This article takes a look at the effects of the bearish year of 2018 on crypto funds. DId 2018 signify the downfall of crypto funds? Read on to find out.
The emergence of cryptocurrency hedge funds – or crypto funds for short – has been well-documented in the bull market in 2017. Crypto hedge funds represent a part of the crypto funds universe, which also includes crypto venture capital and crypto private equity. Grouped together, there are currently 622 crypto funds across all categories, 303 of those being crypto hedge funds, which represent assets of less than $4 billion. Approximately half of the funds are based in the United States, with multiple launches being seen in Australia, China, Malta, Switzerland, The Netherlands and the U.K. in 2018. 2017 represented a great year to start a crypto hedge fund, since the blistering financial returns within the year made it seem almost too easy for anyone to make money.
Bleak Outlook for Crypto Funds
On the flip side, 2018 has seen a significant downturn in the prices of the cryptocurrency market. In fact, the general cryptocurrency market crashed by as much as 80% since its all-time high that was achieved in late 2017. Since crypto hedge funds are fully focused on investing in the wide array of over 2,000 coins and tokens in existence, cryptocurrencies make up a significant portion of a crypto hedge fund’s portfolio. Therefore, it was inevitable that crypto hedge funds were hemorrhaging huge amounts of losses and severely underperformed conventional hedge funds that were focused on traditional investment securities.
Here’s a look at the average hedge fund returns on a monthly (Oct 2018), 3-month and yearly timeframe:
It is obvious that crypto hedge funds were making significant rates of returns in the market boom in 2017, recording a whopping 1,708% returns! However, 2018 was underwhelming with an average loss of 56%.
Here’s a more in-depth, monthly breakdown of the rate of returns in 2017 and 2018:
Ultimately, cryptocurrency investor who invested in a crypto hedge fund lost significant amounts of their capital. Even if they have not sold their positions and ‘realized’ the losses, their capital is still tied up in coins that are only a fraction of what they used to be worth. With Year-to-Date (YTD) returns of -56.78% in 2018, investors had to consider other alternative options to reduce their risk profile within this disruptive, highly-growing technology space.
Cryptocurrencies: The Most Volatile Asset
It is no surprise that cryptocurrencies are highly speculative in nature and represent one of the most volatile asset in existence. Volatility refers to the rate of change in prices over time; the prices of a highly volatile asset would aggressively fluctuate up and down in the short-term. In order to understand how volatile cryptocurrencies really are, let’s take a look at a comparison of the volatility between major asset classes:
We can see the crazy volatility of Bitcoin’s prices as compared to traditional securities such as the Foreign Exchange (ForEx) market, stock market and gold market.
Cryptocurrency’s Correlation With Bitcoin
By now, most should know that the majority of token and coins are directly correlated with Bitcoin’s performance; they tend to stand and fall in-line with Bitcoin’s price movements. This is no coincidence since Bitcoin is the first decentralized cryptocurrency to be created and represents the ‘Founding Father’ of the cryptocurrency market. Additionally, Bitcoin is the largest cryptocurrency around since it possesses over 50% of the overall market share. Therefore, it is of no surprise that Bitcoin represents for the barometer of the overall health of the cryptocurrency market, and it’s dominance warrants a mirror-like movement of all other coins and tokens in the industry.
Here’s a look at the statistical correlation of other cryptocurrencies with Bitcoin:
(Source: Sifr Data)
Furthermore, cryptocurrencies are a relatively young asset class that will likely continue to be volatile until it matures in the long-run. Even the volatility of equities, currently at 13.4% from the stock market’s Volatility Index (VIX), is completely dwarfed by that of Bitcoin’s volatility which stands at a whopping 70% (down from 150% earlier in the year).
The total market capitalization of the cryptocurrency market rose from $18.3B at the start of 2017 to $613B by the start of 2018, generating a sterling growth of over 3000%! The market for cryptocurrencies is rapidly changing, presenting huge opportunities for investors, and in turn, investment managers. But, individuals looking to capitalize on the inefficiencies of the market by offering investment opportunities in actively managed hedge funds need to be wary of and disclose the associated risk.
