Hedge Funds: Exploring Bitcoin Investment Opportunities

Bitcoin has gained support from some of the world's biggest banks and investors, including hedge funds. In 2020, bitcoin hit an all-time high of USD20,000, marking a remarkable year for the world's leading cryptocurrency and attracting the attention of a growing number of hedge fund firms. Hedge funds are capitalising on the crypto boom, with several high-profile hedge fund firms stepping into the cryptocurrency space in recent years. The emergence of cryptocurrency hedge funds has brought a massive inflow of professionals into the market, with 63% of the 150 largest global crypto hedge funds launched in 2018 and 2019.

Hedge funds capitalising on the 2020 crypto boom

Hedge funds are investment vehicles that pool money from various wealthy investors with the goal of achieving positive returns. They are not regulated as heavily as mutual funds and can therefore pursue high-risk investments and strategies.

In 2020, hedge funds were capitalising on the crypto boom by investing in Bitcoin and other cryptocurrencies. Bitcoin hit an all-time high of USD20,000, marking a remarkable year for the world's leading cryptocurrency. Several factors fuelled the digital currency surge, including the macroeconomic backdrop since the Q1 coronavirus crash and a growing investor community that was becoming more comfortable with cryptocurrency infrastructure.

The low-to-negative interest rate environment led many allocators to see Bitcoin as a 'gold version 2.0' proxy, in contrast with overpriced equities. The huge amount of money printing by central banks since Covid-19 brought the ''digital gold' narrative of Bitcoin to the fore.

The Bitcoin 'halving' event in May 2020, which occurs roughly every four years and halves the new supply of Bitcoin, was also pivotal. This event led to a block reward fall from 12.5 to 6.25 Bitcoins.

The growing interest in cryptocurrencies among institutional investors has been reflected in the performance of various indices tracking the performance of hedge funds investing in blockchain and digital currencies. For example, the Hedge Fund Research's Blockchain Composite Index, which tracks the performance of hedge funds trading blockchain digital currency and distributed ledger technologies, soared more than 53% in November 2020, bringing its year-to-date advance to 159%.

Several high-profile hedge fund firms have stepped into the cryptocurrency space in recent years. For example, Paul Tudor-Jones, the founder of Tudor Investment Corp, sees cryptocurrency as an inflationary hedge and has increased his exposure to the asset. Michael Novogratz, the former manager of Fortress Investment Group, now runs a cryptocurrency-focused asset manager, Galaxy Investment Partners. Two Sigma has also begun actively trading digital assets.

Despite the volatile performance of cryptocurrencies, the growing mainstream acceptance of digital assets and the increasing interest among institutional investors have made the crypto market an attractive prospect for hedge funds.

Bitcoin as a hedge against inflation

Bitcoin has emerged as an intriguing option for those seeking an inflation hedge. Its design, with a fixed supply of 21 million coins, safeguards it from the inflationary pressures that traditional currencies face. By nature, Bitcoin cannot undergo dilution through inflation, making it attractive to discerning investors. The decentralised architecture of Bitcoin also means it is free from manipulation or control by central banks and governments, adding an extra layer of security for investors.

Bitcoin's price appreciates under inflationary pressures, confirming its inflation-hedging property. Paul Tudor-Jones, the founder of Tudor Investment Corp, views cryptocurrency as an inflationary hedge and has increased his exposure to Bitcoin. However, the unique design of Bitcoin doesn't guarantee its viability as an inflation hedge in all circumstances. The value of Bitcoin is driven by market demand and supply, with no tangible asset backing it up. This means the price can be volatile, and it can experience dramatic rises and falls over short periods. For example, between late 2017 and early 2018, Bitcoin's price fell from nearly $20,000 to just above $3,000.

The short history of Bitcoin, which has only been in existence for just over a decade, also means its performance in a diverse range of economic scenarios is not entirely known. Its behaviour during inflationary periods, in particular, remains largely untested. Given that inflation tends to occur over long timeframes, Bitcoin's longevity and stability in such conditions are yet to be fully evaluated. The regulatory landscape surrounding cryptocurrencies is another critical factor in assessing Bitcoin's feasibility as an inflation hedge. Despite gaining wider acceptance, cryptocurrencies are still subject to legal and regulatory uncertainties across different jurisdictions.

Therefore, when considering Bitcoin as a hedge against inflation, it is advisable to incorporate it as part of a diversified portfolio. By spreading investments across a range of asset types, investors can leverage Bitcoin's potential benefits while mitigating its risks. A careful, well-researched approach is crucial when considering Bitcoin as part of an inflation-hedging strategy.

