What You Need to Know Before Investing in Crypto Hedge Funds

Handy Tips / 23.05.2020

Hedge funds are not subject to particular federal rules that protect your average investor. They are also known for the high risks associated with them. Add that to the inherently volatile nature of cryptocurrency, and you have a bigger gamble in your hands than any other type of investment. 

That said, crypto hedge funds have increased in popularity over the years, garnering a steady stream of interest from investors.

As the crypto world continues to evolve and attract more attention, the crypto hedge fund trend is also growing stronger. All investments carry risk, but with crypto hedge funds giving you more than average risk, you need to be well prepared. 

If you don’t know where to start, this article will be quite useful. We’ll look into the basics of crypto hedge funds and their challenges in the crypto space. 

What is a Crypto Hedge Fund?

A hedge fund isn’t a specific type of investment. Instead, it’s a different way for a person to invest in a large pool of investment structures. These are managed and continuously analyzed by a money manager or a team of registered investment advisors to make a return. You need to meet a certain income and net worth requirement before investing in a hedge fund.

A crypto hedge fund is a regular hedge fund that manages portfolios containing cryptocurrencies. 

There are two significant types of crypto hedge funds on the market:

  • Funds that manage portfolios containing exclusive cryptocurrency
  • Funds that manage cryptocurrency in their portfolio along with a mix of other types of assets

Both types of cryptocurrency hedge funds are looking to invest for more benefit. However, the fund with an exclusive cryptocurrency portfolio seeks to maximize returns by investing in newly offered coins (ICOs/IEOs/STOs) aiming to replicate the growth of Bitcoin. The mixed portfolio fund is, on the other hand, more risk-averse and less profitable in regards to cryptocurrencies’ stellar rise.

Investing in Crypto Hedge Funds

Hedge funds play an essential role in adding depth to the capital market. When fund managers decide which tokens sales to invest in, they end up reducing or eliminating chances of mispricing in the financial markets. They endlessly analyze the market to know when to buy and sell cryptocurrency to increase the investors’ profits. This leaves the investors with the possibility of making good money without much effort.

In return, the hedge funds get a percentage of the profits gained from the investments depending on the initial agreed rates.

However, before committing to investing in a crypto hedge fund, there are some things you should know. Hedge funds are focused on looking for significant short-term gains instead of long-term slower growth investments. 

While it is possible to earn a lot of money very fast through a hedge fund, there is also a high possibility that you might lose a lot of your capital in volatile speculative investments. So, maybe calling it a gamble might be more fitting. 

That doesn’t mean that you shouldn’t invest in crypto hedge funds or that they aren’t a wise investment. If the layers of risk associated with it still appeal to you, then, by all means, go ahead. Just be sure to do a lot of research on the fund managers beforehand. Remember not to put all your eggs in this one high-risk basket, even with the allure of high returns.

Challenges in The Industry

Cryptocurrency remains a small percentage of the hedge fund industry that is overrun by traditional assets investment. While the volatility of cryptocurrency means that no one can predict its value in the future, its growth history is a positive sign. Nevertheless, the industry is still plagued by some challenges that are preventing the growth of crypto hedge fund investment.

  • Restricted Market

Hedge fund investors are required to reach a particular net worth before they are allowed to invest. Furthermore, they need to be part of an existing team of either an asset management firm or a prop trading firm to invest in a new fund. The conditions set before even being allowed to invest in the hedge funds dissuade many interested investors. It also creates a monopoly in the market of an exclusive group of investors who all belong to the same tax bracket.

  • Strategy

A survey of the most significant global crypto funds by PWC in their Hedge Fund Report identified that there are four main crypto hedge fund strategies. These include quantitative, which was the most common, discretionary long/short, discretionary long-only, and multi-strategy. 

The challenge in choosing a strategy comes in when potential investors want to see a clear plan that doesn’t depend on specific economic conditions or government policies. They want strategies they understand 100% rather than a potentially higher return but complicated and unclear strategy.

  • Cryptocurrency Volatility

In 2019 nearly 70 crypto hedge funds closed due to the volatile non-secure market of bitcoin and other cryptocurrencies—these funds primarily catered to institutional investors such as pension funds and family offices. According to Crypto Fund Research’s website, as of the same year, there are currently 804 cryptocurrency funds in total, 355 of which are hedge funds, and 425 are venture capital funds.

Endnote

According to PWC’s 2020 report, investments in bitcoin and other cryptocurrencies by crypto hedge funds directly correlates with crypto price behavior and growth over time. It showed that total assets under management in crypto funds grew from $1 billion in 2018 to more than $2 billion by the end of 2019. 

As more people are looking to invest in digital assets, there is a wide range of cryptocurrency hedge fund companies to meet their demands. Potential investors must do thorough research on these fund managers and their reputation. After all, you’re going to trust them with your hard-earned money, so due diligence won’t hurt.

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Wayne is a Blockchain enthusiast and expert in crypto trading. Currently, he covers trendy issues on digital currencies.