What is a Crypto Hedge Fund And How Does It Work?
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Understanding a Crypto Hedge Fund
Crypto is an investment instrument that is relatively new and still in its infancy. It is a very high-risk and speculative asset that isn't backed or regulated by governments like a fiat currency. Cryptos are also very volatile, making hedge funds based on them even more volatile than hedge funds focussing on other investment instruments. However, it is a very lucrative investment making it attractive to hedge fund investors. Novelty and lack of regulation cause new crypto tokens to pop up constantly. Bitcoin persists as the standard, followed by Ethereum in market establishment and utility. Dogecoin is an outlier with a unique fan base driving its growth and volatility. Experienced managers run the crypto hedge funds, re-adjusting investments contingent on prevailing market conditions.
Exclusive and Non-Exclusive
A crypto hedge fund may invest exclusively in crypto-assets or make cryptocurrencies part of its investment strategy and traditional instruments in stocks, bonds, etc.
Crypto Hedge Funds Strategies:
• Discretionary Long Only:
Long-only funds whose investors have a longer investment horizon. These funds invest in early-stage token/coin projects, buying, and holding more liquid cryptocurrencies, and have the most prolonged lock-up periods.
• Discretionary Long/Short:
They cover a broad range of strategies, including: long/short, relative value, event-driven, technical analysis, and some crypto-specific strategies, such as mining. They often have a hybrid approach, including investing in early-stage projects. The lock-up period is similar to the Discretionary long-only group.
• Quantitative:
Funds take a quantitative approach to the market in either directional or market-neutral. Representative strategies incorporate market-making, arbitrage, and low latency trading. Due to the requirement of liquidity in quantitative strategies, the funds are restricted to trading only highly liquid crypto assets. Subsequently, these funds have the shortest lock-up periods for investors.
• Multi-strategy:
Funds adopt a mix of the above strategies. Due to the limitations of a particular strategy, some may decide to combine discretionary short/long and quantitative sub-accounts. In order of priority, quantitative funds are the most common among crypto hedge funds, followed by discretionary long/short and discretionary long-only, with multistrategy funds making up a minor proportion.
Fund Utilization
An extensive range of strategies is employed to generate returns. Funds apply technical analysis to understand market movements and use various trading types such as day, swing, and position. Crypto funds use cryptos like Bitcoin for purposes other than for investment. High net worth clients willingly take calculated risks and like to invest in cryptocurrencies.
Proper utilization is critical in investment decision-making for cryptocurrency investors. The unregulated sector allows the crypto market to offer unrivaled opportunities.
However, staking, lending, and borrowing have their drawbacks. The asset value decreases if the network value drops unexpectedly or becomes less popular.
Fee Structure
Crypto hedge funds earn revenue from investors, which covers the running costs. High profits encourage clients to pay the price charged.
Investor Type
Looking at the market for crypto hedge funds, High-net-worth individuals, ‘HNWIs', are the most common investor type. Family offices come second, and funds of funds, a distant third. Although institutions have been aggressively plowing into cryptocurrency markets, they are not yet prevalent investors in crypto hedge funds. This mix in the investor base will gradually change with the increased levels of interest from institutional investors.
Profitable Strategies To Manage A Hedge Fund
Starting A Crypto Hedge Fund
Relatively few barriers exist to starting a hedge fund. Hedge funds are distinct business entities structured as limited partnerships or limited liability companies(LLC). The choice of a commodity determines the procedures. The asset value and management necessitate registration with the Securities and Exchange Commission (SEC).
The Future of Crypto Hedge Funds
More regulations will impact crypto hedge funds and scale institutional interest in them. Regulatory clarity, including a framework, will help the crypto hedge funds industry as institutional investors need it, raising the entry barrier to launching new crypto hedge funds and creating a sustainable long-term ecosystem. There are many unique opportunities, with several new crypto funds focusing on emerging trends like NFTs and the metaverse. Established crypto hedge funds are rapidly growing their assets under management.