Crypto Hedge Funds

A few folks have recently suggested that I could do a crypto hedge fund. Though I have no doubts that such a thing will exist (probably sooner rather than later), and I’d love to jump into that game, there are a lot of issues that will need to be figured out. And not only by me, but by investors and regulators as well.

Market Need
Firstly, and probably most importantly, a crypto fund manager would need to figure out if there’s an actual demand for this type of service. Not many people know that cryptocurrency is a thing, and those that do probably have very little comfort with investing their money in it. For a fund to be viable, there would need to be enough capital inflows to make it a profitable venture. The good thing here, though, is that this isn’t a new problem. With any new fund, managers need to go through the process of doing market research and raising funds, and this wouldn’t be all that different from a typical fund.

Volatility
Another major issue is the ridiculous levels of volatility. Cryptocurrencies can drop by 75% in a month, and rise by 5,000% in a month. Investors in crypto are going to need to be extremely comfortable with seeing wild swings in their portfolios. I’m not sure how many of them will be able to stomach the drops.

Fund manager’s value-add
From a fund manager’s perspective, there’s also the issue of finding some sort of competitive advantage, or ability to provide “alpha” in the crypto markets. There’s not a whole lot of fundamental research to be done. Technical analysis may be an option, though it’s not one that I put have much faith in. I think it will probably be possible to use ML to figure out how to trade cryptos beneficially, but I’m still far from that point.

Fund composition
Another interesting consideration is what cryptos to actually hold in a fund. There are hundreds, perhaps thousands, of cryptocoins out there right now. Obviously the majority of the fund would be composed of the biggest ones, but in what proportion, and how would one balance them in and out as the markets move?

This is actually kind of a fun challenge to solve and not as big of a deal as the other issues, but it’s certainly something that needs to be considered.

Holding funds
The logistics of holding funds is also interesting. Do you maintain a wallet for each client? Do you maintain a single wallet for all clients and have bookkeeping software keep track of who owns what portion? Do you split funds across multiple wallets? What happens if a computer gets stolen? It would be important to make sure security measures are tight and constantly enforced.

Uncle Sam and the rest of the government
Crypto taxes are a major pain right now, but Uncle Sam doesn’t care. He just wants his cut. On top of that, regulatory issues, or rather, uncertainty in regulatory direction, will encircle the crypto world for quite some time.

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None of these are show stoppers. In fact, they actually present an opportunity — those managers that can figure out these issues first will have a good foothold into the industry, and the barriers to entry for newcomers will be significant.

I think for me, the biggest things that I’ll need to be convinced of before I jump into this pool are the ability to add value (which I’m hoping ML will provide), and confidence that there’s a strong desire from investors to actually hold their funds in crypto, and that they’re unable or unwilling to do this themselves.

I actually don’t think something like this is too far away, and like any other large industry, there’s room for multiple winners, and like everything else in crypto, I’m excited to see where it goes.