The cryptocurrency market – though exhibiting similar patterns over the years – is an extremely tumultuous market. Here’s a look at the sequence of Bitcoin rises and crashes over the years.
Looks similar, doesn’t it?
The explosive growth of the cryptocurrency market in 2017 was largely due to hype and speculation, while the fundamentals of the industry took a back seat. Unsurprisingly, the market crashed in 2018 by more than 80% from its all-time highs. A majority of crypto funds will most likely not make any performance fee this year, despite their “complex hedging strategies” or automatically re-balanced functions.
With a bear market still prevailing, times are tough for everyone including crypto hedge funds. Given the struggles, crypto funds are faced with limited options, namely:
- Raising New Funds (Capital),
- Maintain their positions & ride the market out, hoping that 2018 will be better,
- Liquidate Their Positions & Close the Fund
- Change Their Investment Strategy
Perhaps the biggest challenge in performing financial analysis for cryptocurrencies is the absence of a comprehensive and credible framework to value the vast amounts of coins and tokens. The use of traditional financial analysis is obsolete in the cryptocurrency market since cryptocurrency projects are not legally required to furnish financial statements that the public can assess. Not only that, the financial metrics for a coin is vastly different than that of a stock-issuing company. This makes it extremely difficult for anyone to assess the true worth of a coin.
“Cryptocurrency cannot be quantified and valued in the same manner as traditional assets.”
The absence of financial statements and relevant metrics creates a dangerous vacuum in the market since market participants would instead try to value a coin with subjective indicators such as hype and sentiment. The valuation of a coin is usually centered around the expectation of future demand and is thus very susceptible to changes in market sentiment.
Although crypto hedge funds represent the most common form of digital asset funds, numerous types of funds are beginning to enter the market. Venture capital funds are beginning to gain prominence, with an important role in investing directly into a cryptocurrency project at the early-stage rather than investing in the coins and tokens of a project. There are also existing technology or financial technology (FinTech) venture capital funds that are expanding their horizons toward the blockchain industry and investing in blockchain startups and launching their own blockchain funds.
Investing in technology startups — instead of solely relying on price appreciation of existing crypto-assets — may represent a new pivot in the market. Combining the traditional structure of governance and management into the infant blockchain start-up scene may be a high-yielding market given the revolutionary and disruptive nature of the technology.
2019 has been a pretty uneventful year, with cryptocurrency prices stabilizing at its historic lows. The credibility of price predictions from financial and cryptocurrency experts is at a low point currently, since many are coming to terms with the reality that cryptocurrency prices cannot be predicted consistently and accurately.
One palpable observation is the death of the Initial Coin Offering (ICO) market, which until 2017, was booming. However, the market crash and eradication of profits have left many investors avoiding the ICO market completely. Many new cryptocurrency projects are struggling to raise funds via the ICO process. This brings us to the rising popularity of Security Token Offerings (STOs), which are basically regulated ICOs. Some reckon that STOs would reignite the cryptocurrency flame and pave the way to mass adoption of cryptocurrencies.
2019 could be the year when regulations are established, and the cryptocurrency market could find its footing and set off in a clear direction. With greater clarity on regulations, the hindrances that inhibit the industry can be removed and the ecosystem can better function in a thriving environment. There is still a long journey ahead for the infant technology, and time will tell if the disruption that cryptocurrencies promises would materialize.
Source: Crypto Fund Research, Eurekahedge, Sifr Data, Alpaca Securities
(You might also be interested in: Guide to Cryptocurrency Taxes: A Guide to Common Tax Situations)
This article was contributed by Iliya Zaki, Head of Business Development and Marketing for Moonwhale Ventures, a Singapore-based consultancy firm offering Blockchain Business Consulting services and also building a blockchain-based Investment Platform.
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