Digital Assets Report


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Digital asset space developing an institutional image

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The estimated size of the global cryptocurrency market stands at USD293 billion, according to Cointelegraph. Within this arena, PwC estimates that there are around 150 active crypto hedge funds, managing approximately USD1 billion in aggregate AUM. 

Fund sizes remain modest, with the average crypto hedge fund running USD21.9 million (as of Q1 2019), according to the PwC report, although given that this figure is skewed by a selection of funds managing USD50 million-plus, PwC estimates the median fund AUM to be more like USD4.3 million. 

Still, given the volatility that tore through the cryptocurrency markets in 2018, the fact that fund launch activity remains buoyant suggests that investors are still keen to hold crypto fund assets in their wider portfolios. And as the space matures, with more fund launches, and longer track records for investors to interrogate, there is every reason to think that the crypto and wider digital asset space will become more institutional over the coming years; just as we saw with the hedge fund industry a couple of decades ago.

“We have witnessed that numerous large companies are making important efforts in blockchain initiatives, such as JP Morgan, Facebook, Fidelity, ICE… In addition, the VanEck SolidX Bitcoin trust aims to offer bitcoin ETF-like products to institutions, and the People’s Bank of China will launch a state-backed cryptocurrency with Alibaba and Tencent. While the US and China are showing signs of letting digital assets becoming more and more institutional, the EU is not that advanced yet,” opines Christophe de Courson, CEO and Co-founder, Olymp Capital, a Luxembourg-based, CSSF-registered alternative investment fund manager.

“Arguably, crypto is in the same position that traditional hedge funds were in 20 years ago,” comments Ben Watford, Partner, Financial Institutions at Eversheds Sutherland. “It will take time for crypto funds to reach the institutional quality that hedge funds can now attest to, but they are moving steadily closer to this goal.” 

One of the biggest barriers is the lack of depositary and banking options, according to Watford. This creates barriers to entry for new market participants. 

“The issue with that is running one of these crypto funds becomes a rather costly prospect. The break-even point will vary dependant on a number of factors. If you can’t get AUM up to the right level, you can’t run one of these funds and expect to make reasonable returns,” suggests Watford.

Jurisdictions are responding quickly to support the growing universe of digital asset funds and as the infrastructure continues to improve, to address the lack of depositaries among other things, a virtuous circle will likely ensue. Places like the British Virgin Islands are focusing intently on the expectations that becoming one of the world’s leading offshore fund centres for all things crypto/digital, will stand them in good stead.

“Our on-island experts are already world leaders in the management and administration of these types of funds and we look forward to making the BVI the global hub for this exciting type of investment in the near future,” says Simon Gray, Head of Business Development & Marketing, BVI Finance. 

When asked what advice he would offer to someone who is thinking of launching a crypto fund, Gray adds: “We would always advise businesses or individuals looking to set up a fund in the BVI to get expert guidance from a lawyer or administrator before they begin. While we have flexible, accessible regulation and reporting requirements, if one has never developed a fund before it can be a complex process that, without the right guidance, can be fraught with issues. 

“A BVI investment fund will have to adhere to a number of financial services regulations and, from the beginning this year, many entities will also have to navigate new ‘economic substance’ rules which call on firms to prove that elements of their business are physically based in the BVI.”

Boris Bohrer-Bilowitzki is Partner and Head of Business Development at Copper, a London-based technology platform designed to provide institutional custody and prime brokerage support to crypto investor. He is in no doubt that the crypto space is becoming more institutional. “When we talk about trading volumes, I think it is currently still retail-driven. However, thanks to custody applications like ours, ticket sizes are increasing and more players are entering the market. I do think we are on the brink of making the digital asset space properly institutional,” he says.

Copper’s approach to independent custody is helping to make this asset class more appealing to institutional investors but there is still a lot to do. That being said, the scope of strategies is getting wider and more diverse, and some managers are using regulatory approval and product innovation to appease investor concerns and really drive the asset class forward.

Silver 8 Capital is a US-based investment manager that uses fundamental research to select fintech investment themes and uses a traditional open-ended hedge fund structure. It invests long and short in cryptocurrencies and its investment mandate also allows it to invest up to 30 per cent of the fund’s assets in private companies. This VC aspect to purchasing equity interests in start-ups is a similar ‘hybrid strategy’ approach taken by other technology funds. 

“We focus all of our efforts on blockchain,” explains Manuel Anguita, Co-Founder, Silver 8 Capital. “Most of what we invest in is in the US. We can also do non-US investments in other jurisdictions but doing so exposes us to additional risks, such as legal risks, other than just start-up risks.” 

In Anguita’s view, digital assets are on the path to becoming institutional but one hurdle still to be overcome is the fact that cryptocurrencies fall out of the domain expertise of most portfolio managers and investors. 

“Investors don’t necessarily have the time to learn something completely new and, to date, still largely unproven. For now, at least, it’s probably not a good use of their time but as the asset class matures I think the situation will change,” says Anguita. 

Extreme volatility hasn’t necessarily helped, as witnessed by the wild swings in cryptocurrency prices over the last couple of years. In January 2017, bitcoin was trading at less than USD1,000. By December 2017, its price had enjoyed a meteoric rise, spiking just shy of USD20,000 according to the CoinDesk Bitcoin Price Index (BPI).

