It’s hard to resist the hype of the gold rush surrounding the cryptocurrency market. In the past year, digital assets like Bitcoin and Ethereum have transformed from a niche interest into a serious financial industry. And the main drive behind the increasing popularity is the unprecedented surge in their value.
Bitcoin, the forerunner of modern digital money, has seen a near-800% growth since the beginning of the year and is now worth approx. $7,000 a coin. During the same period, Ethereum, the cryptocurrency that powers the world’s largest decentralized computer, has grown from $10 to $300 a piece. Initial coin offerings (ICOs), fundraising mechanisms that are based on blockchain, the technology that underlies cryptocurrencies, have absorbed billions of dollars in 2017 so far.
A dangerous landscape
It looks like everyone wants to jump on the cryptocurrency bandwagon and grab a share of the benefits. Coinbase, one of the biggest cryptocurrency exchanges in the world, recently announced that it had added more than 100,000 users in a single day.
Detractors of cryptocurrencies describe the market as a bubble that is about to burst, likening it to the dot-com era or the tulip mania from 400 years ago. Others believe the price of cryptocurrencies will continue to rise. One example is prominent cybersecurity figure and blockchain proponent John McAfee, who has gone as far as making a painful wager over the price of Bitcoin reaching $500,000 in the next three years.
No matter which camp has the right of it, what’s for sure is that the landscape is still very volatile and dangerous. Prices can rise and drop by the thousands in mere days. Regulations are obscure, confusing and sometimes non-present, leading to a lot of scams and lost investments, or unexpected crackdowns on projects.
It’s also a complicated landscape. Cryptocurrencies and tokens are scattered across dozens of different wallets. User interfaces are often unfriendly and trading between currencies can be a complicated process.
The role of crypto-funds in dealing with challenges
These collective challenges have given rise to funds focused on managing portfolios of cryptocurrencies and tokens. An adaptation of traditional funds, crypto-funds make it easy for investors to navigate this enticing new asset class. Basically, instead of directly purchasing and trading cryptocurrencies, you defer the responsibility to a crypto-fund. Portfolio managers and traders will decide which ICOs to enter and which to avoid, which currencies to buy and sell, and they promise to produce gains on your investment. In return they take a percentage of the profit as management and performance fees.
Metastable Capital, a crypto-fund launched in 2014 whose founders include Naval Ravikant, the chief executive officer and co-founder of AngelList, now manages more than $45 million in digital assets.
Polychain Capital, a successful crypto-fund founded by the Olaf Carlson-Wee, the Coinbase employee who lived on Bitcoin for 3 years, launched with $4 million in 2016. It now has $200 million worth of digital assets under management, thanks in part to investments from Andreessen Horowitz, Founders Fund, Sequoia Capital and Union Square Ventures. Polychain is special in its own right since more than an investment firm, it boosts the value of projects it funds by helping them with marketing efforts and the structure of their token offerings.
Blockchain Capital, a VC firm that specializes in blockchain projects, recently launched two new venture funds valued at $150 million to invest in ICOs. Where traditional venture funds usually rely on big checks from large institutions, Blockchain Capital is raising smaller amounts of money from a wider range of investors.
New players in the field
The success of the first crypto-funds has spurred other players, including traditional financial experts, to enter the space. According to a recent report by financial research firm Autonomous Next, there are now 124 crypto funds, 90 of them having launched this year alone. The funds manage a total of $2.3 billion worth of digital assets. This might not be much compared to the $3.15 trillion collectively held by the traditional hedge funds, but it’s still considerable for a nascent industry that still has yet to see the turn of a decade.
An example of financial veterans entering the cryptocurrency market is Galaxy Digital Assets Fund, the $500 million crypto-fund of Mike Novogratz, the former hedge fund manager at Fortress Investment Group. Novogratz will put $150 million of his own money in the fund, and plans to raise $350 million more by January. Once launched, Galaxy Digital will be the largest crypto hedge fund.
However, not everyone believes hedge funds are a good idea for the cryptocurrency landscape. A recent study by CoinDesk shows that a $100,000 investment in a crypto hedge fund with a 10% gross return will only yield $78 per $1,000 of investment. That is mainly due to the “2 and 20” rule that hedge funds usually adhere to. That’s basically a 2% management fee that is shaved off your investment upfront, and a 20% incentives fees that fund managers take away from your returns.
A less risky alternative to hedge funds are index funds. Bitwise Asset Management’s HOLD 10, the first of its kind, is a passively managed index fund of the top 10 cryptocurrencies by inflation-adjusted market capitalization. The fund, which counts Metastable’s Ravikant among its backers, only charges a 2-3% management fee and will not tax investors with the high performance fees of hedge funds.
New investment vehicles
Another interesting development in the space is the launch of autonomous crypto-fund ecosystems. A noteworthy example is Tokenbox, a platform that leverages the power of blockchain to provide tools for creating, managing and investing in crypto-funds. Fund managers and traders can use Tokenbox to create their own tokenized portfolio of digital assets. This can be cryptocurrencies such as Bitcoin, Ethereum and Monero, or project-specific tokens such as Augur and Gnosis. Investors, on the other hand, use Tokenbox to discover crypto-funds and purchase their tokens. The platform runs on smart contracts, bits of software that execute on the Ethereum blockchain without the need for application servers. This ensures transparency and independence. Tokenbox has also incorporated KYC (know your customer) and AML (anti-money laundering) processes into its platform in order to prevent scams.
The idea of Tokenbox was conceived at The Token Fund, a crypto-fund that launched in early 2017 and has enjoyed great success.
Iconomi, another player in the space, enables the creation of Digital Asset Arrays (DAA), which is analogous to Exchange Traded Funds (ETF). Portfolio managers can use Iconomi’s platform to create their own DAAs, which can include cryptocurrencies as well as tokens from projects. Investors invest in DAAs by purchasing their tokens.
By removing the technical barriers for creating and managing crypto-funds, these platforms are enabling many more organizations to enter the domain.
Not everyone is optimistic
There are still doubts as to whether crypto-funds are a good idea. In a Forbes op-ed, Angela Walch, research fellow at the Centre for Blockchain Technologies at University College London, explains how crypto hedge funds can spill the risks associated to cryptocurrencies into the mainstream financial systems.
“The effect of financialization is to allow the wider world to gamble on the winners and losers within the small crypto systems. It is financialization that can magnify and ripple these risks throughout the financial system, bringing cryptocurrency risks out of their small walled gardens into the wider economy,” Walch writes, concluding that cryptocurrencies can spawn a crisis that can ripple through rippled through the mainstream financial system.
Nonetheless, there’s no doubt that a lot of people are going to get rich on cryptocurrencies in the months to come. And crypto-funds are betting a fortune on it.