If it walks like a VC, talks like a VC and behaves like a VC, it is likely not a hedge fund. And numerous crypto fund managers who have launched in the past few years have chosen for the hedge fund model. Many probably should have gone with a venture capital structure.
Traditionally, hedge funds are measured on their performance over short, discrete intervals. Months, quarters and years. This is reasonable for established markets such as stocks. Price discovery is instantaneous — one can look up the cost of Apple or Netflix pretty fast.
This may also work for crypto funds, but only if they invest in resources which may be priced instantly (e.g., BTC, ETH, etc.). Otherwise, they could have been better off using a venture capital fund arrangement.
A Bad Setup
There’s evidence that lots of crypto funds started with a less-than-ideal arrangement: prominent crypto hedge funds are currently launching venture funds. Some do so while preventing investors from pulling capital from the first hedge funds.
In addition, several funds are now using something called pockets. A mechanism to produce lasting, illiquid investments, side pockets can’t be properly valued by means of a market because there generally is not one. Many funds invest in job tokens or take equity stakes in crypto businesses. Nevertheless, these are investments in assets that can’t be valued precisely.
This is because the majority of those early crypto projects do not trade freely on an open marketplace. And so, a crypto hedge fund begins to seem and feel more like a venture capital fund.
In early 2018 Polychain Capital set up a venture fund.
The problem with many crypto hedge funds is a pure taste that skews toward venture-style as opposed to hedge fund-style investment. They’re more comfortable making lasting investments. And this is a basic flaw when you try to wrap it into a hedge fund structure that’s short-term focused.
It creates a situation where the hedge fund manager might in fact be right, but get punished for it. They may invest in certain crypto advantage that becomes widely used for distributed file storage, for example. However, the investment has destroyed on a yearly performance basis. This is because prior to the investment thesis has been confirmed, the crypto asset dropped off a cliff many times on its way towards the top.
The Curious Case of ‘Crypto Hedge Fund’ Performance
Let us take the case of ABC Crypto Fund (not its real name).
ABC is conducted by a group of highly accomplished technologists hailing from Ivy League schools. ABC ended 2018 down over 70 percent. The managers of ABC don’t have any professional money management expertise. It seems they haven’t entertained the possibility that their love for the technician they selected may not be aligned with current market sentiment. Otherwise, perhaps their present outcome would be different.
Or think about XYZ Crypto Fund (again, not its actual name). XYZ is run by outspoken technologists who publish their views with a tone and certainty so fervent that it would embarrass a religious extremist. Reading their idea pieces, one might think they had attained union with the sacred energy permeating the world. It feels as though they are devoting mere mortals a glimpse behind the curtain to see the internal workings of the cosmos, expressed in crypto language.
What exactly happened with XYZ? Lost about half of the investors’ money in 2018. The irony is they even tout their fund’s similarity to VC funds– but alas, they elected to organize themselves as a hedge fund.
We wish supervisors like ABC and XYZ well and expect that they finally triumph. We’re long-term believers in crypto and digital resources. But we also need to call a spade a spade.
In fairness, it could have been hard to predict exactly what the best structure should have been for crypto funds. Hindsight is 20/20. If we look at things dispassionately, we see many fund managers who espouse a venture-style perspective, trying to hold investments in a hedge fund vehicle.
Said another way, they have a 5- or 10-year horizon (such as a VC), but they have packed their funds in a short-term delivery vehicle (such as a hedge fund manager). Perhaps this is the reason why, when asked about their 2018 performance, they frequently say they’re”investing for the long run.” Also the technological promise is so good, that being”diverted by returns in the short term” is a mistake.
In 2018, the normal crypto hedge fund was down 69.95 percent. Source: Eurekahedge.
In certain conditions, a hedge fund model does make sense for crypto. Some of the best performing crypto funds of 2018 were structured as hedge funds. Rightly so–they used specific strategies which make sense for a hedge fund arrangement. Suffice it to say the hedge model can work well. Some funds ended 2018 with double-digit positive returns even as a number of the most prominent funds were slaughtered.
Market forces will eventually sort things out after a requisite period of quite intense pain. Meanwhile, the time is right to deliver a more realistic perspective into the crypto investment area.
Hope and excitement for technology are terrific. But certain principles of fund have persisted throughout the centuries for good reason. Technology may well change the world for the better. But, economics and market forces can’t be out-coded and should certainly not be over-engineered.
The issue is one can’t have both. No one investing in tokens can reasonably say it’s for the long run. If they truly had a long-term attention, these investors might also invest in routine seed/series A rounds.
So, if you wish to enter the game of choosing the winning technologies in crypto, do yourself and your investors a favor. Call yourself by your proper name: A venture capitalist.