Applied Research

Crypto Hedge Funds: Are They Worth It?

Aug 2022, By Leila Majidizavieh

Introduction

Crypto assets have been amongst the fastest-growing asset classes in recent years. This new asset class has attracted a diverse set of investors, ranging from traditional institutional investors to more nascent investors keen to play a role in the innovation and transformation that blockchain technology promises. Although the nature of this asset class is somewhat speculative and its fundamentals have been questioned by some academics, many retail investors in their search for high returns during a long period of low-interest rates have added crypto assets to their portfolios. The public awareness of the performance of Bitcoin, the largest and the most popular cryptocurrency, has driven the prices and trading volume of the other crypto assets, and social media trends and micro-blogging platforms have also fueled their popularity. This trend accelerated after the COVID-19 pandemic. Empirical research indicates that COVID-19 has positively impacted the cryptocurrency through a mechanism called Herding Behavior. The pandemic spread fear and anxiety amongst investors and in turn caused an increase in the trade volume of crypto assets in the investors’ search for high-return assets [1]. Additionally, the governmental stimulus packages introduced to address the outbreak had positive impacts on the crypto assets market. These stimulus measures are characterized as a wealth shock for households and caused a significant increase in cryptocurrency buy-trades [2].

Crypto Hedge Funds

In addition to individual investors, some institutional investors also tend to include digital assets in their portfolios. This group seeks to benefit from diversification advantages and high returns of crypto assets. However, the highly volatile and speculative nature of crypto assets remains controversial. New funds specialized in digital assets, blockchain, and crypto asset classes have also emerged and the rate of new funds appearing has accelerated since 2020. Although the background factors responsible for the crypto assets and by extension crypto funds’ success have been gradually changing in recent months and a new market situation is forming due to the inflationary pressures, a high expected level of interest rates, and a strategic shift from growth investing to value investing, the net investment flow towards this new asset class remains positive. An analysis using AlternativeSoft supports the aforementioned statement. It shows that from the beginning of 2020 onwards, over 11,459 million dollars have flowed into USD-denominated hedge funds specializing in blockchain and digital assets (see Table 1).

Table 1: Hedge Funds’ Net Inflow based on geography since the start of 2020

Cryptocurrency funds exhibit track records of extremely high positive returns. Their annualized returns in some cases exceed hundreds of percent. Even adjusting their returns using traditional risk-based measures does not change the fact that these funds outperform the conventional market benchmark. The literature on cryptocurrency funds’ performance supports the argument that cryptocurrency fund managers generate significantly positive alphas compared to conventional benchmarks and this extreme outperformance is unlikely to be explained by pure luck [3].

Are Crypto Hedge Funds worth it?

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