Investing in crypto funds: Opportunities and risks for investors

Investments in cryptocurrency funds: opportunities and risks for institutional investors

The arrival of institutional investors in the cryptocurrency sector is a significant event that largely determines its fate. High or low interest in digital assets on the part of professional investment companies directly affects the liquidity and growth performance of the cryptocurrency market.

In this article, we will explore the topic of investing in cryptocurrency funds, the opportunities for institutional investors offered by today’s market, and the prospects for institutional capital in the cryptocurrency segment of the global financial systеm.

The cryptocurrency fund concept

What is a cryptocurrency fund? It is an investment fund that collectively invests in digital assets, technological developments and related projects in the cryptocurrency sector. Its goal is to maximize returns for investors through competent management of their capital.

Large crypto funds work for large investors, offering a high entry threshold, impressive and stable profitability rates, as well as related services. Smaller ones act as intermediaries for retail investors who are not ready to invest in crypto themselves due to lack of desire, time or experience.

What is the importance of institutional interest in the digital asset market?

Providing stability. Cryptocurrency investment funds saturate the financial markets with a large amount of capital, which reduces volatility and stabilizes the situation.

Professionalization. Institutional investors demand higher standards and bring new standards and procedures to the industry, making it more adaptable, skilled and efficient.

Improved reputation and trust. The interaction of the digital asset sector with reputable, well-capitalized institutional funds helps to overcome mistrust and create a positive image in the eyes of regulators and the public.

Situation in the segment

The first cryptocurrency fund, Metastable Capital, appeared in 2014. However, the world of traditional finance and big capital was reluctant and slow to recognize the viability and feasibility of investing in digital assets. And for the next few years, there were no more than a few dozen cryptocurrency investment funds around the world. The boom in the popularity of digital assets in 2016-17 set the stage for cryptocurrency investment funds to actively enter the market. And in 2017 alone, nearly 300 were launched. Stunning potential profitability of hundreds and thousands of percent, as well as low competition amid low returns on traditional assets, attracted institutional investors. Moreover, the growth rate of the number of crypto funds slowed down, but the volume of their investments increased many times over. Despite the overall growth in the volume of assets under management of crypto funds last year, the main funds are still distributed among the largest players, such as a16z (Andreessen Horowitz), Pantera Capital, Sequoia Capital, Framework Ventures and others:

Pantera Capital is the largest investment fund with $5 billion under management, which has been investing in cryptocurrencies and blockchain projects since 2013.

Polychain Capital has been operating since 2016, using active money management strategies. According to the Securities and Exchange Commission, Polychain has more than $1 billion in assets under management.

Andreessen Horowitz (a16z) is a crypto hedge fund founded in 2009. The main area of investment is blockchain and web3 projects. The firm’s total cryptocurrency investments exceed $7 billion.

According to Crypto Fund Research, as of early 2024, there are 868 crypto funds worldwide with offices in more than 85 countries. Crypto funds, the lion’s share of which are hedge funds (421 of them) and venture capital funds (417 of them), manage approximately $70.1 billion in assets.

More than half of them are geographically concentrated in North America (mainly in the US), as well as in Europe and Asia – 20% of the total each.

Types of cryptocurrency funds

Typically, cryptocurrency funds are categorized by access level and investment type.

By access level

According to this criterion, crypto funds are divided into:

Closed or private. The “whales” among investment funds work with this level of access. They have a fixed capital structure, accumulate billions of dollars and attract only qualified investors.

Open-ended. These are funds with unfixed capital that are open to retail investors. They come in regulated and exchange-traded funds (ETFs, with the ability to trade on an exchange).

By type of investment

According to this parameter, the following main categories are distinguished:

Hedge funds. This is a fund managed by professionals in the interest of investors to maximize returns while minimizing risks and guaranteeing security.

Venture capital funds. Specialized in making early investments in promising crypto projects to maximize future returns.

Cryptocurrency ETFs (Exchange Traded Funds)

This type of mutual fund has been in the news lately as the market waited to see if the SEC would allow spot trading of Bitcoin ETFs. This event has served as a major catalyst for the growth of the crypto segment through the influx of additional capital from an expanded pool of investors. Let’s take a closer look at this type of crypto fund.

An ETF is a cryptocurrency fund with a dynamic systеm of issuing shares that are publicly traded on a stock exchange. The company invests in cryptocurrency and then sells a portion of the portfolio. To buy shares, an investor opens a brokerage account through which they can purchase ETF shares. He doesn’t need to create a wallet and store the cryptocurrency. ETF shares can be issued or redeemed depending on market demand, which ensures that the ETF price reflects the real value of the asset.

