One of the latest trends in crypto investing is through hedge funds. The surge in value of cryptocurrencies has led to the growth of hedge funds. More and more ways of getting into cryptocurrencies are popping up each day. In the beginning, the only way to get into cryptocurrencies was through buying the currencies directly in exchanges or through peer-to-peer networks. This still remains the main method through which majority of people get into cryptocurrencies. New ways are popping up every day such as investing in protocol level instead of application level (more of that on another post). Another way is through hedging. Data from Autonomous NEXT shows that there are more than 200 crypto hedge funds and in 2017 alone, 167 of them were launched. These funds are estimated to manage $5 billion in crypto assets. 2017 saw a huge surge in the market value of major cryptocurrencies and so did the formation of hedge funds.
How do hedge funds work?
Basically, hedge funds are a form of an investment fund that is used for speculation on certain assets. The nature of hedge funds is that they are not regulated in the same way as other funds such as mutual funds. A group of accredited investors or institutions come together and form a fund to invest in different assets. Through various risk management techniques, hedge funds make predictions about the future price of a certain asset at a certain time in future. They do this by going long on the market i.e. prediction that the market will rise or shorting the market (anticipating a fall/drop in stock market prices). By nature, hedge funds thrive in volatile markets because they win either way based on how fund managers play their cards and therefore it seems crypto markets are a boon for hedge funds. Hedge funds have existed for long and they can invest in all types of assets such as land, derivatives, real estate, currencies and other assets. In crypto world, hedge funds were not very common until 2017.
The hedge funds returns in 2017 were astronomical similar to gains in the crypto market. This report suggests that some made returns of up to 3000%. However, the returns have not been so good especially in the first quarter of 2018 with returns dropping up to 23%. Also, Coindesk reported that up to 9 crypto hedge funds have closed down in the first quarter of 2018. Nonetheless, this has attracted the regulators with SEC (Securities and Exchange Commission) in the USA to say that it is preparing to examine the operations of more than 100 hedge funds that are focused on cryptocurrencies. Current hedge funds have adopted different mechanisms to ensure profitability seeing that crypto is a completely new asset class which may not behave like existing asset classes.
One of the main crypto hedge funds Polychain Capital was considering going public in Canada but withdrew the decision. It currently has more than $250 million under management. Majority of these hedge funds are located in Europe, Asia, and the USA. In Africa, there has not been much public activity relating to crypto hedge funds. Only an index fund has been heard of which is Crypto20, launched last year. An index fund is a more balanced type of investment. For Crypto20, It invests in top 20 cryptocurrencies. So as an investor owning the crypto 20 coin, holds a portfolio of top 20 cryptocurrencies. The crypto20 index fund is now live. We will talk more about this in subsequent posts.
The use cases of distributed ledger technology that is driving cryptocurrencies such as Bitcoin, Litecoin, Ethereum and more than 1500 other cryptocurrencies is gaining traction each day. Hedging crypto seems to be one of the main ways the moneyed investors are going to enter the cryptocurrency markets globally. All in all, hedging exists on other types of investment markets and in some way it helps stabilize the market and protect investor funds, therefore, it is inevitable that it will end up in the crypto markets. However, crypto markets are by nature decentralized, so it will be interesting to see the whether the decentralized crypto hedge funds will work and what that will mean since now everyone can be able to invest since it will no longer be a preserve for accredited investors. Only time will tell.