PwC 2023 Global Crypto Hedge Fund Report: PwC

Regulatory clarity key to investor engagement

Crypto hedge funds, those that invest exclusively in crypto assets, are demanding greater transparency and regulatory requirements following the collapse of a number of crypto businesses in 2022 to mitigate risk for investors and increase confidence in the asset class. These demands include the mandatory segregation of assets (highlighted by 75% of all respondents), mandatory financial audits (62%) and an independent statement of reserve assets (60%). Liquidity – once considered the overriding factor when choosing a trading venue – is now seen as just as important as platform security: 21% of crypto hedge funds surveyed chose it as their most important consideration – up from 10% last year . Following the market events of 2022, it was also noted that just over half (53%) of crypto hedge funds surveyed had upgraded their counterparty risk management processes.

Traditional hedge funds with exposure to crypto-assets also expressed concern about the evolving regulatory environment – in the US – with 23% pointing out that it will have a material impact on them or lead them to question the viability of reconsider their crypto asset exposures. Just over half (54% of traditional hedge funds not currently investing) confirmed they would change their approach and become more interested in the asset class if perceived operational barriers and uncertainties were resolved – an increase from 29% last year. In contrast, crypto hedge funds appear to be relatively less troubled by these regulatory developments, with only one-third anticipating greater legal and compliance costs and 12% noting that the current regulatory environment in the US may lead them to move to more crypto-friendly jurisdictions moved

Market developments weigh on investor engagement

Last year’s crypto market events – including the collapse of a number of crypto asset service providers – were viewed as overwhelmingly negative by traditional hedge fund respondents: 57% said their outlook was negatively or strongly negatively impacted. Of those funds, 70% manage more than US$1 billion.

More than two-thirds (71%) of traditional hedge funds surveyed are not currently invested in crypto assets – up from 63% last year. The four main reasons not to invest in crypto-assets among traditional hedge funds – consistent with last year’s responses – include: (1) client backlash or reputational risk, (2) lack of regulatory and tax clarity, (3) inadequate or unreliable third party -party data, and (4) outside the scope of current investment mandate.

Conversely, crypto hedge funds surveyed do not appear to be deterred by recent market volatility, with half (50%) noting any impact. Almost one-third (27%) feel positive about the current market – likely due to greater investment opportunities due to a broad decline in crypto-asset valuations. In light of last year’s events, 53% of crypto hedge funds reported updating their counterparty risk management processes.

Tokenization as a way forward

Traditional hedge funds showed a greater degree of curiosity in tokenized assets and securities – with a quarter exploring tokenization – compared to crypto hedge funds, of which only 15% of respondents reported exploring investments in tokenized securities. Tokenization of funds holds the promise of increased efficiency and the reduction of friction by enabling faster settlement times and minimizing operating costs, with approximately one-in-three (31%) traditional hedge funds surveyed identifying tokenization as the biggest growth opportunity in the crypto asset space considered in the coming year.

Investment strategy divergence: traditional vs crypto hedge funds

“General diversification” or “long-term outperformance” are the most common reasons given by traditional hedge funds for including crypto-assets in portfolios. More than half (54%) of traditional hedge funds currently investing in crypto assets intend to maintain the same levels of capital deployed this year. 46% say they intend to deploy more capital in the asset class by the end of 2023 – down from 67% reported last year.

The vast majority (91%) of traditional hedge fund investors with crypto asset exposure say they are invested in the two largest crypto assets by market cap and exchange volume – Bitcoin and Ethereum – up from 67% last year, reflecting a shift to large-cap coins and a more reflect conservative investment approach.

No respondents report being invested in non-fungible tokens (NFTs) – compared to one in five traditional hedge funds last year – a significant cooling since the NFT peak in 2021.

Among crypto hedge funds surveyed, the Market Neutral strategy remained the most popular strategy – although its use decreased from 30% to 20% compared to the previous survey. In contrast, the use of Discretionary Long Only Crypto rose from 14% to 19%, while the use of Quantitative Long/Short Crypto fell from 25% to 18%. This evolution probably has more to do with the current market environment than a long-term shift in overall trading strategies. All crypto hedge fund strategies – with the exception of Market Neutral – experienced losses.

AIMA Chief Executive Jack Inglis said: