12 Mar 2018 · 4 min read

Digital Currency Hedge Funds Are Jumping on the Crypto Bandwagon

Digital currency hedge funds lost an average of 4.6% in January.

Until last year, there have only been a few select funds investing in bitcoin and alternative digital currencies. In 2017, however, as bitcoin went mainstream and Initial Coin Offerings (ICOs) became the latest new investment rage, digital currency-focused hedge funds suddenly started to spring out of the ground like mushrooms.

Since the beginning of 2017, over 189 hedge funds have been founded to capitalize on the high earning potentials of the crypto asset market, according to data compiled by research firm Autonomous NEXT.

At the end of February, there were 226 crypto hedge funds in the market, according to data by the same firm. This figure has doubled since October 2017, when 110 global hedge funds were recorded in this market segment. Moreover, asset under management held by digital currency funds have surged to an estimated USD 3.5 billion to USD 5 billion according to the research company.

A Bad Start to the Year for Crypto Funds

Despite increasing investor demand for digital currency investments and more funds entering this space, returns have been lackluster year-to-date as bitcoin (BTC) dropped from its high of USD 20,000 in mid-December to a low around USD 6,000 in early February.

According to data from hedge fund research firm Eurekahedge, digital currency hedge funds lost an average of 4.6% in January. This runs in comparison to the 1,477.85% returns that the nine crypto hedge funds tracked by Eureka made in 2017.

“While the softer prices of crypto assets does create a more difficult environment for investors, I do not think it will pause the influx of funds and other financial institutions building products in the space. It would take the extreme case of the entire space contracting by 80% and high regulation before the flow of funds turns around,” Autonomous NEXT partner Lex Sokolin told Reuters in February.

Furthermore, many hedge fund managers in this space believe that the latest market correction is nothing more than normal crypto asset market volatility and believe in “hodling” bitcoin and other cryptocurrencies.

Brian Kelly, for example, who runs a digital currency small hedge fund called BKCM Digital Asset Fund told CNBC Squawk Box that he has invested “like 90% [in digital currencies]. I run a fund. I have my money in that. But that's not for everybody. I'm making a big bet."

"This is broader than just a currency. I'm making a bet that this is a new asset class in general," Kelly added.

Kelly’s sentiments are shared by Jehan Chu, co-founder of the crypto hedge fund Kenetic Capital. He told Forbes: “Patience equals profit when it comes to realizing long-term value in the crypto space. Most realized gains thus far are speculative and only a shadow of what’s to come when blockchain technology and its market matures.”

Hedge Fund Strategies in the Digital Asset Space

Hedge funds are usually only open to accredited investors and institutional investors and not for the general public.

The drop in crypto valuations is not necessarily bad for all hedge funds in this space as different funds apply different strategies. According to Reuters, some cryptocurrency hedge funds invest purely in bitcoin, taking both long and short positions, some build diversified portfolios of digital assets while others look to exploit arbitrage opportunities between different exchanges.

Most cryptocurrency hedge funds take more of a passive buy and hold approach and invest in the most promising and most liquid cryptocurrencies in order to benefit from their long-term price appreciation.

Other hedge funds take a more active approach and trade in and out of bitcoin and other cryptocurrencies using leverage to benefit from intra-week price movements.

Additionally, a common but controversial strategy deployed by hedge funds in the ICO sector is to purchase promising tokens during the pre-sale period at a steep discount, to then flip them once the new token hits exchanges. This explains why many ICO tokens lose in value after hitting exchanges to then rally afterward, a phenomenon often “blamed” on ICO bounty hunters looking to cash in.

With hedge funds, who regularly deploy aggressive trading strategies, becoming a larger percentage of market participants, and increase in trading volumes can be expected in the months and years to come. More automated trading will also likely become an aspect of an increased hedge fund presence, as algorithmic trading is a popular tool in the hedge fund investor community.

Whether more institutional investors, such as mutual funds and pension funds, will follow hedge funds into the crypto asset space remains to be seen. But as a global regulatory framework for cryptocurrencies is expected to be put into place in 2018, it would not be a surprise, if cryptocurrencies will become a fully integrated part of the global financial markets in the same way as bitcoin managed to in 2017, when regulated bitcoin futures contracts were launched on two large derivative exchanges in the U.S., the CME and CBOE.