Despite sharp price shocks, the upward momentum in cryptocurrencies and the broader digital asset sector has heralded eye-catching returns for hedge funds over the past 12 months, underlining the asset class’s status as a key area of focus in alternatives.
Despite sharp price shocks, the upward momentum in cryptocurrencies and the broader digital asset sector has heralded eye-catching returns for hedge funds over the past 12 months, underlining the asset class’s status as a key area of focus in alternatives.
Year-end analysis by Hedge Fund Research shows managers investing in cryptocurrencies outflanked all other hedge fund strategies between January and December 2021. HFR’s Cryptocurrency Index – which tracks the investment performance of hedge fund strategies trading bitcoin and other digital currencies long and short – scored a 214.5 per cent annual gain, with managers withstanding a 20 per cent loss in December to rise above the previous year’s 193 per cent advance.
Meanwhile, HFR’s Blockchain Index – a measure of the gains and losses made by those funds trading both cryptocurrencies and digital assets infrastructure, such as blockchain companies and other distributed ledger technologies – advanced 198.5 per cent between January and December 2021. The surge was powered by strong double-digit returns in the first four months of the year, which built on 2020’s 189.3 per cent gain.
The stellar performances reflect the ongoing march of digital assets, which enjoyed a banner year across its various constituent components, marking what industry participants see as a “validation” of this rapidly-evolving but often misunderstood asset class.
Both bitcoin and ethereum reached all-time highs last year, with bitcoin – the world’s foremost cryptocurrency – at one point topping USD67,000. Though it fell short of a widely-anticipated triple-digit growth thanks partly to a hefty December sell-off of some 20 per cent, it nevertheless advanced more than 60 per cent over the past year.
Further afield, the market began to decouple from the long-running dominance of core assets like BTC and ETH, as industry focus turned to emerging opportunities in expanding areas such as NFTs, DAOs, Layer 1 protocols and decentralised finance (DeFi).
“In 2017 and 2018, and even prior to that, bitcoin was the dominant asset – it had north of 90 per cent market cap dominance. Now that’s completely changed,” says Samed Bouaynaya, portfolio manager, Altana Digital Assets Fund, a multi-asset investment manager which entered the cryptocurrency sector in 2014.
“The game has shifted towards obviously more use-case tokens, and we are seeing bitcoin dominance shifting downwards below 40 per cent; currently it stands at around 35-38 per cent.”
“As an asset class, for the first time we became a multi-trillion-dollar industry,” Anatoly Crachilov, founding partner and CEO at London-based Nickel Digital Asset Management, says of last year’s growth, noting that crypto remains the best-performing asset class across one, three, five and ten-year horizons.
“At the beginning of 2021, the whole crypto industry was at USD780 billion. Now, we are over USD2 trillion, even touching at some stages during the year the USD3 trillion mark.”
Meanwhile, total value locked (TVL) – a key metric for measuring the growth of DeFi activity on Ethereum – topped more than USD100 billion. “That’s an important indication that the liquidity and capital is flowing in the DeFi space,” Crachilov adds.
Other key growth metrics include the surge of the stablecoin sector, which grew some 388 per cent, from almost USD30 billion at the start of 2021 to USD140 billion. Meanwhile, the market for non-fungible tokens (NFTs) – which are often tied to artwork and other collectables beyond the financial services arena – has swelled to some USD7 billion, according to JPMorgan analysis. UniSwap, the decentralised trading platform, saw its cumulative market volumes top USD1 trillion, reflecting the growing importance of decentralised exchanges as key players in the digital asset landscape.
DAOs go mainstream
Another burgeoning area of interest – decentralised autonomous organizations (DAOs) – came into mainstream view when ConstitutionDAO, which was formed to purchase an original copy of the US Constitution, was outbid at auction by US hedge fund titan Kenneth Griffin, founder, CEO and co-CIO of Citadel, who paid USD43.2 million for the document.
DAOs, which are comparable to crowdfunding communities, are built around crypto assets, blockchain technology and smart contracts, pooling and deploying capital in ways similar to venture capital or investment firms.
“Structurally you will see far greater growth coming from DeFi because it’s innovation-driven,” remarks Crachilov. “Last year was a good validation of that point because while bitcoin has grown by 60 per cent, which is very respectable, other challengers in the DeFi space have increased by multiples, and that’s just a reflection of innovation.”
Bouaynaya adds: “In terms of market adoption, we have 200 million users now using the sector across multiple chains, trying obviously first of all to exchange their tokens in decentralised exchanges, but also trying to chase yield and farm yields in what we call yield aggregator protocols. We also have derivatives exchanges now. It’s so much more diverse now in terms of utilisation and use cases – it’s no longer the 2017-18 era where people were afraid of the technology.”
Reflecting on crypto’s landmark year, Lisa Fridman, president and co-founder of Quadrata, and former partner and global head of research at PAAMCO Europe, draws parallels between the growth in investment opportunities in crypto today and the meteoric rise of the hedge fund industry 20 years ago.
“It is similar to the environment in which I started my career in the early 2000s, where a number of institutions were quite intrigued by the tools that hedge fund managers could be using to achieve the returns they were targeting,” Fridman says.
“Those institutions did not always have dedicated internal resources to fully underwrite hedge fund exposures. Today, as well, what we see is that there is quite a bit of interest from institutions in blockchain and DeFi. However, there is active dialogue, knowledge sharing and an educational aspect to those relationships, where institutions are gaining more and more capabilities in this space. We expect that cryptocurrencies, blockchain technology and decentralised finance exposure will become a meaningful part of portfolios going forward if compliance-aware framework is created and data issues are addressed.”
Read the full Institutionalising Digital Assets: Powering the hedge fund crypto surge Insight Report here.
