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How Big Is the Global Crypto Hedge Fund Ecosystem and Why 67% of Traditional Hedge Funds May Increase Their Crypto Allocation This Year? (#106 - 13 June 2022)

The Future of Money with Henri Arslanian
How Big Is the Global Crypto Hedge Fund Ecosystem and Why 67% of Traditional Hedge Funds May Increase Their Crypto Allocation This Year? (#106 - 13 June 2022)
By Henri Arslanian • Issue #97 • View online
The much anticipated 4th Annual Crypto Hedge Fund Report by PwC-Elwood-AIMA is finally out! 
I highly recommend you read the full report here. But if you are busy or your time is limited, I summarize the key takeaways that you need to know in this issue of the newsletter.
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Here we go!

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PwC, Elwood, and AIMA just published their 4th Annual Global Crypto Hedge Fund Report, which is packed with several interesting takeaways about the continued development and maturation of the crypto hedge fund industry.
The report includes several observations that are well worth highlighting. 
According to the report, there are potentially over 300 crypto hedge funds operating in today’s ecosystem. And half of these funds were launched within the past three years. 
Interestingly enough, the launch of new funds appears to be heavily correlated with the price of Bitcoin.
For example, a large number of funds launched in bull markets (in 2018, 2020, and 2021), with only moderate levels of new launch activity in bear markets.
When looking at the most common strategies of crypto hedge funds, meanwhile, we can see that market-neutral funds have emerged as the most common strategy employed by crypto funds, accounting for 30% of all activity.
Market-neutral is followed by quantitative long/short funds (25%) and discretionary long-only (14%).
Multi-strategy and discretionary long/short only make up a noticeably smaller share, with each sitting at 12%.
And similar to the findings from last year, the overwhelming majority of investors in the crypto hedge fund space are high-net worth individuals (HNWIs) and family offices, with 86% of funds featuring HNWI investors and 66% of funds featuring investments from family offices.
As for total AuM (Assets under Management), crypto hedge funds around the world saw an 8% jump from US$3.8 billion in 2020 to US$4.1 billion in 2021.
It is important to note here that this report only covers crypto hedge funds and excludes long only, passive or VC funds.
A total AuM of US$4 billion is still very small when you consider that the total AuM of the “traditional” hedge fund industry is over US$4 trillion. So definitely a lot of growth potential!
In addition, the average AuM increased from US$35 million to US$58.6 million, whilst the median AuM rose from under US$9 million to US$24.5 million.
When it comes to fund performance over the course of 2021, on a median basis, discretionary long/short funds were the best performing (199%), beating out discretionary long-only funds (176%).
Average management fees also held steady at 2.2%, but average performance fees actually decreased from 22.5% to 21.6%, with falling fees likely a result of an increasingly competitive environment as more new funds continue to enter the space.
It is important to note that these fees are higher than for traditional hedge funds. But this can be justified considering the higher costs involved in setting up a crypto hedge fund, like custody or security considerations for example. 
As far as the types of digital assets traded by crypto hedge funds, not surprisingly, Bitcoin/BTC and Ethereum/ETH come on top.
However, what’s interesting to note here is that only 29% of surveyed funds reported in 2021 that at least half of their daily crypto trading volumes were comprised of Bitcoin, compared to 56% in 2020, which shows that funds are diversifying into altcoins. 
After BTC and ETH, for example, the top five altcoins traded by funds last year were Solana/SOL (51%), Polkadot/DOT (48%), Terra/LUNA (45%), Avalanche/AVAX (42%), and Uniswap/UNI (39%). 
The high percentage of crypto hedge funds trading Luna is an interesting data point and it will be interesting to see how the collapse of Luna will affect the performance of the crypto hedge funds. 
Separately, the report also shows that crypto hedge funds are also quite active in a broader range of activities like borrowing, staking, and lending.
In addition to increasing levels of interest in altcoins, crypto hedge funds also saw rising levels of activity via stablecoins.
USD Coin (USDC) and Tether (USDT) were by far the most heavily traded, at 73% and 69%, respectively.
Other stablecoins, meanwhile, like TerraUSD (UST), MakerDAO (DAI), and Binance’s stablecoin (BUSD) saw smaller levels of interest.
Here as well, it will be interesting to see the impact of the collapse of UST on these funds. It is likely that many of them were active on the Anchor protocol (something we covered previously in this newsletter) so how they were impacted will be something to watch.
The data also shows an overall increase in the use of derivative products, which we can probably attribute to the continued development and maturation of the broader crypto ecosystem.
62% of the surveyed funds now trade derivatives, for example.
Crypto hedge funds also saw a considerable uptick in DeFi activity last year, with 41.6% of surveyed respondents engaging with decentralized finance (up from 31.5% in 2020).
Uniswap was the most widely used platform at 20%, followed by 1Inch (9%) and SushiSwap (9%).
Moving on to custody and counterparty risk, the use of independent custodians saw a notable jump from 2020 to 2021, with 82% of funds electing to use a third-party custodian (compared to 76% in 2020).
Two clear market leaders have emerged, accounting for 42% of custody services, compared to only 22% in 2020. 
We should not be surprised to start seeing consolidation in the custody space as a battle for assets under custody may emerge.
Respondents were also asked which crypto exchanges they were using and the reasons for choosing them.
Four platforms, in particular, stood out, accounting for more than 30% of respondent answers.
The most widely-used platform, meanwhile, was used by nearly half of all surveyed funds. 
The top considerations when selecting a trading venue were liquidity (39%), trading opportunities like the variety of products and derivatives (18%), and security (11%).
As the industry becomes more institutionalized and more institutional investors enter the space, we should expect elements like security, reputation or regulation move up the consideration list.  
