Letter from Hong Kong: Crypto Funds Whet Investor Appetite

Although cryptocurrencies are going through a big bear market, fund-raising activity in the blockchain industry is showing little sign of slowing, even in the Asian financial hubs of Hong Kong and Singapore.

Top cryptocurrencies such as Bitcoin and Ether are down by nearly 70 percent from their peak, the latter having lost nearly half of its value in the past two months alone, with regulators and economists who had been dismissing the claim, put forward by many die-hard believers of Bitcoin, that the virtual currencies will soon replace dollar and yen as main currencies a pipe-dream, feeling vindicated.

Yet, the current bear market and the lack of regulatory clarity hasn’t stopped crypto assets from becoming a highly investable asset class, a trend that is likely to gain further momentum as the blockchain as a technology goes more mainstream.

Nearly 165 cryptocurrency funds, including hedge and venture capital funds, were expected to be launched in 2018, surpassing the record 156 such funds debuted in 2017, according to the Rohnert Park, Calif-based CryptoFundResearch.

There are currently more than 400 cryptocurrency funds in the world. The lack of regulation is what is partly driving these funds, said Josh Gnaizda, chief executive of CryptoFundResearch.

The cryptocurrency hedge funds that trade in Bitcoin and Ethereum, which are considered as commodities, not securities in the US, have fewer compliance costs with regulators like the Securities Exchange Commission (SEC), Gnaizda told Asia Sentinel.

“This minimizes one significant barrier to entry,” he said. In addition, the proliferation of a form of crowd-funding through the issuance called initial coin offerings – for which investors get digital token in exchange for Bitcoin and Ether – have also made things easier for venture capital funds to deploy investments without having to negotiate specific terms, he said.

Cryptocurrency funds are currently divided into two main categories: hedge and venture capital funds. There are also crypto ETFs and private equity firms as well.

Not surprisingly, most of these funds are shoestring operations. Almost half of the existing funds have less than US$10 million in capital, though the bigger ones such as Pantera Capital have hundreds of millions in funds.

Because of the highly volatile nature of the cryptocurrency sector, funds that use sophisticated mathematical models to capitalize on sharp price swings tend to attract more capital, said Gnaizda.

Many are raised in cities like New York and San Francisco, the traditional bastions of hedge and venture capital funds.

Asia’s financial hubs such as Hong Kong and Singapore have also benefitted from the crypto funds boom as many hedge funds and venture capitals use the two cities as a launch pad for their myriad investment vehicles.

Despite the Chinese government’s ban on cryptocurrency trading, Beijing continues to support investment in blockchain, also known as distributed or shared ledger. It is partly the reason why Chinese firms such as Huobi, a Chinese exchange, has also launched a billion-dollar fund.

Blockchain is increasingly being implemented in a wide array of sectors from digitizing trade finance to mobile payments to seamless sourcing of agricultural products as well as in storing and trading of digital identities of expensive artwork.

As the technology becomes more mainstream, many investors, especially institutions, are moving into the sector partly because of the “fear of missing out." If they waited until the regulations gain clarity, they fear that they might be entering too late into the game.

As of this juncture, most governments are not sure how exactly to classify many of these assets, as evidenced by the US SEC’s dithering on its decision to whether to approve Bitcoin exchange traded-funds (ETFs).

The SEC is expected to ponder again over the decision on the cryptocurrency ETFs in late September.

“Will they cave to popular pressure? Crypto, even while down 70 percent, is way more exciting than any other asset class,” writes Arthur Hayes, the chief executive of Hong Kong-based crypto-exchange, BitMex, in his folksy daily report on August 14. “The exchanges, asset managers, and white-shoe investment banks all want in. The only inhibiting factor is regulators.”

As market matures, traditional hedge funds are seen as launching cryptocurrency divisions while the existing VCs may also likely to invest in blockchain startups.

Not surprisingly, at this stage, the crypto funds market is still tiny in size. Total crypto funds manage just $7.1 billion, which is far less than many of the top traditional hedge funds, and account for just 0.1 percent of the total asset size of the global hedge funds sector.

And questions remain as to whether the markets were able to absorb the supply of so many funds, or if the new entrants would succeed in the market which is really in the doldrums.

Gnaizda of CryptoFundResearch, for one, said “it remains to be unclear if the industry can support such a large number of funds, with limited track record, if we experience an extended bear market.