The indisputable rise of Bitcoin has legitimized it in the eyes of big players. The accessible infrastructure has made even large transactions easy, opening the door for hedge fund entry.
So far, the returns on the investments have been impressive. However, the Bitcoin community is divided on whether this is a good thing. But what are Bitcoin hedge funds exactly, and how do they work?
What Is a Hedge Fund, Anyway?
To understand the mechanics behind a Bitcoin hedge fund, it’s essential to demystify the basic principles of any hedge fund. In short, a hedge fund is a type of investment that uses pooled funds and employs various strategies to maximize profits for investors.
The main goal of a hedge fund is to identify different market opportunities. They’re mostly private transactions constructed with limited partnerships, and they require large amounts of the initial investment.
Investors are also required to keep their money in the fund for a specific time, representing a lock-up period. During that time, they can’t liquidate their assets, and withdrawals are scheduled.
The first hedge fund was launched in 1949 but they didn’t really come to prominence until the 1980s. Today, there are thousands of hedge funds worldwide, and crypto hedge funds are among them.
How Do Bitcoin Hedge Funds Work?
As mentioned, the continuous growth of Bitcoin and its increased accessibility has won over many investors looking to avoid risks as much as possible. There are two basic ways a Bitcoin hedge fund functions.
The first approach involves a fund manager who makes all the important investment decisions. The other option is the systemic approach. This relies on various computer models for trading. The systemic approach reduces risk, as the entire process is more or less automated.
However, the discretionary approach is the preferred choice for most of these hedge funds as it statistically leads to better performance. There are other strategies as well. For example, the quantitative approach represents approaching the market in a directional and market-neutral manner.
The liquidity aspect is crucial here, therefore, the funds for trading are limited. Another possibility is using the multi-strategy approach, which, as the name implies, is a combination of all strategies mentioned. Given that Bitcoin is well-known for its volatility, this is often the approach that brings the best results.
The Two Types of Crypto Hedge Funds
When talking about Bitcoin hedge funds, there is another classification worth noting. There are two distinct types of crypto hedge funds in terms of what types of currency hedge funds manage.
Thus, we have a crypto hedge fund that manages Bitcoin and other cryptocurrencies, primarily Ethereum. The other type manages cryptocurrency as well as other asset classes.
Main Characteristics of Bitcoin Hedge Funds
The promise of great returns makes Bitcoin hedge funds an incredibly appealing idea. However, it’s not so easy to get in on the action.
In fact, Bitcoin hedge funds, like traditional hedge funds, have specific features and prerequisites one has to possess to benefit from them.
They Are Not Very Open
There’s a reason not everyone you know invests in a hedge fund of some kind. Bitcoin hedge funds, in particular, can only take money from “accredited” or “qualified” investors.
Some Bitcoin hedge funds will require the investors to provide over £100,000 of the initial investment. But there are those where the starting investment ranges between £10,000-£25,000.
Essentially, a suitable investor for a Bitcoin hedge fund is the one who has already made tremendous profits on the cryptocurrency exchanges. While there are many successful Bitcoin investors, many more have yet to hit that level.
One of the main perks of hedge funds, in general, is that they can essentially invest in anything. Stocks, land, real estate, and currencies are all on the table.
Unlike mutual funds that stick to bonds and stocks, hedge funds are only limited by mandate. Plus, hedge funds charge performance fees and the expense ratio, a structure known as Two and Twenty.
They Employ Leverage
As Bitcoin hedge funds have been reporting massive success over recent years, managers have also employed leverage as a strategy.
Borrowing money has the tendency to amplify the returns when it comes to hedge funds, making it a popular strategy. Not one without risk, though, as hedge funds can also be wiped out.
Bitcoin Hedge Funds and Regulatory Considerations
One of the most critical questions regarding Bitcoin hedge funds is what is the regulatory angle. Generally speaking, it’s the same as that which applies to traditional hedge funds and regulation.
That means the considerations are based on the fund’s origin jurisdiction and places where it operates. However, there is another aspect that needs to be considered in terms of Bitcoin hedge fund regulations. It applies to the investors who use the Initial Coin Offering (ICO) structure.
They are subject to the respective rules, which are considerably different depending on the jurisdiction. They’re also under plenty of scrutiny from various regulatory and governmental bodies around the world.
Bitcoin’s decentralized system is the main reason why there is plenty of urgencies to regulate everything about it, including Bitcoin hedge funds. But it’s also the reason why so much of the regulation doesn’t exist. A lot of consensus on how to approach the matter is still missing.
Bitcoin Hedge Funds – Investment or Gamble?
There is no doubt that the entire cryptocurrency space has been mostly speculative thus far. This is the main reason why many hedge funds are understandably cautious. Some hedge fund experts see it as a form of gambling, others see it as a major opportunity, regardless of how long it lasts.
The Bitcoin bubble is the buzzword of the day, and everyone seems to be scrutinizing it. However, that doesn’t change anything for hedge funds looking for new ways to make money.
Ultimately, investing in cryptocurrency is risky by default, and it’s crucial to enter the market with all the necessary information and reasonable caution.
Author Bio: Hitesh is a digital marketing strategist and entrepreneur with more than 15 years of experience in digital marketing, start-ups, branding, and customer acquisition strategies. Hitesh is the CEO and Founder of Reposition Group, which specializes in digital growth strategies for companies in the cryptocurrency market such as Bitamp.com.