About one-third of hedge funds have jumped into crypto

Posted: 9 June 2022 5:23 pm
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Survey finds 38% of traditional hedge funds now invest in digital assets, boosting liquidity and helping tame wild price swings. Should you dive in, too?

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About 38% of traditional hedge funds surveyed by PwC are now investing in digital assets, almost double from a year earlier, signaling widening acceptance of cryptocurrencies among institutional investors.

But about 57% of them have less than 1% of their total assets under management invested in digital assets, according to the results of the survey conducted in the first quarter. “Most traditional hedge funds getting into digital assets are still just dipping their toes,” PwC said.

About 29% of fund managers who have no exposure to digital assets plan to add them to their portfolio, according to the PwC report. It’s unclear whether the recent declines seen after the survey was conducted have altered their plans.

Is this a signal for retail investors to dive in as well?

What does increasing institutional investment in crypto mean for you?

Institutional interest means more buyers and sellers in the crypto market, narrowing the bid-ask spread for assets like Bitcoin and Ethereum. That may help you get better prices, regardless whether you’re selling or buying coins.

At the same time, it can narrow the price swings. That means lower risk that you’d wake up one morning seeing 20% of the value of your Bitcoin wiped out over a few hours. It could still happen during a market catastrophe, of course, but the odds decline as more money comes into the market.

Bitcoin had a volatility of 75%, compared with 14% for US equities, according to a Bridgewater Associates research in January. The cryptocurrency’s liquidity is about 1.4% that of the US stock market, according to the hedge fund founded by billionaire Ray Dalio.

Of course, a lot has changed in the past five months that may have altered those numbers, but the magnitude of price swings for Bitcoin is still much higher than it is for US stocks.

Pros and cons of increasing institutional investor participation

Increasing participation of institutional investors could boost demand for crypto assets, helping push prices. Right now, more than two-thirds of the $39.8 billion in crypto assets held by institutional investors are in Bitcoin and 22% are in Ethereum, according to CoinShares data released June 6.

Higher liquidity increases not only the potential for bullish positions in the crypto market, but also bearish positions.

About 25% of the crypto funds covered in the PwC report are quantitative long/short, which means they utilize computer models and algorithms to decide whether to place bullish or bearish bets on crypto assets.

That signals the increasing sophistication of the market. You’re not just betting against institutional investors that look at changes in fundamental supply and demand and macroeconomic factors in deciding their positions. Sometimes, computers could spot the wave of bearish bets building in the market before it becomes obvious enough for retail investors like you to flee. That could work to your disadvantage.

Only 14% are discretionary long, which tracks fundamentals in deciding when to buy, while the remaining 12% are discretionary long/short funds.

Opportunities abound even in a downturn

The most common strategy among crypto funds covered by the PwC report is market-neutral, which aims to profit regardless of the direction of the market. That usually involves using derivatives to mitigate or eliminate broader market risk and get more specific exposure to the underlying crypto asset. You might, for example, buy Bitcoin in the spot market, then sell futures on CME and pocket the difference.

Bridgewater said the strategy of buying spot Bitcoin and selling CME Bitcoin futures has earned about a 10% annualized return since mid-2019, according to a research on its website in January. The trade was profitable because futures traded at a sizable premium to spot, driven by the lack of dollar funding within the crypto markets, relative to demand by speculators for additional leverage, according to the hedge fund.

Of course, that type of trade is much more complicated than it sounds. You’d need to research how the CME settlement of Bitcoin futures work, the delivery of the crypto asset, fees involved and all the technical aspects that it entails to be able to weigh whether you could make the same profit. And as most futures contracts go, there’s the delivery month to consider when weighing whether you’ll actually make money from the trade.

Trying to get a handle on the markets? Explore strategies for how to trade crypto or see if there's a better platform for you with our guide to the best crypto exchanges.

Disclaimer: Cryptocurrencies are speculative, complex and involve significant risks – they are highly volatile and sensitive to secondary activity. Performance is unpredictable and past performance is no guarantee of future performance. Consider your own circumstances, and obtain your own advice, before relying on this information. You should also verify the nature of any product or service (including its legal status and relevant regulatory requirements) and consult the relevant Regulators' websites before making any decision. Finder, or the author, may have holdings in the cryptocurrencies discussed.

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