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It’s been easy for digital asset hedge fund managers to look back of late. But what lies ahead? Consolidation, opportunity, and the looming question of regulation.  

This article first appeared in the February 2023 Digital Assets Insights Report

It’s been easy for digital asset hedge fund managers to look back of late. But what lies ahead? Consolidation, opportunity, and the looming question of regulation.  

The consensus among crypto natives is that last year’s events have disrupted, remodelled, and fortified the industry’s foundations and created a trading environment rife with opportunity. Traditional hedge fund managers feel similarly, research suggests.  

More hedge fund managers – crypto natives and traditional – plan to launch a digital assets fund now than they did 12 months ago. Last year, 31% of hedge fund firms surveyed by Hedgeweek in January were planning a launch. This year, it’s 41%. Naturally, the 2023 figure is higher for crypto natives (62%), but the 31% of traditional hedge fund firms developing a new digital assets product and the 38% now investing in digital assets (PwC research, published in June) suggest that, despite the disruption, there is real faith in the industry’s future.      

“Historically, digital assets have had four-year cycles, and we believe 2023 will be a time of consolidation,” says Roland Roventa, portfolio manager at Altana Wealth’s digital assets fund. Altana Wealth launched to outside investment in 2011 with a focus on FX. It began investing in cryptocurrencies in 2014 – one of the first London-based hedge fund firms to do so.    

“Every bear market has created a higher low and built a base for the next expansionary phase,” Roventa continues. “The current market provides investors a unique opportunity to find fundamental value in this emerging asset class at distressed prices.” 

Roventa describes Altana as “overly bullish on the future of digital assets long term” but “cautiously optimistic for 2023”. Others, like Anthony Scaramucci, appear less cautious, more optimistic. His Skybridge Capital had a poor 2022 from losses on FX and cryptocurrencies but is betting bitcoin hits $35k this year. 

And many hedge fund managers agree. Of those surveyed by Hedgeweek – mostly in January, as bitcoin’s price surged – more than 70% said they expected bitcoin’s price to peak beyond $30k during 2023. Interestingly, respondents from digital asset specialist firms congregated around the mid-tier $30-40k band, arguably displaying the aforementioned ‘cautious optimism’. Respondents from traditional hedge fund firms, meanwhile, were more likely to select a bullish (>$40k) or bearish (<$30k) option.    

Opportunities through tech

As noted in a previous chapter, the crises in 2022 overshadowed some significant technological advances in the crypto trading infrastructure around options products and decentralised finance. In 2023, analysts expect digital asset hedge funds to seek opportunities for alpha in the growth of NFTs (non-fungible tokens) and Web3, and to benefit from the tokenisation of real-world assets and investment funds.  

A tokenisation fund would effectively give retail investors the opportunity to invest in products with high minimum investments by buying a fraction – or token – of that larger investment rendered digitally on a blockchain. Last March, research from Token City found that 65% of fund managers thought hedge funds would be the most likely vehicle to first see significant tokenisation. More than 70% said private equity.  

Several large private market specialists have made headlines in recent months by launching tokenised funds. These include $800bn investment manager Hamilton Lane, who announced in October plans to tokenize three funds through a partnership with digital-assets securities firm Securitize. It opened the first of these on the Polygon Blockchain earlier this month.  

Tokenised hedge funds have been slower to materialise – or at least slower to make headlines. One of the few examples in the public domain is a global macro product run by Asia Genesis CIO Chua Soon Hock that was recently listed on ADDX, the Singapore-based digital securities private markets exchange.

A report last year from ADDX and global consulting firm BCG said tokenisation could be a $16 trillion business opportunity by 2030. It is certainly starting to capture the imagination of managers. The topic was the most cited example of an emerging ‘disruptive technology’ by Hedgeweek survey respondents.  

In terms of what might be considered established disruptive technologies, digital asset hedge funds appear to have stopped developments around artificial intelligence (AI) and Big Data. Among the 38% of digital asset hedge fund firms surveyed by Hedgeweek that do not currently use Big Data in a meaningful way, none planned to. Among the 62% that do not currently use AI/machine learning, only 8% planned to. 

Of greater interest, for now at least, is ChatGPT – the chatbot from OpenAI made available to the public in November 2022. Nearly a third of digital asset hedge fund firms surveyed by Hedgeweek were exploring how ChatGPT could benefit their business (see boxout for ChatGPT’s own thoughts on this). Incredibly, nearly 25% of digital asset hedge fund firms – and 11% of traditional hedge fund firms – are already using it.  

Regulatory risks  
Ultimately, though, all the technological progress, all the opportunities from an expanded trading toolkit, and all the cautious optimism for coin price could be eclipsed by the actions of one group – regulators.  

According to Galaxy Digital CEO Mike Novogratz, the biggest risk to the digital asset hedge fund industry, particularly in the US, is around incoming regulation, which must balance protecting investors and the broader financial system with innovation. “If regulation ends up stifling innovation, there’s the potential that the US’s role as a leader in crypto adoption and innovation is ceded to other jurisdictions, some of which may be less friendly to US interests,” he says.  

So far, the US is yet to unveil formal plans for cryptocurrency regulation – though it is one of the few areas of policy that enjoys bipartisan support among US lawmakers, making movement this year likely. For now, confusion remains over whether digital assets should be the jurisdiction of the SEC or the CFTC. For its part, the SEC has been bringing enforcement actions on a case-by-case basis. Some US managers have accused the regulator of prioritising a piecemeal approach over the creation a proper framework. 

The EU, by comparison, made steady progress with its Markets in Crypto-Assets (MiCA) throughout 2022 and is expected to have it take effect towards the end of 2024. Across the channel, the UK launched a consultation this month on its own legislation proposals, unveiled to mixed reviews in the aftermath of the FTX collapse. 

The hope for all – meaningful collaboration between regional regulators. 

The FTX event highlights the need for globally coordinated regulation, say Albourne Partners’ Travis Williamson and Steven D’Mello. A resultant framework should “increase transparency around reserves, ideally separating financing, custody, and trading into separate platforms, although this could be less likely to be achieved amidst the fallout from FTX.”

They add: regulatory developments around stablecoins, such as MiCA, could also help participants manage counterparty risk by bringing more certainty around regulated stablecoins.

As one interviewee said to Hedgeweek, government regulation could significantly help or hurt the growth of the digital assets investment industry. For now, it is too early to tell which way the pendulum will swing.

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