The idea behind crypto hedge funds is to enable investors to expand their portfolios and reduce the risk of loss by investing in digital assets and crypto-based products. Crypto hedge funds also enable traders to make money through crypto investments. However, unlike traditional hedge funds, they’re less regulated.
In this guide, we’ll explain how hedge funds work, what are their main advantages and disadvantages, and how to start a crypto hedge fund. We’ll also list the three largest hedge funds in the market.
What Are Crypto Hedge Funds?
Crypto hedge funds can be explained as capital that allows investors to invest in digital assets. Like traditional hedge funds, these funds allow buying and selling crypto, as well as investing in futures and crypto derivatives.
Crypto hedge funds can be used to invest in both digital assets and crypto-based products.
There are two main types of crypto hedge funds. The first refers to managing portfolios that rely only on digital assets. Their role is to replicate venture capital funds, which is why they usually bring more money. The second one refers to adding crypto assets to existing portfolios. Its goal is to combine different types of assets to avoid huge risks.
Other types of crypto hedge funds include:
- Quantitative funds
- Bullish-only funds
- Long and short funds
- VC-based funds
- Multi-strategy funds
- Yield-focused funds
How Do Crypto Hedge Funds Work?
Crypto hedge funds are similar to their traditional counterparts — they allow investors to contribute to a pot managed by experts. These pooled funds are used to invest in blockchain projects that may be related to OTCs, early-stage tokens, etc.
Most crypto hedge funds come with a minimum investment requirement that can vary between $100,000 and $1 million.
Crypto hedge funds use two investment approaches — discretionary and systematic.
The discretionary approach involves fund managers, whose task is to make all important investment decisions. In contrast, the systematic approach uses computer models to process transactions. This approach is also less risky since it’s automated. However, most of its funds are maintained through annual rewards.
Furthermore, crypto hedge funds charge two types of fees — management and performance fees. The management fee ranges from 1% to 3%, while the performance fee ranges from 10% to 40% of the investment return.
There is also a hurdle rate, or a minimum return rate that a crypto hedge fund must reach before performance fees are collected by the manager. For example, a crypto hedge fund with a 20% hurdle rate will start collecting performance fees only when it reaches a 20% return.
Crypto hedge funds use various investment strategies, like:
- Quantitative trading
- Sentimental analysis
- Yield farming and staking
- Leveraged trading
- Macro strategies
- Short-selling strategies
Advantages of Crypto Hedge Funds
Crypto hedge funds are an important part of the crypto ecosystem that offer many benefits to investors, such as:
Potential for High Returns
Crypto hedge funds have the potential for high returns — they generate higher income than traditional options, such as bonds and stocks.
How so? Because their earning system is based on the growth of crypto asset prices. This means that investors can benefit from high crypto returns with minimal risk. In addition to that, crypto hedge funds use leverage to provide higher returns.
Professional Fund Managers
Crypto hedge funds simplify the process of investing in the crypto market, making them useful for beginners.
Investors will leave the research work to professional managers who will determine which digital assets are profitable. They will also protect their digital assets from potential rug pulls and scams.
In short, crypto hedge fund managers have extensive knowledge of the crypto industry and its risks. They can help both beginner and professional investors make informed decisions.
Crypto hedge funds allow investors to diversify their portfolios. By putting their funds into different pools, they’ll increase their chances of earning high returns.
Disadvantages of Crypto Hedge Funds
The main disadvantages of crypto hedge funds include:
As mentioned above, crypto hedge funds charge management and performance fees that vary from 1–3% and 10–40%, respectively.
Crypto hedge funds are available only to people who have a large capital — they come with a minimum investment requirement that ranges from $100,000 to $1 million.
Investing in digital assets is generally risky as cryptocurrencies are very volatile. Crypto hedge funds can increase this risk if you use the wrong investment strategy.
Pre-Requirements for Starting a Hedge Fund
Before creating a crypto hedge fund, pay attention to the following factors:
Compliance With Regulations
Each jurisdiction has its regulations that you must adhere to avoid legal issues. On that note, find a trustworthy manager who will understand the SEC policies and the regulations of the jurisdiction in which your hedge fund will operate.
Choose the legal structure by which you want your hedge fund to be managed. This can be a limited partnership or an LLC.
Decide which crypto hedge fund investment strategy you’ll use. This will help you make informed decisions.
How to Start a Crypto Hedge Fund
Here are the steps to starting your crypto hedge fund:
1. Create a Business Plan
Analyze the crypto market to find out all about the current trends. This will help you determine the demographics of your investors. Your fund must also have a transparent structure that will contain information about fees.
2. Take Care of Legal Documentation
If you want to have a legitimate crypto hedge fund, you’ll have to obtain a license from the jurisdiction in which you operate. This license will also increase your credibility with investors. In addition to that, you’ll have to implement Anti-Money Laundering and KYC procedures.
3. Secure Your Assets
To protect your assets from potential cyber-attacks, use hot and some premier cold storage wallets.
4. Build a Team
Make sure that each member of your team has an appropriate role. On that note, your team should have traders, portfolio managers, compliance officers, and cyber security experts. If you want investors to trust you, you should also build a good tracking record.
5. Perform Risk Assessments
To create a successful crypto hedge fund, you’ll need to identify potential risks. On that note, a good strategy is to diversify your portfolio. In this way, you’ll be able to spread the risk over different digital assets. Likewise, you should implement various trading strategies to adapt to different market conditions.
And finally, you should define KPIs. This will help you measure the success of your crypto hedge fund.
Top Crypto Hedge Funds
The largest and the most popular crypto hedge funds include:
- Digital Currency Group — AUM $50 billion
- Multicoin Capital — AUM $8.9 billion
- Polychain Capital — AUM $6.6 billion
Crypto hedge funds will help beginners and professional investors to manage their digital assets more easily. They will also enable them to diversify their portfolios and generate high returns. The greatest advantage of crypto hedge funds lies in the professional fund managers. Their job is to evaluate which cryptocurrencies are worth investing in.
However, crypto hedge funds also come with certain challenges. Namely, their minimum investment requirement can go up to $1 million. Moreover, you’ll have to pay management and performance fees.
How many crypto hedge funds are there?
What is the average return of a crypto hedge fund?