Cryptocurrency Hedge Funds are investment vehicles that invest money in the cryptocurrency space. The typical investors of cryptocurrency Hedge Funds include high net worth individuals, family offices and funds of funds. The assets under management (AUM) of crypto Hedge Funds have been growing continuously between 2018 and 2021. