Hedge Funds: Putting The Toe In Dark Cryptocurrency Waters

According to Intertrust’s latest survey, 98% of CFOs say their hedge funds would look to invest up to 7.2% of their assets in cryptocurrencies by 2026, and such percentage would account for around $312 billion if replicated across the business. However, faced with regulatory obscurity and reputational risk, how can hedge funds wring the juice out of the crypto world?

Hedge Funds Expect to Invest More in Cryptocurrency

It is no secret that hedge fund managers are overflowing with intent, especially in the U.S., where 17% of surveyed CFOs openly stated that they expect to have up to 10.6% of their assets in cryptocurrencies in the next five years –namely Bitcoin with 10%.

Last May, the talk on Wall Street was that JPMorgan Chase & Co. JPM would launch an actively managed investment fund based on Bitcoins this summer, with a strong interest in offering its clients secure access to Bitcoin investments, hence backing up Intertrust’s survey findings.

The wave is getting bigger, as payment methods such as Visa, Mastercard, and PayPal accept cryptocurrencies. Also financial entities such as Morgan Stanley MS, BlackRock BLK, or Fidelity already market investment funds and ETFs on crypto assets.

Putting the Toe in Dark Water

What is more interesting, is that some traditional fund managers even went to capitalize on the Bitcoin BTC/USD price boom last year. Billionaire investor Paul Tudor Jones II, of Tudor Investment Corporation, revealed that he owns a small percentage of Bitcoin, while pioneer Stan Druckenmiller followed suit by stating that he invested in the benchmark cryptocurrency to dampen the risk of U.S. inflation –which hit an all-time record in May.

“I like Bitcoin as a portfolio diversifier. Everybody asks me what should I do with my Bitcoin? The only thing I know for certain, I want 5% in gold, 5% in Bitcoin, 5% in cash, 5% in commodities. At this point in time, I don’t know what I want to do with the other 80% until I see what the Fed is going to do,” Jones told CNBC.

However, some in the EU remain coy. Jaime Martínez, Asset Allocation Global Director at Spanish giant BBVA BBVA/USD AM, told El Economista: “In 10 years it will be much more normal (…) Today, we are not going to complicate our clients with things that we do not control well. Another thing is that in Switzerland access is given to whoever wants to do it, it is different. We are not planning to make movements in that sense at the moment.”

Still, James Delaney, director of government affairs at the Association Investment Management Association, told Barclays that around 90% of hedge funds investing in digital assets aim to roll out more capital into the asset class by the end of 2021, while nearly 25% of hedge fund managers still yet to invest are at least in the late-stage planning to invest or looking to invest.

Hazy Regulation to Straddle

Delaney goes on to assert that removing or easing the barriers spawned from regulatory uncertainty would help encourage wary market participants to engage more decidedly with the crypto sector. Similarly, Anthony Tu-Sekine, head of blockchain and cryptocurrency group at Seward & Kissel, opines that the regulatory landscape in the US at the moment is “something of a mixed bag.”

“In the crypto mainstream, if you have investments in Bitcoin and Ether USDT/USD, I don’t think there’s a huge danger that regulators will change the mind on their existing guidance with respect to those assets,” he says.

The problem lies, however, in the more obscure crypto assets, as Tu-Sekine believes there is “significant regulatory risk as market authorities continue to play catch-up on the fringe elements.” He adds that the regulatory response by the Biden administration remains “somewhat in flux.”

According to Steven D'Mello, partner at Albourne Partners, who took part in Barclays' recent DigitalAssetsLIVE event, “Managers should be proactively sweeping assets off-exchange, to protect against some of that regulatory risk that exchanges face.”

“Managers that have to self-custody assets where perhaps there’s no custody solution available should be aware of the SEC custody rule in the requirements, and what it means to potentially not meet them,” he concludes.