As far as governance, the report shows a substantial increase in the number of funds with independent board directors, rising from 38% in 2020 to 51% in 2021, an important development considering the correlation between independent board directors and good governance.
We should also expect this percentage to increase over the coming years as the industry becomes more institutionalized. 
Crypto funds also saw a slight rise in how funds are administered, with 91% of surveyed funds reportedly using an independent fund administrator.
Whilst areas like custody or fund administration are becoming more common, it seems that there is lots of space for growth for trading systems.
For example, the report shows that the majority of funds have built their own trading technology. 
55% of funds, for example, are developing their technology internally, whilst 19% rely on external vendors. The remaining 26%, meanwhile, use both in-house and outsourced technology.
And, not surprisingly, crypto hedge funds tend to be domiciled in a lot of the same jurisdictions as traditional hedge funds, with the Cayman Islands (49%), the British Virgin Islands (13%), and Gibraltar (12%) taking the top three spots.  
The same goes for the location of the fund manager with the top three being the U.S. (30%), the U.K. (10%), and Hong Kong (6%).
And to finish on a lighter note, crypto hedge fund managers were also given the chance to predict where the price of Bitcoin and the total crypto market cap would sit by the end of 2022.
At the time the survey was conducted in April 2022, the overall sentiment within crypto circles had turned considerably bearish, yet fund managers remained quite bullish in their responses, predicting that Bitcoin would end the year above where it sat at the time (US$40,000). 
Median predictions of the price of Bitcoin actually sat at US$75,000. 42% of the responses sat within the US$75,000 - US$100,000 range, whilst 35% of predictions sat between US$50,000 and US$75,000.
As for market capitalization predictions, crypto’s total market capitalization was worth roughly US$1.5 trillion at the time the survey was conducted.
As was the case with the price of Bitcoin, though, fund managers were bullish from this perspective, as well, with 97% of respondents expecting the market to close the year above then-current levels. 
Most predictions ranged between US$2 trillion and US$3 trillion, with a median predicted level of US$3 trillion. 
All in all, some very interesting trends that give us some insight into the rapidly shifting crypto hedge fund landscape!
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The latest PwC, Elwood and AIMA report contains some very interesting data on what traditional hedge funds are doing in crypto.  
The data used in the report comes from a survey of 89 hedge funds conducted in the first quarter of 2022, with the participating funds representing US$436 billion in Assets Under Management (AuM).
Roughly one out of three traditional hedge funds that participated in this survey are currently investing in digital assets.
When this same study was conducted a year ago, only one in five traditional funds had invested in the digital assets space, representing a significant year-on-year jump (21% vs. 38%).
And the average percentage of AuM allocated to digital assets is 4%, compared to 3% in the previous year. 
Of the surveyed funds that are currently investing in digital assets, 57% have less than 1% of their total AuM allocated to this asset class. 
When it comes to future plans in the space, 67% of these funds are planning to shift even more capital into the digital assets ecosystem by the end of 2022. 
Of the funds that are planning to invest more capital into the space by the end of the year, 57% have less than 1% of their total AuM dedicated to digital assets.
But even a 1% increase is material when it comes to a sample of hedge funds representing over $400 billion in assets. For example, a 1% increase in allocation into crypto from the traditional hedge funds surveyed would represent $4 billion of new capital in the crypto space which is equal to the total AuM of native crypto hedge funds today.
One of the most interesting takeaways from the report indicates that nearly two-thirds (62%) of the hedge fund managers who participated in this survey are not currently invested in digital assets. But, at this time last year, 79% of hedge fund managers were not involved in the space. 
Of the hedge funds that are currently active in the digital assets ecosystem, managers cited several key challenges, with lack of regulatory and tax regime clarity (89%), lack of liquidity amongst key products like ETFs, futures, and options (78%), asset custody (78%), prime broker services (78%), and fiat withdrawals via exchanges (72%).
When focused specifically on regulatory issues, over a third of respondents (36%) attributed their apprehensions to a globally fragmented regulatory landscape.
Lack of infrastructure/service provider availability for auditing and accounting purposes represents another barrier to entry for some of these funds.
The auditing and accounting space in now seen by participants as being most in need of improvement (94%), outranking custody and safekeeping as the biggest service provider challenges preventing greater adoption of digital assets.
But, on the bright side, 27% of respondents stated that if some of these barriers were removed, they would quickly accelerate their involvement in the digital assets space, a significant increase from 18% a year ago.
Yet 45% of respondents stated that the removal of some of these barriers would have no effect on their current approaches, as investments in digital assets either remain outside the scope of current investment mandates or some funds continue to view the space with skepticism. 
Ultimately, lots of exciting developments in the traditional hedge fund world that represent quite the shift from just a few years ago!
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Henri Arslanian
*Please note that this newsletter reflects Henri’s personal views and not those of any organisation he is involved with. This newsletter is for educational purposes only and none of its content should be construed as investment or financial advice of any kind. 
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Henri Arslanian

Future of Finance and Money - PwC Global Crypto Leader, Best Selling Author, Keynote Speaker, University Professor, Host of Crypto Capsule™ - Views are my own

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