Discover why hedge funds are interested in crypto and the long-term implications of their growing involvement.
According to the Global Crypto Hedge Fund Report, nearly half of hedge funds holding traditional assets like stocks and bonds reported exposure to cryptocurrencies in 2023. Moreover, a third of these funds plan to increase their exposure by the end of 2024, reflecting a broad trend toward holding crypto assets.
Let’s dive in to understand what’s driving hedge fund interest in cryptocurrencies and how it might impact the market this year and beyond.
Crypto Goes Mainstream
Crypto has grown from a research paper to a significant financial asset over the past decade. While the first Bitcoin ETFs hit the market in 2021, these funds held futures contracts rather than physical Bitcoin, limiting the appeal for many investors. That said, funds like BITO have successfully tracked the spot price for years without significant issues. In January 2024, the Securities and Exchange Commission (SEC) approved the first “spot” Bitcoin exchange-traded funds (ETFs). Unlike previous ETFs, these funds are backed by physical Bitcoin, providing direct exposure to the nascent digital assets. Notably, these funds also influence Bitcoin price directly by impacting real-time supply and demand.
ETFs are a popular venue for traditional hedge funds to gain exposure to crypto markets, while spot (direct investment) is the most popular among digital hedge funds. Source: PwC
As of November 3, 2024, Bitcoin ETFs held more than $83 billion in assets, with daily trading volumes exceeding $3 billion. Meanwhile, Ethereum ETFs held about $6.6 billion in assets with just over $100 million daily trading volume. While this is just a tiny slice of the $2.3 trillion crypto industry, these figures are up from zero just a few years ago.
The largest ETFs include:
iShares Bitcoin Trust (IBIT) – $17.24 Billion
Grayscale Bitcoin Trust (GBTC) – $15.23 Billion
Wise Origin Bitcoin Trust by Fidelity (FBTC) – $11.25 Billion
At the same time, the SEC’s position on crypto assets has become more transparent. The agency clarified that Bitcoin was not a security—reducing the regulatory risk of holding Bitcoin funds—while suggesting Ethereum may not be a security. As a result, many institutional investors are less fearful of holding these funds in their portfolios.
That said, not everything has become crystal clear in the regulatory world. The tax treatment of crypto assets remains in flux, particularly with issues like using crypto bridges or decentralized finance platforms. Until we resolve these issues, hedge funds may avoid more opaque corners of the market.
(That said, if you’re an individual investor, platforms like ZenLedger can help you comply with IRS rules and regulations. While there’s still some uncertainty, our platform can help you adhere to a conservative approach to minimize the risk of an audit.)
Seeking Alpha & Diversification
Crypto assets offer more volatility than most conventional financial assets, making them a valuable source of market-beating returns for hedge funds. For instance, Bitcoin prices doubled over the past year, moving from about $35,000 in November 2023 to around $70,000 in November 2024, according to CoinMarketCap.
Others are attracted to crypto for its diversification benefits. Between 2018 and 2021, the correlation between Bitcoin and stocks of all geographies has been between 0.2 and 0.3, making it an excellent way to diversify. These dynamics can help improve a broader portfolio’s risk-reward characteristics even if crypto prices fall.
The rise of decentralized finance (DeFi) could open even more doors. Unlike a stock, Bitcoin has no intrinsic value and generates no cash yield for investors, making it less valuable in the eyes of many value investors. Staking or lending Bitcoin through bridges or other protocols could alter these dynamics and offer investors a real return.
Stablecoins remain rare among traditional hedge funds, but digital hedge funds use them for transactions and to generate yield via DeFi. Source: PwC
According to DeFi Llama, the DeFi market has more than $85 billion in total value locked with a daily volume of about $4.5 billion. Meanwhile, Coinbase’s retail-focused platform offers up to 12% APY for lending crypto assets, which suggests hedge funds could find much more lucrative yields by cutting out the intermediaries.
Market Efficiency & Arbitrage
Quant hedge funds are finding more opportunities to exploit inefficiencies in the crypto markets. For example, market-neutral arbitrage strategies are generating 20-30% yields compared to the high single-digit returns seen in traditional financial assets. These strategies involve minimal risk apart from any leverage used for the position.
These strategies could also help improve liquidity in the crypto markets, tightening bid/ask spreads and reducing transaction costs. Over time, these improvements could make crypto much more competitive for real-time payments or make new Web3 of DeFi projects more practical to implement and use.
