Hedge funds rush in: Cryptocurrency changes are coming

In recent years, the market size of cryptocurrency has continued to expand. Coupled with the geopolitical "black swan" of Russia and Ukraine and unprecedented inflation risks, the attitude of traditional Wall Street players towards cryptocurrency has quietly changed, and more and more hedge funds have begun to get involved in this field.

It should be noted that a crypto hedge fund refers to an active fund whose purpose is to obtain excess returns (the so-called "alpha returns") that are not affected by the overall volatility of the cryptocurrency market, in sharp contrast to passive cryptocurrency index funds.

As the market becomes more efficient, cryptocurrencies, as a high-volatility asset, have greater return potential than traditional assets, and have therefore been favored by hedge funds. Some industry insiders believe that the scale of cryptocurrency hedge funds will continue to expand, and that cryptocurrency and hybrid funds will dominate the hedge fund issuance market in 2022. The cryptocurrency market, which is dominated by retail investors, is ushering in changes.

Inflation risks are rising

Legendary hedge fund tycoon invests in cryptocurrency

According to the 2021 Hedge Fund Industry Report released by the Alternative Investment Management Association (AIMA) in cooperation with PwC, 21% of hedge funds have invested in digital assets, with the investment amount accounting for an average of 3% of their assets under management. In addition, 86% of hedge funds that have already invested in cryptocurrencies plan to increase their investments, and among the hedge funds that have not yet invested, 26% said they are in the final stages of planning or executing investment decisions.

According to a report by PwC, almost all traditional hedge fund strategies have entered the cryptocurrency field. Currently, there are more than 400 active cryptocurrency hedge funds in the world, and the number is increasing every day.

JPMorgan Chase believes that inflation risks have rekindled investors' interest in Bitcoin as a hedge asset, and institutional investors are returning to the Bitcoin market, perhaps because they believe that Bitcoin is a better hedge asset than gold.

(The number of newly issued cryptocurrency hedge funds and Bitcoin price trends Source: PwC)

Steven Cohen, founder and CEO of Point72, a hedge fund with $22 billion in assets, once said that he has completely switched to the field of cryptocurrency; Brevan Howard, a top global hedge fund, also announced in January the launch of a new cryptocurrency hedge fund that will accept funds from external investors, betting on the price trends of cryptocurrencies such as Bitcoin and Ethereum while looking for arbitrage opportunities.

Brevan Howard is known for its macro trading, and its co-founder Alan Howard is known as a hedge fund tycoon. During the periods of severe market volatility in 2007 and 2008, he achieved returns of 25% and 20% respectively, far exceeding his peers. In 2020, the return rate was as high as 100%.

In addition to the new fund for external investors, Brevan Howard has also formed a new cryptocurrency department, including 12 portfolio managers, with assets under management of more than $250 million. Howard himself has also invested in cryptocurrencies, blockchain and other assets.

Last year, Brevan Howard said that its hedge fund with $5.6 billion in assets under management would begin investing in digital assets, with an investment ratio of no more than 1.5%. In 2020, the fund also acquired a 25% stake in One River, an asset management company that owns a cryptocurrency fund.

Paul Tudor Jones, founder and CEO of Tudor Investment, is also increasing his investment in cryptocurrencies. He has told his clients that Bitcoin may play an increasingly important role in a world hungry for new safe assets. Jones became famous for successfully predicting the crash of Black Monday in 1987. The hedge fund he managed had no losses for 25 consecutive years and was called the world's second trader after Soros.

Recently, Citadel, a heavyweight hedge fund with an asset management scale of over $30 billion, has also changed its attitude towards cryptocurrencies. Its CEO Ken Griffin recently admitted that he was wrong to compare Bitcoin to the "Tulip Bubble" and instead called cryptocurrency one of the best "stories" in the financial field in the past 15 years. He also said he planned to invest in Bitcoin.

In January this year, when Griffin's Citadel Securities first accepted external investment, investors included Sequoia Capital and cryptocurrency investment institution Paradigm. At that time, Paradigm co-founder and partner Matt Huang said that he expected Citadel Securities to get involved in new asset classes including cryptocurrencies.

But while the big guys are enthusiastic about investing, some people continue to take a wait-and-see attitude towards cryptocurrencies. Asset management company Rebeco believes that although Bitcoin has similar scarcity to gold, and is easy to trade and carry, compared with gold, Bitcoin lacks a similar trading history as a value-preserving asset. Henry Neville, an analyst at Man Group, the world's largest listed hedge fund, believes that Bitcoin has not yet experienced the test of an inflation cycle.