The emergence of crypto hedge funds

The cryptocurrency hedge fund industry is still in its infancy but is likely to be the future of finance. One of the most significant developments in the cryptocurrency space is the emergence of crypto hedge funds, which has led to a massive inflow of professionals entering the market. Crypto hedge funds are investment funds that aim to provide active investment management in the cryptocurrency market. The performance of crypto hedge funds has been mixed, with some funds generating sustainable alpha while others have struggled due to high volatility and downward trends in cryptocurrencies. However, the industry is evolving quickly, with the ecosystem for crypto assets and crypto hedge funds growing.

The majority of investors in crypto hedge funds are family offices or high-net-worth individuals, but a growing number of funds of funds have been investing in crypto hedge funds, causing the ecosystem to evolve rapidly. The percentage of crypto hedge funds with assets under management of over $20 million nearly doubled to $44 million in 2019, indicating that more funds are reaching a critical size and sustainability. The total assets under management of crypto funds worldwide doubled from $1 billion in 2018 to $2 billion at the end of 2019, with indications that this number tripled by the end of 2020.

The growth in investor demand for crypto hedge funds is becoming apparent, with institutional investors increasingly viewing cryptocurrencies as a hedging perspective and an alternative investment asset class. Well-known Wall Street names, including George Ball, the former CEO of Prudential Securities, have suggested that Bitcoin and other cryptocurrencies could be a "safe haven" for investors and traders. The acceptance of cryptocurrencies as a medium of exchange by businesses and organizations has increased due to advantages such as low transaction fees and a high degree of anonymity. This has contributed to a growing consumer base, transaction frequency, and attention from investors.

The COVID-19 pandemic has also played a role in the emergence of crypto hedge funds. While it negatively impacted the performance of some hedge fund strategies, it did not affect the relationship between crypto-currency hedge funds and Bitcoin or Ethereum. The pandemic may have contributed to the perception of cryptocurrencies as a safe haven during times of economic crisis, further boosting investor interest.

The crypto hedge fund industry is still developing, and it remains to be seen whether it will fulfill its promise as the future of finance. However, the increasing talent inflow from the traditional hedge fund world, the growing acceptance of cryptocurrencies as an asset class, and the surge in investor demand indicate that crypto hedge funds are here to stay and will play a significant role in the future of finance.

Hedge funds buying exchange-traded bitcoin products

Hedge funds have been investing in exchange-traded bitcoin products, such as the Grayscale Bitcoin Trust (GBTC), which was converted into an ETF in 2024. This move by hedge funds is part of a broader trend of institutional investors buying exchange-traded products as well as the underlying cryptocurrency.

In 2024, a spot Bitcoin ETF was approved by the SEC, allowing investors to be exposed to bitcoin's price moves in their regular brokerage accounts. While money flowing into spot-Bitcoin exchange-traded funds has slowed, there has been a combined net inflow of almost $12 billion since their debut in January.

Hedge funds have been taking advantage of the arbitrage opportunity presented by the discount in the price of Grayscale's trust compared to its underlying assets. For example, hedge fund Hunting Hill invested in GBTC when it was trading at a 42% discount and closed its position when the discount narrowed to 7%.

The Bitcoin 'halving' event, which occurs roughly every four years and involves halving the new supply of bitcoin, has also contributed to the increased interest from hedge funds. This event, which took place in May, led to a block reward fall from 12.5 to 6.25 bitcoins.

The performance of bitcoin and the growing mainstream acceptance of cryptocurrency have made it an attractive investment opportunity for hedge funds.

The future of finance

Bitcoin has seen a surge in popularity and value in recent years, with its price climbing to within touching distance of its late 2017 highs of around $20,000. This has led to a growing interest from institutional investors, including hedge funds, in cryptocurrencies as an emerging alternative asset class.

The crypto hedge fund industry is still nascent, but it is undoubtedly the future of finance. Crypto hedge funds have seen massive inflows of professionals entering the market, with 63% of the largest global crypto hedge funds launched in 2018 and 2019. The industry has a market cap of around $500 billion across digital currencies, with more than $100 billion traded daily.

Several factors have fuelled the digital currency surge, including the shifting macroeconomic backdrop since the Q1 2020 coronavirus crash and an investor community that is gradually becoming more comfortable with the cryptocurrency's infrastructure. The low-to-negative interest rate environment has also led many allocators to view Bitcoin as a 'gold version 2.0' proxy, in contrast with overpriced equities.

However, challenges remain for the digital asset hedge fund sector, including volatile and unstable returns, and operational barriers as the cryptocurrency sector is still comparatively under-developed compared to other markets where hedge funds trade.

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