Crypto markets lag behind TradFi in drawing hedge fund engagement

Crypto markets have attracted their share of hedge funds. The heightened volatility allows for hedging strategies, attracting a share of firms that also double as sources of VC funding.

The share of cryptocurrency hedge funds is relatively smaller compared to traditional finance. In TradFi, hedge funds oversee 100% more assets, taking up 3-4% of available markets. In crypto, even with its relatively smaller market, hedge funds only carry 1.5% of investable assets. 

The current number of funds hinges on a valuation of $1.1T for crypto assets excluding Bitcoin (BTC). The Bitcoin market cap is also above $1.1T, offering a more liquid market. Analysts believe hedge funds can continue to expand into the crypto space as they mature, reaching the share of funds in TradFi.

Demand for both traditional and crypto hedge funds grew in Q1, with assets under management reaching $4.3 trillion . Hedge funds became attractive as market turbulence grew, offering a way to offset slow general growth with actively managed strategies. 

In the past year, crypto funds added 200 new entities with varying quant strategies. Predominantly, funds from the US entered the market as interest in crypto grew. Hedge funds differ in their strategies, as well as in their crypto-holding behaviors. Some choose to use Coinbase Custody, while others actively engage with public blockchains and hold coins outright. 

Crypto funds have a relatively short track record

Most crypto hedge funds have a short track record, with 56.2% between 1-3 years in the market. Roughly 34% of funds have existed for more than three years, and just 7.2% have a track record of four or more years. Vision Track noted that about 35% of the existing hedge funds were wiped out during the 2022-2023 bear market. From May 2022 onward, 250 out of 715 crypto-dedicated funds had to close.

At the end of 2023, crypto hedge funds had $15.2B under management, with $11.4B distributed to fundamental strategies, $1.8B in quant directional funds and $1.9B in market neutral funds.

Crypto hedge fund allocation is also slower than the market trends and narratives, as outlined in the Vision Track report for 2023. Crypto natives can allocate funds faster and in a more agile way, as narratives switch within weeks.

Funds with fundamental strategies performed the best due to the diligent selection of assets. Hedge funds assets under management remained flat at around $10B for most of 2023. The assets expanded by more than 41% at the end of the year when the last quarter started giving the first signs of a bull market. 

Crypto hedge funds are also awaiting the realization of asset tokenization, which could lead to $400B in new opportunities and liquidity. For now, beyond Securitize, few startups have created tokenized assets. 

Crypto hedge funds face market and technological obstacles

Hedge funds have been key for the development of the crypto space, as they have also provided VC funding. Some of the biggest players in the space include Pantera Capital, Polychain Capital, and Digital Asset Group. New entrants have been cautious since the crash of Three Arrows Capital, one of the leading hedge funds, during the boom of 2021.

Crypto hedge funds also faced a culling during the first significant bear market of 2018, when most of them closed. The other problem for crypto is that assets are not guaranteed longevity or liquidity, as several older generations of coins and tokens have crashed to zero with no liquidity or use cases.

The other big obstacle for hedge funds is the ability to outperform Bitcoin (BTC). Most altcoins underperform or go down to zero compared to BTC. For that reason, mainstream hedge funds seek simplified ways of interacting with BTC, especially through the recently launched fully regulated ETFs. Crypto insider funds sometimes manage to outperform BTC through active asset management. 

For crypto, the funds also come from crypto insider organizations, which understand the more specific earnings potential of the sector. Hedge funds like MEV Capital are active in DeFi, directly managing vaults and liquidity.

Cryptopolitan reporting by Hristina Vasileva