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A beginner’s guide to cryptocurrency funds
What are cryptocurrency funds, how do they work and where can you get started?
Acceptance of cryptocurrency has been on the rise, with more and more ambitious blockchain-based ventures developing across the globe. To accommodate the growing need for simple ways to invest in crypto, digital asset funds have become a popular vessel for investors to gain exposure to this new class of assets using US dollars.
What are crypto funds, how do they work, and what benefits and risks should you consider before handing over any of your hard-earned cash? Keep reading to find out.
What exactly is a cryptocurrency fund?
A cryptocurrency fund is an investment fund that allows its customers to gain exposure to the cryptocurrency asset class. Crypto funds allow investors to pool their capital together so that it can be invested on their behalf by a fund manager. It’s then the manager’s job to make investment decisions using that capital based on the customer’s underlying strategy and goals for risk and return.
There are a few different types of cryptocurrency funds, including hedge fund, publicly traded funds and exchange-traded funds. The exact strategy for buying and selling digital currency can vary from one fund to the next.
For example, some funds offer exposure to just one digital currency, such as Bitcoin, while others spread their capital across a diverse range of crypto assets. Some will take a long-term “buy and hold” approach, whereas others look to actively trade to take advantage of short-term market movements.
In return, for managing your investments, crypto funds take a percentage of the profit made from buying and selling cryptos as fees.
The growth of cryptocurrency funds
From shares and property to commodities and bonds, investment funds have been providing exposure to other, better established asset classes for years. However, they’re much more of a recent phenomenon in the world of cryptocurrency. In spite of their infancy, the last half-decade has seen a significant increase in crypto-based funds available globally. Once only available to a select few, in 2021 Americans have easy access to a number of new investment opportunities. That said, the number of available cryptocurrency funds in the US is still relatively small.
With the increased liquidity of global crypto markets and an easing of some of the murky regulations surrounding digital assets, investment funds have been able to transition into this growing market sector without the uncertainty that was felt just a few years ago. According to Crypto Fund Research, the total number of funds in existence around the world now exceeds 800.
What are the benefits of dealing with cryptocurrency funds?
There are several reasons why you may consider buying digital currency through a crypto fund, including:
- Expert management. The biggest advantage of crypto funds is that you can hand control of your portfolio to a professional. Rather than dedicating the time and effort needed to research different currencies and monitor market movements, you let an experienced crypto fund manager make all the tough decisions.
- Avoid crypto confusion. If you’re new to the world of cryptocurrency, wrapping your head around how digital currencies work and how to safely buy and store them can be overwhelming. Using a crypto fund means you can avoid the hassle of transacting on cryptocurrency exchanges, dealing with the risk of hacking or theft and setting up secure crypto wallets. Instead, you can gain exposure to digital currencies using US dollars.
- Diversify your portfolio. Using a managed fund allows you to spread your capital across a more diverse range of crypto assets. This helps manage your level of risk in case one particular market segment experiences a downturn.
- Buying power. Investment funds also offer the benefits that come with increased buying power. For example, because of the higher amount of capital it has to invest, a crypto fund may be able to access digital currency projects that are out of financial reach for individual investors. It’s also much more cost-effective for a crypto fund than an individual buyer to purchase and maintain a diverse portfolio of crypto assets.
Cryptocurrency funds vs venture capital funds
Cryptocurrency funds should not be confused with venture capital funds, which offer a slightly different way to buy into tech-related projects. Venture capital funds allow investors to pool their money together and invest in early-stage projects, with the capital under the control of a fund manager. Cryptocurrency funds are essentially the same as investing in a start-up, just in the world of blockchains and digital assets.
Venture capital types of funds take private equity stakes in the business in which they invest. This means that they directly invest in a company and adopt a high risk/reward strategy to support businesses with a strong potential for growth. Venture capital funds also frequently take a hands-on role with the companies they invest in, such as providing guidance to the business owners or even taking a seat on the board.
Different types of cryptocurrency funds
Cryptocurrency funds can be split into 4 main categories:
- Publicly traded funds (mutual funds). These funds are listed on public exchanges and are typically used alongside a strategy of buying and holding cryptos for the long term. They can only be purchased at the end of the trading day and are managed by an expert who makes decisions about how the funds’ assets are distributed. Some concentrate on just one major crypto, such as Bitcoin or Ethereum, while others offer exposure to multiple currencies, for example the top 10 or 20 cryptos by market cap. The specific assets in the fund are determined by the fund manager, and may change depending on the investor’s strategy. Management fees of around 1% to 2.5% usually apply.
- Exchange-traded funds. More commonly known as ETFs, these funds are similar to mutual funds. They are both listed on exchanges and comprise a long-term strategy of incremental gains. Whereas mutual funds’ indexes are actively managed, ETFs are passive and usually track the price of an asset (like Bitcoin) or a “basket” of assets (top cryptocurrencies by market cap). ETFs also include investment types such as “grantor trusts” which usually only track the price of a single commodity (such as GBTC). As of 2021, no Bitcoin ETFs exist on major American stock exchanges. This is due to regulatory restrictions put in place by the government; however, this is likely to change in the near future as the ASX considers launching an ETF. ETFs charge a management fee, but it is usually much cheaper than that of actively managed funds.
- Private buy-and-hold funds. Private funds aren’t listed on any exchanges and usually have eligibility criteria – for example, only those with $50,000 capital or more can join. However, similar to public funds, they typically adopt a buy-and-hold approach and charge an annual management fee.