Outperforming as stock returns stabilize

Cryptocurrency funds gain popularity

Data shows that crypto assets outperform traditional risk assets such as stocks during crises. For example, since the outbreak of the Russia-Ukraine conflict on February 24, the two digital currencies have risen by 14.5% and 13.5% respectively, while the S&P 500 index has only risen by 3.2% during this period.

On the other hand, in the long run, the returns of cryptocurrency assets are gradually stabilizing. According to data on March 14, the Barclay Hedge Cryptocurrency Trader Index, which aims to track transactions by cryptocurrency asset management companies, fell by only 1.5% in February, far lower than its 13% in January and 10% in December last year.

Joe DiPasquale, CEO of BitBull Capital, the world's first cryptocurrency hedge fund, said the Russia-Ukraine conflict did not cause panic, and thanks to the rebound of Bitcoin and Ethereum in February, the company's two hedge funds using market neutral strategies have still risen this year.

The superior performance compared to traditional risky assets and the gradually stabilizing return rate have led more investors to actively invest in cryptocurrency funds and related companies.

According to data from asset manager CoinShares, cryptocurrency investment products and funds saw $163 million in institutional inflows in the two weeks ending March 4, while inflows into blockchain stocks totaled about $15.6 million. Meanwhile, bond funds saw net outflows of $7.8 billion in the week ending March 9, while real estate funds saw outflows of $770 million over the same period, according to fund analytics firm Lipper.

A report from information exchange platform With Intelligence pointed out that the number of cryptocurrency products entering the development stage increased significantly last year, especially in the fourth quarter. This trend is expected to continue this year. Driven by the interest of institutional investors, more high-quality products will be launched, and cryptocurrency and hybrid funds will dominate the hedge fund issuance market this year.

The cryptocurrency venture capital sector is also favored by capital. According to a report by data company Fundstrat, venture capital firms invested about $4 billion in the cryptocurrency sector in the last three weeks of February. So far this year, the average weekly investment attracted by the cryptocurrency sector has been between $800 million and about $2 billion. In addition, new cryptocurrency funds have also raised nearly $3 billion in the past two weeks ending March 11.

“Crypto-native companies are still raising money at very high valuations, and many rounds are still oversubscribed,” said George Melka, CEO of cryptocurrency brokerage SFOX, adding that valuations for cryptocurrency startups are the highest he has ever seen.

Bain Capital Ventures, a subsidiary of private equity giant Bain Capital, also announced earlier this week that it would launch a $560 million fund focused on cryptocurrency-related investments.

The Wild West was taken down

Regulatory guidelines under the executive order are becoming clearer

The market and industry insiders have always believed that the cryptocurrency market is like the "Wild West" and lacks sufficient regulation, but the executive order signed by US President Biden on March 9 filled this gap. The use of cryptocurrencies for crimes such as money laundering has always troubled financial regulators, and this presidential executive order gives them greater regulatory power over the industry.

The executive order requires federal regulators to assess the risks that the approximately $1.75 trillion crypto market may pose to consumers, investors and the macroeconomy. U.S. Treasury Secretary Janet Yellen said that this move will support responsible innovation and bring substantial benefits to the country, consumers and the business community. At the same time, government agencies will also pay attention to risks related to illegal finance to prevent risks to consumers, investors, the financial system and the economy.

Some participants welcomed the idea of ​​the government increasing its involvement in cryptocurrencies. Adam Zarazinski, CEO of Inca Digital, said the executive order provides an opportunity for "new ways to raise funds." Marcel Kasumovich, head of research at hedge fund One River, believes that the focus on financial stability reflects the government's intention to bring digital currencies into the mainstream system.

Katherine Dowling, general counsel at Bitwise Asset Management, a crypto index fund management company, also said that an executive order that provides more legal clarity and government regulation would be a "long-term positive for cryptocurrencies."

But Hilary Allen, a professor of financial management at American University, warned against embracing cryptocurrencies too hastily. She said, "As cryptocurrencies are integrated into our financial system, they create vulnerabilities not only for those who invest in cryptocurrencies, but also for every participant in our economy."

In fact, cryptocurrency-based crime hit an all-time high in 2021. According to a report by blockchain research firm Chainalysis, illicit addresses received $14 billion in the year, up from $7.8 billion in 2020.

“Criminal abuse of cryptocurrencies poses a significant barrier to continued adoption, increases the likelihood of government restrictions, and, worst of all, harms innocent people around the world,” Chainalysis said.

(Statistical source of cryptocurrency value and category received by illegal addresses: Chainalysis)