Cryptocurrency hedge funds work much like traditional hedge funds in that they allow individual investors to contribute to an expert-managed investment pot.
Investing in cryptocurrency can be a daunting task for many individuals, as it requires a certain level of technical expertise, risk management prowess, free time and understanding of the market.
Cryptocurrencies offer a solution for those who want to invest in digital assets without the need to handle the complexities that come with manually purchasing, securing and managing them.
Globally, an estimated $100+ billion is managed by more than 600 different crypto funds. This is equivalent to approximately 10% of the total market capitalization of all cryptocurrencies — making crypto funds a major player in the complex market dynamics that shape the industry.
This article will provide an in-depth look at what cryptocurrency funds are, how they work, the potential for profit, and the alternatives available for those looking to invest in the cryptocurrency market.
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How Do Crypto Hedge Funds Work?
Cryptocurrency hedge funds work much like traditional hedge funds in that they allow individual investors to contribute to an expert-managed investment pot.
The pooled user-contributed funds are then used to make investments in various blockchain projects — whether that be equity investments, early-stage tokens, OTC deals or something else.
The exact investment methodology and rationale will vary from fund to fund, but most funds focus on SAFT investments and secondary market purchases.
Fund managers will usually have heavy experience in identifying and securing attractive deals, trading volatile markets, and identifying trends. This expertise and knowledge is used to grow the fund’s net asset value (NAV) by picking good investments.
In most cases, cryptocurrency funds will have a minimum investment amount — often called a minimum ticket size. This typically ranges from $100,000 to $1 million, but can be more or less in some cases.
One of the key features of cryptocurrency funds is the fee structure. Here are some terms that are commonly used to describe the fees associated with these funds:
- Management Fee: This is a fee that is charged to investors to cover the costs of running the fund. This fee is typically a percentage of the fund's AUM and is charged on a regular basis, such as annually or quarterly.
- Performance Fee: This is a fee that is charged to investors based on the fund's performance. It is usually charged as a percentage of the fund's returns that exceed the hurdle rate and provides an incentive for the fund manager to perform well.
- Hurdle Rate: This is the minimum rate of return that a fund must achieve before the manager can start to collect performance fees. Such that a fund with a hurdle rate of 10% will only start to collect performance fees once the fund has achieved a return of 10% or more.
A 2% management fee and 20% performance fee can be considered typical for a crypto fund, but some funds may charge significantly more (e.g. high performing funds) or less (e.g. passively managed funds).
Popular Crypto Funds
Today, there are well over 500 crypto VC funds. While most are relatively obscure, some have gone on to garner massive influence and have billions of dollars in assets under management (AUM).
Not all crypto VC funds are transparent about their AUM, but some of the popular funds currently include:
- Grayscale Investments: Grayscale Investments is a digital currency asset management firm that offers investment products such as trusts, funds and ETFs for Bitcoin, Ethereum and other digital assets. Its AUM currently exceeds $17 billion, making it one of the largest companies in the crypto investment space.
- Multicoin Capital: With an AUM of $8.9 billion, Multicoin Capital is the second-largest crypto VC fund. As a thesis-driven investment firm, Multicoin Capital invests in disruptive blockchain-based projects, including infrastructure, layer 1s and identity solutions.
- Pantera Capital: Pantera Capital is a leading investment firm focused on blockchain technology and digital assets. They invest in a variety of asset classes, such as venture capital, token sales and secondary market digital assets. They have a strong track record of investing in successful projects, such as Ripple, Augur and MakerDAO. Its AUM currently stands at $3.8 billion.
- Polychain Capital: One of the leading digital asset management firms, Polychain Capital specializes in blockchain technology and decentralized networks. They invest in a variety of assets such as tokens, protocols and projects that are built on blockchain technology. Their portfolio includes investments in successful projects such as Algorand, Chainlink and Cosmos. As of March 2022, it had an AUM of $6.6 billion, but this has likely dropped considerably.
It should be noted that bigger doesn’t always equal better when it comes to crypto venture funds, as is demonstrated by the recent collapse of Three Arrows Capital (3AC) — the now bankrupt crypto hedge fund that controlled over $10 billion at its peak.
How Profitable are Crypto Hedge Funds?
Like traditional hedge funds, crypto funds can vary considerably in their profitability and investment time horizon. Given the extreme volatility of the cryptocurrency market and the sheer number of unicorns, some have managed to generate an impressive return on investment for participants.
According to data from Crypto Fund Research, Majestic Asset Management comes in as the best-performing crypto fund overall in Q2 2022, followed by Q21 Capital and Balmoral Digital.
While most private crypto VC funds are tight-lipped about their returns, some public VC funds will post the performance of their funds online, and others will only release performance information to participants.
Some of the most successful crypto VC funds can dramatically outperform even the best traditional venture funds. Pantera Capital's Venture Fund III, for example, achieved a Total Value Paid In (TVPI) of 8.6x and an Internal Rate of Return (IRR) of 143.7%. While its Venture Fund I (launched in 2013) generated a TVPI of 20.7x.
But they’re not without their risks. Several crypto VC funds have gone bust over the last year, including the 3AC, which lost approximately $3 billion between 2021 and 2021 due to its failed investments in the Terra ecosystem.
Investors that participate in failed funds can experience complete or near-complete losses.
Alternatives to Crypto Funds
As we previously touched on, cryptocurrency funds can be incredibly efficient and profitable, but also come with their own set of risks and limitations — as was highlighted by the recent Digital Currency Group fiasco. Fortunately, there are a number of alternative investment vehicles, many of which rival the potential of cryptocurrency funds while providing a number of unique benefits.
Arguably the most prominent of these is the tokenized index funds. These generally provide exposure to a range of digital assets in a single investment vehicle. The Crypto20 (C20) token, for example, provides exposure to the top 20 cryptocurrencies by market capitalization, whereas the Total Crypto Market Cap Token Price (TCAP) token tracks the total market cap of all cryptocurrencies. These provide holders with the control to buy and sell the asset at their convenience, without any early exit or withdrawal fees. It should be noted that most of these tokens suffer from limited liquidity.
There are also regulated tokenized index funds that provide exposure to traditional markets. This includes SPDR S&P 500 ETF tokenized stock FTX (SPY) — but these are typically considered securities.
Actively Managed Certificates (AMCs) are also growing in popularity in the crypto space since they allow firms to raise funds for and deploy capital into a wide variety of underlying assets quickly and efficiently.
Having achieved a TVPI of 14.1x and IRR of 113.3% with its venture arm, DAO Maker — a popular blockchain venture fundraising launchpad — is currently in the process of raising ~$25 million from qualified investors for its AMC. whereas Levmi, iMAPS ETI AG, Zeltner & Co, and a growing number of other firms also offer crypto-focused AMCs.
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