2021 the company launched BG Digital as a division that deals with digital assets. According to Brevan Howard Asset Management, BH Digital actively takes part in staking, network governance and running nodes as well. Additionally, BH Digital aims to strengthen crypto investments through a variety of services such as capital raising, blockchain development and compliance assistance.
In 2022, it was reported that the company managed to raise more than $1 billion from institutional investors for a crypto fund, and that it took over a crypto hedge fund run by Dragonfly Capital in 2023.
Similar to other crypto hedge funds, BH Digital includes a 2% management fee and 20% performance fee.
Why are crypto hedge funds important?
Crypto hedge funds are an important trait of the new digital economy; they became more than just investment vehicles by reshaping the digital assets’ ecosystem.
These hedge funds navigate through a complex market filled with constant technological innovation and an uncertain regulatory environment. To do this task efficiently, a crypto hedge fund needs to set out teams that encompass a deep understanding of the crypto market and blockchain technology.
They are considered to be liquidity providers; since cryptocurrency markets are prone to price fluctuations, crypto hedge funds assume the role of whales and due to their capital, they can try to decrease the overall volatility. Because of their expertise, these hedge funds can hold onto their positions even during periods of market volatility by taking on a long-term view.
Crypto hedge funds assumed the role of a bridge between traditional finance and the crypto space. The inclusion of established institutions and broad investment companies with a good track record signals to investors that cryptocurrencies are an asset class that is worthy to consider.
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Finally, crypto hedge funds have the potential to foster innovation within the crypto space and speed up crypto adoption. Many crypto hedge funds are active participants that give away a portion of their funds to venture capital investments in blockchain startups as well as conducting constant research in the area of blockchain innovations.
What do you need to know before investing?
All investments are risky, but the crypto space and hedge funds are associated with a higher degree of risk. These two combined means that you can earn a lot of money quickly but you can also lose your funds.
Even though crypto hedge funds employ teams of experts and various robust risk management techniques, it is always a good idea to do your own research before investing.
When it comes to crypto products, keep in mind that not all assets are created equal. Due to a lack of regulation and rapid technological advancements, new tokens are appearing frequently.
You should take some time to examine the hedge fund before investing; take a look at the founders, the company’s track record and learn about market dynamics. Only by educating yourself you can make informed investment decisions.
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