John Garvey, Global Leader of Financial Services at PwC USA, stated:
“Despite market volatility, a decline in digital asset prices, and the collapse of some crypto businesses, investments in crypto assets are expected to remain strong in 2023. Traditional hedge funds, who have long been committed to the market, are not only increasing the amount of crypto assets they manage, but also maintaining or increasing the amount of capital they invest in the ecosystem. However, regulatory uncertainty and barriers are increasingly affecting the investment decisions of many funds, with over half of respondents indicating that they are likely to invest or increase investment in digital assets once there is greater transparency, regulatory certainty, and risk management.”
Regulatory clarity is critical for investor participation
Crypto hedge funds dedicated to investing in digital assets are calling for greater transparency and regulatory requirements to mitigate investor risk and boost confidence in the asset class, a request made in the wake of some crypto business collapses in 2022. These requests include asset segregation (cited by 75% of all surveyed), mandatory financial audits (62%), and independent reserve asset reporting (60%). Liquidity was once seen as the primary factor in choosing trading venues but is now considered equally important as platform security: liquidity was chosen as the most important consideration factor by 21% of surveyed crypto hedge funds, up from 10% last year. More than half (53%) of crypto hedge funds surveyed said they have upgraded their counterparty risk management processes following the market events of 2022.
For traditional hedge funds that have already invested in digital assets, they also expressed concerns about the evolving regulatory environment, particularly in the United States. Of those, 23% said it would have a material impact on them or cause them to re-evaluate the feasibility of their crypto asset positions. More than half (54%) of traditional hedge funds confirmed that they would change their approach and be more interested in the asset class if perceived industry barriers and uncertainties were resolved, up from 29% last year. In contrast, crypto hedge funds seem relatively indifferent to these regulatory developments, with only one-third of respondents expecting to face greater legal and compliance costs and 12% of respondents believing that the current regulatory environment in the United States may lead them to move to more crypto-friendly jurisdictions.”
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Market Developments Affect Investor Participation
Last year’s cryptocurrency market events, including the collapse of some cryptocurrency asset service providers, were generally seen as negative by traditional hedge fund respondents: 57% of funds reported that their prospects were negatively or strongly negatively impacted. Of these funds, 70% manage assets of over $1 billion.
More than two-thirds (71%) of traditional hedge funds surveyed currently do not invest in cryptocurrency assets, an increase from 63% last year. The four main reasons why traditional hedge funds do not invest in cryptocurrency assets are the same as last year’s responses, including: (1) client reaction or reputational risk, (2) lack of regulatory and tax clarity, (3) insufficient or unreliable third-party data, and (4) outside the scope of the current investment mandate.
In contrast, surveyed cryptocurrency hedge funds appear to be unaffected by recent market volatility, with half (50%) reporting no impact. Nearly one-third (27%) have an optimistic view of the current market, possibly due to the wide-ranging decline in cryptocurrency asset valuations presenting more investment opportunities. Given last year’s events, 53% of cryptocurrency hedge funds report having updated their counterpart risk management processes.
Tokenization as a Development Path Receives More Attention
Compared to cryptocurrency hedge funds, traditional hedge funds show greater curiosity about tokenized assets and securities, with one-quarter of funds exploring tokenization. By contrast, only 15% of cryptocurrency hedge fund respondents reported exploring investments in tokenized securities. Fund tokenization promises faster settlement times and reduced operational costs, improving efficiency and reducing friction. About one-third (31%) of surveyed traditional hedge funds cited tokenization as the biggest growth opportunity in the cryptocurrency asset space over the next year.
Traditional Hedge Funds and Cryptocurrency Hedge Funds Diverge in Investment Strategies
“Diversification of asset portfolios” or “long-term excess returns” are the most common reasons why traditional hedge funds include cryptocurrency assets in their portfolios. More than half (54%) of traditional hedge funds currently investing in cryptocurrency assets indicate they plan to maintain the same level of fund allocation this year. Forty-six percent (46%) of funds indicate they plan to increase investments in this asset class by the end of 2023, a decrease from 67% last year.
The vast majority (91%) of traditional hedge fund investors who have invested in crypto assets say they hold the two largest cryptocurrencies by market value and trading volume – Bitcoin and Ethereum, up from 67% last year, indicating a shift towards large-cap coins and reflecting a more conservative investment approach.
None of the respondents said they invested in NFTs, compared to one fifth of traditional hedge funds that invested in NFTs last year, indicating that the market’s enthusiasm for NFTs has cooled significantly since the peak of 2021.
Among the interviewed crypto hedge funds, market-neutral strategies remain the most popular, although their usage has decreased from 30% to 20% compared to the last survey. Conversely, the usage of pure long crypto strategies increased from 14% to 19%, while the usage of quantitative long-short crypto strategies decreased from 25% to 18%. This evolution may be more related to the current market environment than to an overall change in long-term trading strategies. All crypto hedge fund strategies except market-neutral ones have suffered losses.
Jack Inglis, CEO of AIMA, said:
“The digital asset field has had to face its fundamental operational flaws, including risk management and allegations of corporate misconduct. Investor interest in the sector has shown some resilience in some new areas, particularly tokenization, which will provide a foundation for industry participants to rebuild institutional investors and traditional hedge funds’ confidence in this asset class.”
Alexandre Schmidt, index fund manager at CoinShares, said:
“In the complex environment of 2022, crypto hedge funds have shown remarkable resilience. Most of the surveyed funds have generated positive alpha returns, highlighting the important role these companies play in the digital asset ecosystem. As we move through the time beyond 2023, regulatory bodies are a barrier in the short term, but this will pave a clearer path for long-term investment in digital assets, promoting higher adoption rates from small retail investors to large institutional investors.”
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