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Traditional Hedge Funds Entering the Crypto Market
In January earlier this year, 11 of the world’s biggest asset managers entered the crypto space, primarily through Bitcoin exchange-traded funds (ETFs). This influx introduced billions of dollars from institutional investors who had previously hesitated to invest in cryptocurrencies. However, many of these asset managers soon realized that their traditional investment strategies were not as effective in the crypto market.
Challenges of Traditional Hedge Funds in Crypto
Regulatory Mismatch
Offshore structures used by traditional hedge funds do not align well with the regulatory environment of cryptocurrencies. In traditional finance, hedge funds often operate offshore to benefit from less regulatory scrutiny. However, in the crypto market, assets managed through these funds must be sent to unregulated exchanges, posing significant risks.
Delayed Reporting
Traditional hedge funds usually provide performance data only after completing monthly or quarterly audits, often 45 days after the fact. In the fast-paced crypto markets, where prices can swing by 10% within hours, such delays are unacceptable. Timely reporting is crucial to keep up with the volatile nature of cryptocurrency trading.
24/7 Market Dynamics
The crypto market operates 24/7, requiring constant monitoring and quick decision-making. Traditional hedge funds, accustomed to defined trading hours and periodic reporting, struggle to keep pace. Crypto-native traders adapt quickly to market changes, whereas traditional hedge fund managers find it challenging to match the speed and volatility of the crypto market.
The SMA Solution: A Better Fit for Crypto Investments
Separately Managed Accounts (SMAs) offer a more suitable alternative to hedge funds for crypto investments. SMAs provide direct ownership of assets, real-time reporting, and a custom approach to investment management, aligning better with the crypto market’s dynamics.
Direct Ownership
One of the primary benefits of SMAs is direct ownership of underlying assets. Unlike hedge funds, where assets are pooled, each SMA is traded as a separate entity. This transparency allows investors to see exactly where their money is and how it’s performing at any given time.
Real-Time Reporting
SMAs offer real-time performance data, enabling investors to track their portfolios minute-by-minute. This is a significant advantage over hedge funds, which often report performance weeks or months after market activity.
Customized Investment Strategies
SMAs allow for bespoke investment strategies tailored to each client’s specific needs and risk tolerance. This flexibility is crucial in the volatile crypto market, where the ability to quickly adjust strategies can mean the difference between profit and loss.
Institutional Benefits
Institutional investors benefit significantly from the flexibility of SMAs. For example, SMAs facilitate tax optimization strategies like tax-loss harvesting, essential in the volatile crypto market. Additionally, SMAs allow for asset diversification within the crypto space, enabling investors to build customized portfolios that align with their financial goals.
Enhanced Security
SMAs also offer enhanced security by allowing trading without leaving assets in the hands of third parties. This minimizes the risks associated with unregulated exchanges. Companies like BitGo, Zodia, Fireblocks, and Copper.co now offer secure off-exchange settlement services, adding layers of security and transparency.
Regulatory Support for SMAs
Regulation is increasingly favoring SMAs over traditional hedge funds. For instance, Singapore’s Monetary Authority has introduced new rules requiring crypto exchanges to hold customer funds in trust, protecting assets and investors. Such regulations align with the SMA model, emphasizing transparency, security, and individualized management.
Additionally, the collapse of FTX in 2022 highlighted the importance of proper regulatory measures. In Japan, where regulations required crypto exchanges to segregate customer deposits, FTX Japan’s users were able to recover their funds. This regulatory approach aligns with the principles of SMAs, offering an added layer of protection.
Future of Institutional Crypto Investments
While traditional hedge funds struggle to adapt to the crypto market, SMAs offer a bespoke, transparent, and timely solution for modern institutional investors. With direct ownership, real-time reporting, and customized strategies, SMAs are poised to become the investment vehicle of choice for institutions looking to acquire digital assets.
SMAs provide a sophisticated and secure framework for generating returns in the fast-paced crypto market.
Stephen Wundke is the strategy and revenue director at Algoz Technologies. He joined Algoz in late 2022 and pioneered the unique SMA structure for an off-exchange settlement product called Quant Pro, using Zodia Custody and Bitfinex.
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