The only limiting factor is the size of the market. While the crypto market may seem extensive at $2.5 trillion, that pales compared to the $109 trillion equity or the $140 trillion fixed-income market. So, while 20-30% yields are enviable on the surface, many hedge funds would rather make a 9% yield on $1 million ($90,000) than a 20% yield on $1,000 ($200).
Beyond Cryptocurrencies
In extraordinary situations or distressed investing, hedge funds target high-profile crypto implosions. Recently, these funds scooped up nearly a billion dollars’ worth of obligations that FTX owes to BlockFi. These obligations, fetching 10 cents on the dollar when FTX collapsed appear ready to be fully repaid with interest after a lengthy court process.
Like quant funds, these hedge funds provide their own value to the crypto market. They enable investors to immediately recoup some of their losses due to fraud while putting pressure on perpetrators to pay rather than just writing off the losses. In this case, BlockFi customers could receive a payout now rather than waiting longer for the courts.
What’s Next for Crypto?
The growing involvement of hedge funds could help the crypto markets mature faster. For example, we’ve seen how hedge funds can help with everything from lowering transaction costs to holding fraudulent companies responsible for their damages. And ultimately, these developments could help the industry become even larger.
Of course, Bitcoin and Ethereum only scratch the surface of crypto’s long-term potential. The rise of stablecoins could change how many hedge funds operate at the core, holding digital assets rather than U.S. dollars. And new cross-border payment systems or digital securities could make international markets even more accessible.
However, regulatory uncertainty remains one of the biggest factors inhibiting crypto adoption among hedge funds. PwC found that 45% of traditional hedge funds and 56% of digital hedge funds see it as a critical risk. Those without digital asset exposure cited no investor mandate or little to no investment conviction in the asset class as a reason to avoid crypto.
The Bottom Line
Hedge funds continue to dabble in the crypto markets and there’s little sign that these trends will slow or reverse. Instead, their involvement could transform the market by making it more efficient and accessible to everyday investors. Over time, their involvement could expand beyond primarily Bitcoin and Ethereum.
If you trade crypto assets, ZenLedger can help simplify tax time. Our platform aggregates transactions across your wallets and exchanges, computes your capital gain or loss, and generates the paperwork you must file yearly. You can also find ways to save through tax-loss harvesting while accessing a detailed audit log to defend yourself in an audit.
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
More Traditional Hedge Funds Are Dabbling in Crypto
According to the Global Crypto Hedge Fund Report, nearly half of hedge funds holding traditional assets like stocks and bonds reported exposure to cryptocurrencies in 2023. Moreover, a third of these funds plan to increase their exposure by the end of 2024, reflecting a broad trend toward holding crypto assets.
Let’s dive in to understand what’s driving hedge fund interest in cryptocurrencies and how it might impact the market this year and beyond.
Crypto Goes Mainstream
Crypto has grown from a research paper to a significant financial asset over the past decade. While the first Bitcoin ETFs hit the market in 2021, these funds held futures contracts rather than physical Bitcoin, limiting the appeal for many investors. That said, funds like BITO have successfully tracked the spot price for years without significant issues.
In January 2024, the Securities and Exchange Commission (SEC) approved the first “spot” Bitcoin exchange-traded funds (ETFs). Unlike previous ETFs, these funds are backed by physical Bitcoin, providing direct exposure to the nascent digital assets. Notably, these funds also influence Bitcoin price directly by impacting real-time supply and demand.
ETFs are a popular venue for traditional hedge funds to gain exposure to crypto markets, while spot (direct investment) is the most popular among digital hedge funds. Source: PwC
As of November 3, 2024, Bitcoin ETFs held more than $83 billion in assets, with daily trading volumes exceeding $3 billion. Meanwhile, Ethereum ETFs held about $6.6 billion in assets with just over $100 million daily trading volume. While this is just a tiny slice of the $2.3 trillion crypto industry, these figures are up from zero just a few years ago.
The largest ETFs include:
At the same time, the SEC’s position on crypto assets has become more transparent. The agency clarified that Bitcoin was not a security—reducing the regulatory risk of holding Bitcoin funds—while suggesting Ethereum may not be a security. As a result, many institutional investors are less fearful of holding these funds in their portfolios.
That said, not everything has become crystal clear in the regulatory world. The tax treatment of crypto assets remains in flux, particularly with issues like using crypto bridges or decentralized finance platforms. Until we resolve these issues, hedge funds may avoid more opaque corners of the market.
