Although the nascent crypto hedge fund industry still has lots of developing to do, it will undoubtedly be the future of finance. I started exploring Bitcoin first in 2012 and, still today, I am fascinated by the opportunities and future potential digital assets pose as an emerging alternative asset class. One of the most relevant recent developments, which is often not covered, is the emergence of crypto hedge funds. Compared to the early days of crypto assets, when there were mainly private investors or traders in the space, a massive inflow of professionals entering the market has begun with the emergence of crypto hedge funds.
In fact, looking at data from 150 of the largest global crypto hedge funds, 63% were launched in 2018 and 2019, according to a survey by Big Four audit firm PricewaterhouseCoopers and Elwood Asset Management Services earlier this year.
It is all about the performance
Based on the annual PwC–Elwood Crypto Hedge Fund Report, the most common crypto hedge fund strategy is quantitative (48% of funds), followed by discretionary long-only (19%), discretionary long/short (17%), and multi-strategy (17%). When it comes to crypto fund performance, systematic crypto funds have been outperforming passive strategies (investing long-only), discretionary long/short, and multi-strategies quite significantly. In 2019, the average crypto hedge fund performance by strategy was as following:
These numbers suggest that systematic hedge funds are the best performing strategy for digital assets, but, in general, all crypto hedge fund strategies are able to generate sustainable alpha.
The ecosystem for crypto assets and crypto hedge funds is growing
The vast majority of investors in crypto hedge funds are either family offices or high-net-worth individuals. A growing number of funds of funds have been investing in crypto hedge funds, causing the whole ecosystem to evolve quite quickly. The fact that the percentage of crypto hedge funds with assets under management of over $20 million nearly doubled to $44 million last year indicates that more funds are reaching a critical size, which enables them to sustain their strategy.
More and more talent from the traditional hedge fund world is moving into digital assets, including established hedge fund titans like Paul Tudor Jones. Wall Street is also becoming more open to Bitcoin (BTC) as a new asset class, and well-known Wall Street names including George Ball, the former CEO of Prudential Securities, suggested Bitcoin or other cryptocurrencies could be “a safe haven” for investors and traders as an alternative investment.
The news of MicroStrategy buying $250 million in Bitcoin (60% of their treasury) in August 2020 and stating: “Bitcoin is digital gold — harder, stronger, faster, and smarter than any money that has preceded it” have been a big boost for established investors looking into the crypto markets. Back in May 2020, I explained why Bitcoin is an ideal inflationary hedge, and institutional investors are increasingly looking at this emerging asset class from a hedging perspective. It is obvious that investments in crypto hedge funds will be a big part of these additional inflows of capital.
A massive increase in investor demand
Given the transparency among most regulated crypto hedge funds with external investors regarding the fund’s performance and assets under management, the growth in investments is becoming apparent. Total assets under management of crypto funds worldwide doubled from 2018 to the end of 2019 (from $1 billion to $2 billion); and there are clear indications that this number will have roughly tripled by the end of 2020. Compared to other alternative asset classes, these are still rather small sums, but the growth rate indicates the direction the industry is moving in. Increases in assets allocated to crypto hedge funds and further indications that Bitcoin is a digital store of value and a new hedge against inflation show why and how demand from investors has been accelerating.
Interesting times ahead for crypto hedge funds
Looking at the talent moving into the space and the increasing demand from institutional investors makes me quite confident about the near future. It will be crucial for the industry to generate sustainable alpha in the future and prove that active investment strategies among crypto hedge funds are superior to a passive long-only approach, such as “holding.” This performance was demonstrated to date by the outperforming of successful crypto fund managers.