After reaching those giddy heights, 2018 hit bitcoin bulls hard. The price had plummeted to close the year out at USD3,747, although on the flip-side, over USD2 trillion of bitcoin was traded, marking a 61 per cent year-on-year increase. 

On into 2019, and by 10th July the bitcoin price had rallied once more to over USD12,500. It has since pared back some of those gains, trading at USD8,202 (at the time of writing). 

Dealing with these volatility swings is symptomatic of an asset class that still attracts significant retail capital. It is also reflective of the fast-moving trials and tribulations of fintech start-ups exploring blockchain technology. 

“We are dealing with a lot of uncertainty,” says Anguita. “This asset is quite unique because you have the risk profile of early stage tech ventures in the public markets and it is typically the case that with such ventures the amount of uncertainty you have to deal with is enormous. Risks materialise and you rapidly change your opinion of the asset. 

“In addition, these markets are still not yet very liquid. The lack of liquidity amplifies the changing of opinions in the market. Volatility is an expression of uncertainty and as a result we have to deal with large swings in the day-to-day valuation of these technology companies. It’s all part of the equation.”

The risk here is not volatility risk – you have to be able to withstand wild swings in performance – it is the risk of the technology working or not over the medium-term horizon. 

“It’s a different approach to trading fixed income bonds or equities,” says Anguita, “where these markets are more related to the business cycle. A technology solution might become obsolete and we end up being wrong with our fundamental assumptions. That is the risk.” 

Some fund managers are using the imprimatur of trusted regulators to give credence to their fund strategies and help assuage any fears investors might have as they dip their toe in to the digital asset space.

Olymp Capital recently became the first asset management fund dedicated to blockchain and digital assets to be registered with the Commission de Surveillance du Secteur Financier (CSSF). Olymp aims to bridge the gap between traditional investors and the emerging blockchain market. 

It is the first asset manager registered by the CSSF able to manage Equity, Tokens and hybrid-type investments in the blockchain ecosystem. 

“We have designed the Fund as any other PE or VC fund. We are not surprised to be CSSF registered but it confirmed that to duplicate the best practices and design of traditional Funds was the right decision,” says de Courson. 

Another regulated fund manager in Luxembourg is Block Asset Management, which became the first blockchain/crypto-focussed Alternative Investment Fund Manager (AIFM) registered with the CSSF. 

BAM operates the world’s first crypto fund of funds, which went live in January 2018. The fund has been designed to offer investors full access to the world’s fastest-growing asset class with the benefits of sound risk management and portfolio diversification to reduce volatility.

To address the speed at which investors can both invest and cash out their cryptocurrency investments, BAM recently devised a creative solution: issuing the first ever publicly-listed crypto tracker certificate on the Vienna Stock Exchange. The certificate is linked to the performance of BAM’s fund of funds which it will, hopefully, mirror on the public market and is essentially a feeder mechanism.

“In short, it helps us with distribution,” says BAM co-founder and CCO, Kevin Ballard. “An exchange-listed tracker certificate is basically a box-ticking exercise for the compliance teams at major financial institutions including private banks. Major asset managers and private banks wanted exposure to the digital asset space but in a way that allows them to retain custody. Unlike investing in the fund directly, the OTC certificate permits the bank or asset manager to retain custody.”

As Manuel De Luque Muntaner, co-founder and CEO further explains: “After one year of running the fund we realised that most of the major banks didn’t want to take a crypto fund on board. We looked into how to solve this problem and we decided that if we created a tracker certificate, which is basically an OTC instrument, it would make it easier for the banks to invest in. The tracker certificate is basically a feeder to the main fund – and it has proven to be no problem at all for the banks. Some of the biggest asset managers in Latin America have added our certificate into their model portfolios.”

Given the structural link between blockchain and digital assets, Olymp Capital has positioned itself as a natural leader in the European VC ecosystem specialised in blockchain-related investments. And as De Courson states, he is looking to take full advantage of the opportunities offered in this specific field “thanks to our network in the space”.

“We are dedicating resources to source best-of class early-stage companies which are well positioned to disrupt global business in large industries and ecosystem, thanks to the blockchain technology integration.” 

As more digital asset strategies emerge, the institutional look and feel of the asset class will continue to improve. One can now get access to quant strategies, arbitrage strategies, peer to peer lending strategies, mining strategies “and in our FoFs we have exposure to ICO/SCO strategies that are similar to PE or VC-type strategies”, confirms De Luque. “We also have one strategy that invests in blockchain-related listed companies – companies like IBM, Microsoft who are investing huge amounts in blockchain technology.” 

The fund-of-funds being managed by BAM identifies six strategies within the digital assets space and currently invests in 10 funds in its portfolio.

“In total we have over 800 funds in our database. The majority, however, do not pass our strict due diligence process. A lot of companies make it sound like they are running a Rolls Royce but when you look under the hood you find it is nothing more than a hamster spinning on a wheel. If they don’t have an independent fund administrator, an annual audit or a team with experienced in fund and money management, they are rejected,” concludes Ballard. 

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