Cryptocurrency hedge funds exploded into a near trillion dollar industry over the past few years. But service records have been spotty — some investors have lost hundreds of thousands of dollars even as the crypto market expanded. Crypto is still notoriously volatile, and the COVID-19 scare took many crypto focused hedge funds down. Other crypto hedge funds double assets under management (AUM) in 2019.
Are cryptocurrency hedge funds the investment vehicle for you? Let’s take a closer look at what a cryptocurrency hedge fund is and how it can be used.
Crypto Hedge Fund Explained
A crypto hedge fund is basically a crypto trading platform where you pay someone else to do the trading. Crypto hedge funds are similar to traditional hedge funds in this way, but that’s really where the similarities end.
Regulatory agencies classify cryptocurrencies like Bitcoin and Ether as commodities not securities. The hedge funds that deal with crypto are not subject to securities regulations. There is an ongoing fight about this classification, but the courts don’t seem to have a viable case for reclassification.
The lack of regulatory guidance means that crypto hedge funds must set forth their own set of best practices to protect investors and the industry. No regulation means a greater risk of fraud in the world of crypto than in traditional hedge fund investing. Investor losses can be much higher as well because speculative coins — also unregulated — can quickly disappear through theft or fraud.
Hedge funds are not actually known for hedging — limiting trading risk — but for leverage. Leverage exponentially multiplies trading risk to potentially capture higher gains. This can be extremely profitable, but it also means a potential for huge losses.
Hedge funds don’t have the advantage of time, either. If trades go wrong for a fund, you can’t always simply wait for the tide to turn. Big, fast losses sometimes mean liquidation.
All of the downside potential hasn’t stopped investors from moving into the crypto hedge fund space. Approximately 150 hedge funds are splitting $2 billion in funding with the median fund managing $8.2 million. Year over year the amount under management has doubled from 2018.. Crypto funds are forced to charge higher fixed fees or divest attention away from pure investing. Outside of Bitcoin, the top crypto traded by crypto hedge funds included Ether, Ripple, Litecoin, Bitcoin Cash and EOS.
How to Start a Crypto Hedge Fund
A lack of regulation in the cryptocurrency space also means that anyone can start a hedge fund. You don’t need an office, technical expertise or employees — all you really need is the trust of people who will invest in you. There are many “hedge fund technology” platforms that take care of the back end tech, leaving you to focus on marketing and trade.
Here’s a short primer on how to build your own simple crypto hedge fund:
- Define your strategy: There are many different ways to trade, but hedge funds usually stick to a specific strategy. Remember, you must not only have a successful trading plan, but you must also be able to easily describe that trading plan to potential investors.
- Create a brand: You could make the argument that a credible name is just as important as a trading record in an unregulated space.
- Choose a platform: Your chosen platform will allow you to purchase the crypto you want. Because there is no regulation, you can collect funds through any medium, including a personal credit card (not recommended). As long as you have an account with a platform to make the trades you want, you can make them. Keep in mind that different platforms may be subject to regulation and charge different transaction fees.
- Open exchange accounts: Unregulated exchanges put your funds at risk of loss even if your investment is solid. If your money is in an exchange that goes down, you lose. It’s important to spread your risk among many exchanges so that if 1 goes down, you don’t lose all of your investors’ money.
- Set up different fund types: Different cryptocurrencies are set up to fund different industries. Your edge as a hedge fund manager usually includes a great knowledge of particular industries. Your fund types communicate the kinds of investments you will make.
- Invest: After analyzing your investment choices, you’ll use your chosen exchanges to improve your portfolio value.
How to Hedge Cryptocurrency Risk
No matter how aggressive a hedge fund manager may be, he should be a master at risk management. Here are a few popular strategies:
- Short selling: The entire cryptocurrency market tends to move in the direction of Bitcoin — its 1st and most stable coin. Short selling Bitcoin is a simple way to mitigate long exposure. Some hedge fund managers will borrow Bitcoin to short sell it, keeping all available investor cash in the core position.
- CFDs: Contract for differences (CFDs) allow you to open positions in a coin without actually owning the coin. This saves you the trouble of dealing with a new wallet or exchange, which would take fees for its transactions. CFDs also allow you to short sell without borrowing.
- Futures: The Chicago Board of Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) both offered futures on Bitcoin starting in 2017. The CBOE no longer does, but the CME still does. Futures give you the ability to sell Bitcoin in the future at a preset price regardless of the open market price.
Popular Crypto Hedge Funds
If you are looking to invest in a fund, here are some of the most popular and well-respected:
1. Polychain Capital
Olaf Carlson-Wee founded Polychain in 2016 with backing from fiat venture capitalists. Polychain also invests in crypto startups as well as currencies. Its more successful investments include Celo and Coinbase — the No. 1 crypto exchange on the market.
2. Pantera Capital
Pantera was focused on traditional investments before switching in 2013. It has its hands in at least 70 cryptoprojects. The CEO is well known for being a Bitcoin bull — stating publicly that it will reach levels of $40,000 over the next year.
3. Andreessen Horowitz
Andreessen Horowitz was actually 1 of the original funds to invest in Polychain. It is also in a number of high profile partnerships addressing COVID-19 issues and also has a video lecture series called “Crypto Startup School”. Andreessen became well known as a mainstream venture capital firm before moving into the crypto landscape.
There are many brokers that can help you trade crypto for profit as well. Let’s take a look at some of the most well-known:
- Best For:Demo Accountssecurely through eToro's website
Cryptocurrency is offered by eToro USA LLC (“the MSB”) (NMLS: 1769299) and is not FDIC or SIPC insured. Investing involves risk
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- Best For:Coinbase Learnsecurely through Coinbase's website
Sum of median estimated savings and rewards earned, per user in 2021 across multiple Coinbase programs (excluding sweepstakes). This amount includes fee waivers from Coinbase One (excluding the subscription cost), rewards from Coinbase Card, and staking rewards. ³Crypto rewards is an optional Coinbase offer. Upon purchase of USDC, you will be automatically opted in to rewards. If you’d like to opt out or learn more about rewards, you can click here. The rewards rate is subject to change and can vary by region. Customers will be able to see the latest applicable rates directly within their accounts.
- Best For:Buying & selling Dogecoinsecurely through Robinhood Crypto's website
- Best For:Mobile Userssecurely through Plus500's website
- Best For:Crypto futures traderssecurely through Kraken's website
- Best For:Low Minimumssecurely through Webull Crypto's website
Get in on the Ground Floor
Although crypto hedge funds are expanding, developments are still in an early stage. If you have been looking to invest in Bitcoin or Ether but don’t have the time to research the landscape, getting involved with a hedge fund may be the vehicle for you. There are substantial risks, but should success strike, it will be well worth your investment.
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