- Hedge funds. Cryptocurrency hedge funds adopt complicated alternative investment strategies with the aim of providing returns to members in both rising and falling markets. For example, they might take advantage of cryptocurrency arbitrage opportunities, trade on leverage or use complicated trading algorithms. Hedge funds usually try to outperform a specific benchmark, such as a market index, and if they exceed the benchmark, they charge performance fees of 15%, 25% or even higher.
Best performing cryptocurrency funds
It is difficult to quantify the best performing cryptocurrency funds when you consider the actual investments are often dictated by and tailored to individual strategy. Certain funds track singular commodities (particularly Bitcoin) and their performance is reliant on the asset’s performance. That said, we can assess some broader funds based on their past performances to get an idea of their risk profiles and year-on-year performance.
According to PWC’s annual crypto hedge fund report, the median return of crypto hedge funds in 2020 was 128%, compared to the much smaller 30% in 2019. This demonstrates that a lot of funds’ performances will depend on how the crypto market moves in that year – especially those tracking the price of a single asset.
The most important thing to do when assessing what the “best performing cryptocurrency” funds are is research. Contact the funds’ management, consider your strategies (do you want to hold for the long term; do you just want exposure to Bitcoin without having to own any?) and assess the annual fees.
How do funds determine what cryptocurrencies to invest in?
There are several factors a fund manager will consider when choosing what cryptocurrencies to invest in, but the most important consideration is the fund’s stated goal for risk and return. For example, some funds are focused on stable long-term growth and would be more likely to consider major cryptos in the top 10 by market capitalisation. Other funds adopt a high risk/high reward strategy designed to achieve maximum profit in a short space of time and may focus more on low-cap cryptos, margin trading and ICOs.
Most funds target a particular area of the market. For example, one might focus on the top 30 cryptocurrencies, another might look to invest in ICOs and a third might specifically focus on projects attempting to solve blockchain scalability problems.
The currencies and projects to invest in are chosen after in-depth analyses. Technical analysis (predicting the market by looking for patterns in price and volume charts) and fundamental analysis (determining the intrinsic value of a currency by considering economic and financial factors) can both be applied to cryptocurrencies to assess whether prices will go up or down. The exact process followed in each type of analysis is beyond the scope of this article, so do your own research to find out exactly what’s involved.
What to consider when comparing funds
When comparing cryptocurrency funds, make sure to consider the following factors:
- Strategy. What is the investment objective for the fund? What level of risk will you need to accept to potentially achieve those returns? What types of cryptocurrencies will the fund invest in? How do all these specifics relate to your own investment goals and timeframe?
- How cryptocurrencies are chosen. Does the fund use technical analysis, fundamental analysis or some other investment approach? What process is followed when determining which cryptos to buy?
- Type of trading. Does the fund use manual trading or algorithmic trading when buying and selling cryptos? While manual trading is more focused on carefully selecting cryptos for long-term growth, algorithmic trading is designed to ensure that trades are placed at the optimal time and that you can quickly react to market shifts.
- Fees. How much is the annual management fee? Do entry and exit fees also apply? Is there a performance fee if the fund outperforms a specific benchmark?
- Team. How much information is available about the team behind the fund? Who will be managing your capital? How much experience do they have?
- Past performance. While past performance is not a reliable indicator of future performance, it’s still a good idea to examine the fund’s track record for meeting its goals.
- Minimum investment. Many crypto funds require a substantial minimum investment to get started. This should be one of the first things you look at, as those with lesser capital may have to reconsider their investment options. You should also be aware that certain funds have other eligibility criteria that you must meet.
By considering these and other factors, you should be able to narrow down your choices to find a fund that aligns with your chosen risk/reward strategy.
What are some of the risks of investing in cryptocurrency funds?
Just like any other type of investment, cryptocurrency funds come with a certain level of risk. Some of the factors you’ll need to take into account include:
- Loss of control. Handing control of your investments over to someone else – often a complete stranger – is a big stumbling block for many.
- Fees. Make sure you’re fully aware of all the fees a fund charges before you sign up as they can have a significant impact on your overall returns. Hedge funds in particular can have fees of up to 30% of returns.
- Volatility. Cryptocurrencies are famously volatile and come with a high level of risk. If you’re looking for a stable investment with minimal risk, it’s probably a good idea to explore other options.
- Expecting history to repeat itself. Past performance is not a reliable indicator of future performance. Just because a fund has experienced solid returns in the past, that doesn’t mean it will do so in the future. There’s no guarantee that new cryptocurrencies will see the rise in value that Bitcoin and Ethereum did, and investing on this premise would be a very risky manoeuvre.
- Tax implications. Make sure you’re across all the tax requirements for crypto investments. Investing in the coins directly affects your tax differently to investing in a fund. Seek personalised advice from an accountant or tax expert about how investing in a crypto fund will affect your cryptocurrency tax obligations.
- Regulatory uncertainty. Crypto investment funds will continue to come under scrutiny from regulators for the foreseeable future, with authorities around the world cracking down on cryptocurrencies. They are currently unavailable on the ASX or the SEC (for Wall Street investors), though this may change in 2021.
While the rise of crypto funds is good news for the legitimacy of digital currencies as an asset class, there’s still only a limited range of funds available in the US. Joining one of these funds also comes with a certain level of risk, so make sure to do your own research and compare a range of options before deciding whether it’s a sensible approach for you.
Disclosure: At the time of writing the author holds ADA, ICX, IOTA and XLM.
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