This instrument has added appeal because ETFs are regulated by securities laws and are responsible for safeguarding crypto assets. In January 2024, the Securities and Exchange Commission gave the go-ahead for 11 spot bitcoin ETFs to trade on major exchanges. Trading volumes have been staggering. IBIT alone, for example, had daily trading volume of more than $1 billion. BlackRock’s iShares Bitcoin Trust (IBIT) spot bitcoin ETF received approximately $10 billion in assets under management in a month and a half.

For more than a decade, U.S. regulators have not approved the launch of ETFs tracking the spot price of bitcoin. And now it has happened. The SEC was forced to make a favorable decision in favor of spot bitcoin funds after finally losing the Grayscale Investments case in the Court of Appeals.

Risks of Investing in Cryptocurrency ETFs

The general volatility risks of cryptocurrency investments.

Investors put money into a fund rather than investing directly in the asset. This limits the ability to use the cryptocurrency.

Specifics of regulation. Regulation of cryptocurrency ETF funds falls under the Investment Company Act of 1940, which makes the tax-sensitive value of crypto assets more susceptible to SEC decisions.

Advantages of Cryptocurrency ETFs

Spot bitcoin ETFs provide access to the bitcoin market through traditional stock exchanges. This is an innovation in cryptocurrency investing and an important step in integrating digital assets into the mainstream financial systеm.

Cryptocurrency ETF fund transparency. Access to assets without direct ownership and real-time price transparency. This is convenient for institutional investors who prefer passive strategies.

Accustomed to regulation. Institutional investors are used to operating on traditional exchanges within a defined regulatory framework. The approval of spot bitcoin ETFs on the New York Stock Exchange and NASDAQ reassures investors, increases their confidence in the crypto market and is a sign of cryptocurrencies’ increasing influence on traditional financial markets.

Cryptocurrency Hedge Funds

This type of fund also makes money from asset appreciation, but does not offer shares for trading on the stock exchange. They are usually only available to qualified investors and require a high entry threshold: from $5 million in U.S. hedge funds and from about $100 thousand in offshore zones. Unlike ETFs, they are not as strictly regulated. Organizations of this type are authorized to manage assets for both retail and institutional investors. Hedge funds take an active approach to managing cryptocurrency assets and offer high returns.

Advantages of Crypto Hedge Funds

High level of professionalism in asset management. Initially focused on hedging market risks, hedge funds have over time shown a preference for increasingly aggressive and high-return strategies that involve a higher degree of risk. People who manage crypto hedge funds must have the highest qualifications and impressive experience.

Excellent applicability in diversification. Portfolio diversification through cryptocurrencies when participating in a hedge fund provides an opportunity to increase the liquidity of cryptocurrency investments and the overall return on investment.

Security of cryptocurrency investments. By charging high fees, crypto hedge funds that are professional risk mitigators share responsibility with investors and maximize the safety of the investment.

Disadvantages

High commissions. Hedge fund commissions consist of a management fee (usually within 1-4%, on average is about 2%) and a commission on income (in standard cases is about 20%, sometimes — up to 50%). At the same time, the commission is calculated at the end of the year, taking into account the tax aspects of cryptocurrency funds and less compensation for losses for the period.

High entry threshold. Interaction with this type of funds requires impressive capital investment.

Sentiment and outlook

Notably, according to Crypto Fund Research, despite its year-over-year volatility, the historical returns of crypto funds have consistently outperformed bitcoin.

In the past, institutional investors may have been wary of cryptocurrencies as an alternative investment due to regulatory restrictions. But now, spot bitcoin ETFs have given them access to the U.S. market, which has over $6 trillion in funds under management. This liquidity will undoubtedly influence money management strategies and attract more institutional investors. Also not to be overlooked is the increasingly important role of blockchain technology in funds to optimize asset management processes, which will have a positive impact on the segment.

At the beginning of the second quarter of 2024, experts note an increase in optimism about digital assets among investment funds compared to last year. According to The Block, 74% of institutional cryptocurrency investors plan to increase investments in the near future, and 13% of them plan to “significantly” increase capital in cryptocurrencies. There is even more positive sentiment about investing in cryptocurrencies over the longer term, with 92% of respondents viewing the industry’s prospects as “enticing” over the next five years.

Thank you for reading our article. Invest your money safely and profitably!

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