Crypto Hedge Funds: Paving the Way for the Future of Finance

adviceHow to gain an early advantage in the burgeoning crypto world

Initially labelled as a financial fad, cryptocurrencies are slowly but surely becoming a mainstream financial product. Today, entities such as Goldman Sachs, BBVA, and BlackRock offer their clients access to cryptocurrency investment vehicles. Here’s what you need to know about the crypto fever and how your business can take advantage of it.
Crypto hedge funds snapshot

Cryptocurrencies are more than their exponential growth in market capital or price quoting dents against Elon Musk’s tweets. The e-currency has effectively created an international market in crypto hedge funds and pushed governments to enact regulations around their use. The latest example is China’s version of Bitcoin: its very own digital yuan, backed by the People’s Bank of China.

The exponential growth shown by the multiplication of new crypto hedge funds, according to PwC, is directly correlated to the price of Bitcoin, which escalated dramatically between 2019 and 2020. PwC outlined four cryptocurrency hedge fund strategies:

  • Quantitative:This is the most common crypto hedge fund, representing 38 percent of PwC’s dataset. Characterized by low latency trading, liquidity is the primary factor that drives these funds, which solely trade more liquid cryptocurrencies. This trait means it has the shortest lockup periods for investors.
  • Discretionary long/short:This fund strategy is event driven, backed by technical analysis, and characterized by cryptocurrency mining and its relative value. Discretionary long/short hedge funds often have hybrid strategies, which can include investments in early-stage projects.
  • Discretionary long only:This strategy is a long-term investment. These funds tend to invest in early-stage token or coin projects, and supplement with the purchase of more liquid cryptocurrencies. Conversely, discretionary long only funds have the longest lockup periods for investors.
  • Multi-strategy:These funds implement a combination of the above strategies based on investor preference.

The average ticket size of these funds is US$1.1 million with a median of 23 separate investors per fund. In terms of investor profile, high net-worth individuals lead the crypto hedge fund scene (54 percent), followed by family offices (30 percent).

The untapped potential of crypto hedge funds

Crypto hedge funds have experienced exponential growth, with ample room for more: PwC counts between 150 and 200 active crypto hedge funds, 81 percent of which were formed between 2017 and 2018. Moreover, total Assets under Management (AuM) of crypto hedge funds increased on a global scale, from US$2 billion in 2019 to US$3.8 billion in 2020.

Crypto hedge fund strategies blew 2019’s overall performance out of the water compared to 2020’s numbers relative to median performance comparison:

20202019
Quantitative long/short+72%+17%
Discretionary long/short+129%+23%
Discretionary long only+294%+10%
Multi-strategy+114%+12%

Source: PwC

Global reach of crypto hedge funds

Crypto hedge funds tend to be located in the same jurisdictions as traditional hedge funds. The Cayman Islands are the crypto hedge fund Mecca (34 percent of total crypto hedge funds), followed by:

  • The U.S. (33 percent)
  • Gibraltar (9 percent)
  • The British Virgin Islands (8 percent)
  • Luxemburg (3 percent)

Crypto hedge fund managers, in contrast, are primarily located in the U.S. (43 percent), followed by:

  • The UK (19 percent)
  • Hong Kong (11 percent)
  • The Cayman Islands (8 percent)
  • Switzerland (7 percent)

In recent years, hedge fund locations and managers have multiplied — good news for investors looking to inject their capital in such instruments but who fear market oversaturation.

Investors should call on local experts to set up a crypto hedge fund foothold. In the Netherlands, a rising star of the European crypto hedge fund landscape, investors can gather corporate secretarial services, tax compliance and accounting advice, and support incorporating a company via Dutch company setup experts, such as CompanyNL, to use the Kingdom of the Low Countries as a launching pad for the rest of Europe.

What are the challenges of crypto hedge funds?

The Cayman Islands offer attractive incentives that include no income tax, corporation tax or capital gains tax, estate duty, inheritance tax, gift tax, or withholding tax. It, therefore, comes as no surprise that the Cayman Islands house more than 10,500 funds, with a total net asset value of US$3.5 trillion. However, investor beware, as Cayman Island-domiciled funds do not qualify under the EU’s Alternative Investment Fund Managers Directive (AIFMD) for an EU “passport” — which allows easier access to EU member states.

Taxation adds another layer of complexity when structuring, deploying, and operating a crypto hedge fund. While these considerations mimic those one would have under a traditional hedge fund in several ways, some are crypto-specific:

  • Sources of income/gains: Crypto hedge funds can have a variety of sources of income — staking income, mining income, token rewards, coin lending, hard fork, chain split, and airdrops, to name a few. Each warrants its own unique considerations from a tax standpoint.
  • Fund tax safe harbors:If a crypto fund is set up in a different jurisdiction to that of the investment team, detailed consideration will need to be provided to gauge whether the activities of the investment team could result in tax obligations arising from the fund.

Although many crypto currencies lack the stamp of approval of several central banks across the world, governments are looking to establish a first-mover advantage, which bodes well for its future. While it is difficult to definitively predict where cryptocurrency will be in the long-term, companies that intend to capitalize on the ongoing wave of institutional adoption of cryptocurrencies and their related hedge funds can rely on the services of a global Employer of Record to grow their business via the use of cryptocurrency investment vehicles. Get an early mover advantage by setting up global task forces and spearhead a global crypto footprint.