(That said, if you’re an individual investor, platforms like ZenLedger can help you comply with IRS rules and regulations. While there’s still some uncertainty, our platform can help you adhere to a conservative approach to minimize the risk of an audit.)
Seeking Alpha & Diversification
Crypto assets offer more volatility than most conventional financial assets, making them a valuable source of market-beating returns for hedge funds. For instance, Bitcoin prices doubled over the past year, moving from about $35,000 in November 2023 to around $70,000 in November 2024, according to CoinMarketCap.
Others are attracted to crypto for its diversification benefits. Between 2018 and 2021, the correlation between Bitcoin and stocks of all geographies has been between 0.2 and 0.3, making it an excellent way to diversify. These dynamics can help improve a broader portfolio’s risk-reward characteristics even if crypto prices fall.
The rise of decentralized finance (DeFi) could open even more doors. Unlike a stock, Bitcoin has no intrinsic value and generates no cash yield for investors, making it less valuable in the eyes of many value investors. Staking or lending Bitcoin through bridges or other protocols could alter these dynamics and offer investors a real return.
Stablecoins remain rare among traditional hedge funds, but digital hedge funds use them for transactions and to generate yield via DeFi. Source: PwC
According to DeFi Llama, the DeFi market has more than $85 billion in total value locked with a daily volume of about $4.5 billion. Meanwhile, Coinbase’s retail-focused platform offers up to 12% APY for lending crypto assets, which suggests hedge funds could find much more lucrative yields by cutting out the intermediaries.
Market Efficiency & Arbitrage
Quant hedge funds are finding more opportunities to exploit inefficiencies in the crypto markets. For example, market-neutral arbitrage strategies are generating 20-30% yields compared to the high single-digit returns seen in traditional financial assets. These strategies involve minimal risk apart from any leverage used for the position.
These strategies could also help improve liquidity in the crypto markets, tightening bid/ask spreads and reducing transaction costs. Over time, these improvements could make crypto much more competitive for real-time payments or make new Web3 of DeFi projects more practical to implement and use.
The only limiting factor is the size of the market. While the crypto market may seem extensive at $2.5 trillion, that pales compared to the $109 trillion equity or the $140 trillion fixed-income market. So, while 20-30% yields are enviable on the surface, many hedge funds would rather make a 9% yield on $1 million ($90,000) than a 20% yield on $1,000 ($200).
Beyond Cryptocurrencies
In extraordinary situations or distressed investing, hedge funds target high-profile crypto implosions. Recently, these funds scooped up nearly a billion dollars’ worth of obligations that FTX owes to BlockFi. These obligations, fetching 10 cents on the dollar when FTX collapsed appear ready to be fully repaid with interest after a lengthy court process.
Like quant funds, these hedge funds provide their own value to the crypto market. They enable investors to immediately recoup some of their losses due to fraud while putting pressure on perpetrators to pay rather than just writing off the losses. In this case, BlockFi customers could receive a payout now rather than waiting longer for the courts.
What’s Next for Crypto?
The growing involvement of hedge funds could help the crypto markets mature faster. For example, we’ve seen how hedge funds can help with everything from lowering transaction costs to holding fraudulent companies responsible for their damages. And ultimately, these developments could help the industry become even larger.
Of course, Bitcoin and Ethereum only scratch the surface of crypto’s long-term potential. The rise of stablecoins could change how many hedge funds operate at the core, holding digital assets rather than U.S. dollars. And new cross-border payment systems or digital securities could make international markets even more accessible.
However, regulatory uncertainty remains one of the biggest factors inhibiting crypto adoption among hedge funds. PwC found that 45% of traditional hedge funds and 56% of digital hedge funds see it as a critical risk. Those without digital asset exposure cited no investor mandate or little to no investment conviction in the asset class as a reason to avoid crypto.
The Bottom Line
Hedge funds continue to dabble in the crypto markets and there’s little sign that these trends will slow or reverse. Instead, their involvement could transform the market by making it more efficient and accessible to everyday investors. Over time, their involvement could expand beyond primarily Bitcoin and Ethereum.
If you trade crypto assets, ZenLedger can help simplify tax time. Our platform aggregates transactions across your wallets and exchanges, computes your capital gain or loss, and generates the paperwork you must file yearly. You can also find ways to save through tax-loss harvesting while accessing a detailed audit log to defend yourself in an audit.
Get started today for free!
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
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