Crypto markets have seen growing interest from hedge funds, who are attracted by the sector’s volatility and potential for diverse strategies. However, despite this interest, crypto hedge funds remain notably smaller than traditional finance.
Smaller share in crypto markets
In traditional finance, hedge funds dominate, managing 100% more assets and accounting for 3-4% of available markets. In contrast, even with its smaller market, the crypto space sees hedge funds managing only 1.5% of investable assets. This is based on a valuation of $1.1 trillion for crypto assets, excluding Bitcoin. Bitcoin alone has a market cap exceeding $1.1 trillion, providing a more liquid market.
Analysts believe that hedge funds could increase their presence as the crypto market matures, aiming to reach the level of engagement seen in traditional finance. Despite this potential, the current landscape is still developing. Demand for hedge funds in conventional and crypto markets grew in Q1, with assets under management reaching $4.3 trillion. Hedge funds have become increasingly attractive during market turbulence, offering strategies to offset slow general growth through active management.
Emerging crypto hedge funds
The past year saw the addition of 200 new crypto hedge funds, many employing various quantitative strategies. Predominantly, these funds are based in the U.S., reflecting growing interest in the crypto space. However, the track record of most crypto hedge funds remains short. Data shows that 56.2% of these funds have been in the market for only 1-3 years, while 34% have existed for over three years. Only 7.2% have a track record exceeding four years. The 2022-2023 bear market led to the closure of about 35% of existing hedge funds, with 250 out of 715 crypto-dedicated funds shutting down from May 2022 onward.
At the end of 2023, crypto hedge funds managed $15.2 billion, with $11.4 billion allocated to fundamental strategies, $1.8 billion in quant directional funds, and $1.9 billion in market-neutral funds. However, these funds have been allocated slowly compared to market trends, as noted in the Vision Track report for 2023. Crypto-native funds, by contrast, can allocate more quickly as narratives shift rapidly.
Challenges facing crypto hedge funds
Crypto hedge funds face significant challenges, including market volatility and technological obstacles. Hedge funds have played a key role in developing the crypto sector, providing vital VC funding. Considerable players include Pantera Capital, Polychain Capital, and Digital Asset Group. However, new entrants have been cautious following the collapse of Three Arrows Capital during the 2021 market boom.
The crypto sector also faced a downturn during the 2018 bear market, leading to the closure of many hedge funds. A significant issue is the need for guaranteed longevity or liquidity for crypto assets, with many older coins and tokens losing value or becoming obsolete. Additionally, outperforming Bitcoin (BTC) remains a significant challenge, as most altcoins underperform or decline in value compared to BTC.
Mainstream hedge funds often prefer simplified methods of interacting with Bitcoin, such as through fully regulated ETFs. On the other hand, some crypto insider funds manage to outperform Bitcoin through active asset management. Hedge funds like MEV Capital are actively engaged in DeFi, managing vaults and liquidity directly.
As the crypto market continues to evolve, hedge funds are expected to play an increasingly important role, although they still face significant hurdles. The potential for asset tokenization could open new opportunities, but for now, crypto hedge funds must navigate a complex and volatile landscape.