Roughly a third of hedge fund managers are considering launching a digital assets-focused strategy over the next 12 months, underlining the depth of appetite.
Roughly a third of hedge fund managers are considering launching a digital assets-focused strategy over the next 12 months, underlining the depth of appetite.
With such a sizable chunk of the hedge fund community keen to step into this fast-paced, constantly-evolving sector, the scale of the challenges confronting prospective market entrants are coming into ever-sharper focus, with those having already made the splash flagging up an assortment of costs and complexities posed by the 24/7 nature of crypto.
Hedgeweek quizzed more than 50 alternative investment firms, managing a range of hedge fund strategies across the globe, on their interest in digital assets, as well as on the perceived barriers and risks within the market.
The survey findings show around 30 per cent of the sample are preparing to roll out a digital assets-focused fund in the next 12 months, with a further 7.5 per cent “possibly” launching within the same timeframe. The data also hints at the growing interest in crypto among allocators and the extent of investor inquiry, with close to 38 per cent of respondents said they have been asked by allocators to offer a digital assets vehicle.
Against this backdrop of surging interest on both sides of the manager-investor dynamic, and the prospect of a slew of new participants in the coming year, crypto-focused hedge funds say the process of successfully launching and running a crypto-focused hedge fund can be a challenging and sometimes painful exercise.
Vast space
Indeed, one in five participants in Hedgeweek’s study pinpointed launch costs and complexity as the greatest obstacle to launching crypto strategy currently. One respondent who said they were “possibly” launching a fund this year described digital assets as a “vast space with a lot of new knowledge to be learned.” Another manager, not planning to enter the market, fears a “loss of credibility from doing something quite different from core strengths.”
Those crypto managers on the front-line point to higher start-up costs, with the asset class demanding a sizable technology spend, along with the ability to source service providers that offer crypto capabilities, and find the talent and expertise within the sector.
“The overhead costs that a crypto hedge fund has are significantly higher compared to a more traditional, say, long/short equity fund which is based on fundamental analysis,” says Carlos Betancourt, founding principal at New York-based BKCoin Capital, who flags up tech costs as a key issue.
The 24/7 round-the-clock nature of digital assets mean risk management systems have to be adapted to run across multiple venues and time-zones, which can be a major step-change for even the most aggressively-traded hedge fund strategies.
“Right off the bat, if you think about exactly what it is that we are doing, if we’re not investing heavily in technology, we effectively become obsolete very quickly,” Betancourt tells Hedgeweek, adding how the firm has “poured a ton of money” into its tech capability since launching in 2018.
BKCoin founding principal Kevin Kang says: “We’re competing against some of the biggest high frequency trading firms now, so some of the upgrades that we’ve been making on the tech fund are very costly.”
Others point to significant premiums for both auditor and administration services, while the service providers themselves face hurdles in managing and maintaining crypto hedge fund services in what is a rapidly-developing environment.
“The first thing you notice when you come into crypto is that many of the things you took for granted in traditional markets don’t actually exist here,” says Asen Kostadinov, head of strategy at Copper.
Discovery mission
“Custody is a fairly obvious thing; however, you also need a lot of other things. At the very least you need a law firm; you need to assess where the best jurisdiction is in which to set up the fund. You need to find technical providers to help you get into the market, for example, order management systems. How do you actually connect to the different exchanges? How do you get the data that you need?
“All of these things are generally easily solved in traditional finance. But here you need to go on a discovery mission, and these are some of the questions we are being asked by clients who are new to this space.”
Meanwhile, Anatoly Crachilov, founder and CEO of Nickel Digital Asset Management, points to an assortment of other challenges facing prospective crypto hedge fund launches. These include the sizable cost and limited availability of directors’ insurance, while opening bank accounts (“it can be a six-month struggle”), and obtaining exchange accounts (“a demanding process which is not what it used to be five years ago”) can be equally difficult.
“You have new trading venues and new instruments being launched which the service providers adapt to, and that is not an easy process,” Crachilov says.
“Once you establish the relationship with an exchange, if you are an aggressive or high-frequency trader, you may need to rewrite all the APIs, as you may need a different latency on APIs,” Crachilov says.
“Portfolio management systems, order management, execution systems, exchange access – these are all things that are taken for granted in traditional finance that generally either have to be heavily adapted from other systems – say from commodity trading in order to handle crypto – or have to be built from scratch,” he adds. “Those are the challenges that hedge funds are confronting today.”
Read the full Institutionalising Digital Assets: Powering the hedge fund crypto surge Insight Report here.
