Cryptocurrency funds are a new type of investment vehicle that is comparable to traditional portfolio investments such as hedge funds, but consists solely of digital assets. For this reason, they play according to slightly different rules than their traditional colleagues. Knowing how they differ and where to get involved is key for those who want to enter this new and fascinating world. That is why we have outlined the main points in this useful guide.
What are cryptocurrency funds?
The term “cryptocurrency fund” refers to a portfolio that contains a variety of different digital assets and is generally managed by one or a few people. Investors can buy these funds to share the benefits as the value of the fund increases. According to Crypto Fund Research, just over half of them act as venture capital funds, while the rest are mostly hedge funds.
Venture capital funds involve various investors who pool their money to buy from smaller companies with high growth potential. With crypto funds, these companies are of course new projects and altcoins. As soon as the asset or assets have grown in sufficient quantity, they are usually sold and investors participate in the profit.
Hedge funds act as portfolios that are actively managed and minimize market risk, hence the name “hedge”. These can be any asset, but different assets are typically used in long and short strategies to diversify the portfolio and make the fund resilient or even profitable in the face of high volatility. These funds are also usually managed by small teams and are often only available to experienced investors. The minimum investment ranges from tens of thousands to hundreds of thousands of dollars.
Traditional hedge funds generally have minimal time constraints, so investors would undertake to keep their money in the fund for at least one year, for example. They also tend to have fairly high fees, around 20% of the profit, as an incentive for managers to perform well. In this sense, this means placing trust in the team that manages the strategies, and there is no guarantee that the fund will eventually return. In the event of mismanagement, the market volatility that these funds are designed to protect against can also quickly wipe them out. This was observed in March with the sharp decline amid panic in the coronavirus market. Some crypto funds were unprepared for such a sudden decline and collapsed as a result.
Common strategies from cryptocurrency fund managers
At this point, we should examine the strategies that fund managers use to increase their investments. A common tactic that is often used is called “long / short equity”. In this scenario, fund managers look at assets that they believe are undervalued and overvalued, and then place long and short positions accordingly. If your analysis is correct, your portfolio should be profitable when the market rises or falls.
A similar strategy is called “market neutral”. The aim is to balance long and short positions so that market exposure is reduced to zero. Therefore, a manager in the same industry or asset can take 50% long and 50% short to reduce the risk of volatility. It should be noted that risk reduction generally also means lower returns, which is acceptable compensation for some.
Another common strategy is arbitration. There are many types of arbitrage, but the general idea is to buy assets on one exchange and then sell them on another that offers a better price. This is common with traditional hedge funds, but the cryptocurrency market often offers more lucrative opportunities due to its young and volatile nature. It is common for different platforms to offer slightly different prices for different assets. If the move can be quick enough, it can be relatively easy to make a profit. However, speed is key, which makes this strategy a popular favorite among radio frequency traders.
There are other strategies, such as the “global macro” that tries to take positions based on larger trends within a market and “only briefly” that essentially focuses on explicitly shortening (executing a short strategy) the assets, which make the manager feel overrated. Finally, there is the “quantitative” that focuses exclusively on models, data and research to build the portfolio. To be realistic, it is not uncommon to use several different strategies. However, it is important that fund managers understand what they are doing when implementing one of these strategies and make this transparent to investors.
A variety of different investment opportunities
This is generally the biggest risk when investing in a cryptocurrency fund: clients need to trust those behind it. Therefore research is important. The more information managers are willing to report who they are, how they manage and what their track record looks like, the more they can determine whether they are suitable for an investor. For this reason, for many, partnering with a reputable company is an essential part of the trust that their investment will pay off. Some of the biggest names in cryptocurrency funds include Digital Currency Group, Galaxy Digital and Pantera Capital. They all focus specifically on cryptocurrencies and other digital assets.
Of course, this generally requires large initial investments by qualified people. However, private investors wishing to participate in this type of promotion could consider projects such as Tokenbox. Tokenbox not only acts as a generic wallet and exchange, it also allows users to “tokenize” their wallets and invest in tokens attached to others’ wallets. This is a simplified way to open a new cryptocurrency fund or to participate in an existing one. Tokens linked to profit portfolios can be bought and sold. Their value depends explicitly on the performance of your fund. Managers can show their success in trying to attract more sponsors. All of this is possible without a massive initial investment, but behaves like buying a cryptocurrency on a stock exchange.
What can this market expect?
The outlook for the cryptocurrency fund is pretty good these days. According to a report by PricewaterhouseCoopers and Elwood Asset Management Services Ltd. The total value of assets under management in these funds rose from $ 1 billion in 2018 to an impressive $ 2 billion in 2019, doubling the size of the market in a single fund year. In addition, the average return on these investments was 30% in 2019, slightly below 2018, but still significantly higher than traditional hedge funds. This is of course due to the profit margin available on the market. Although a variety of cryptocurrencies are included in different offerings, the study found that 97% offered Bitcoin (BTC), followed by Ether with 67% (ETH) and others like XRP (XRP), Bitcoin Cash (BCH) and Litecoin. (LTC), all offered for approximately a third of the funds available.
All of this indicates a market that is just being explored. Given the mass acceptance of cryptocurrencies, it is natural that the number and value of these investment vehicles will continue to increase. Risks will always be there, so investors should always do their homework, but the untapped potential of digital assets looks promising. If more private investors can be attracted to this area, the history of crypto funds may begin.
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