Crypto hedge funds are proliferating at an accelerating pace

Even with the tremendous volatility in the crypto sector, there are many more traditional hedge funds investing in crypto and more specialist crypto funds being created as the digital asset class gains acceptance. Two-thirds of crypto hedge funds will fail due to the massive sell-off that was sparked by Fed tightening, Mike Novogratz predicts. Of traditional hedge funds surveyed, 38% are currently investing in digital assets, compared to 21% a year ago.

Meanwhile, the number of specialist crypto hedge funds is estimated to now top 300 globally, with the pace of new funds being created accelerating in the past two years. Total assets under management (AuM) of crypto hedge funds surveyed was US$4.1bn in 2021, up 8% from the year prior. According to a report, most traditional hedge funds getting into digital assets are still just dipping their toes – 57% have less than 1% of total AuM in digital assets. But it is notable that for 20% of these funds, digital assets represent between 5% and 50% of AuM.

Further, two-thirds of funds (67%) currently investing in digital assets intend to deploy more capital into the asset class by the end of 2022. There are literally 1,900 crypto hedge funds. It is guessed two thirds will go out of business and the recent collapse of Terra vividly demonstrated the potential risks in digital assets. The volatility will continue, but the market is maturing and with that not only many more crypto-focused hedge funds and higher AuM are coming but also more traditional funds are entering the crypto space.

Regulatory uncertainty is a key issue for hedge funds, whether or not they are currently invested in digital assets. Lack of regulatory and tax regime clarity was cited as a top challenge by 89% of hedge fund managers who currently invest in digital assets and for managers not currently investing in crypto, regulatory uncertainty ranked as a main obstacle by 83%.

Crypto-focused funds are attracting an increasing amount of investment talent, according to a report. In 2021, the average investment team size grew from 7.6 to 9.6 people. There is also an increasing focus on operations and governance. The percentage of crypto hedge funds using an independent custodian increased in 2021 from 76% to 82%. The vast majority, 91%, of funds surveyed have hired an independent auditor.

The number of funds with independent board directors also saw a marked increase to 51% in 2021, compared to 38% in 2020. In the traditional hedge fund space, managers point to a number of market infrastructure areas in need of improvements for digital asset adoption, led by audit and accounting, identified by 94%, and also including risk management and compliance (93%), ability to use digital assets as collateral (93%) and fund administration (89%).

Bitcoin, the largest cryptocurrency by market capitalization, is down 36% since the start of 2022. Bitcoin has faced resistance above the $30,000 level and was changing hands at $30,367 at presstime. The report highlights crypto hedge funds and excludes data from crypto index/tracking/passive funds and crypto venture capital funds.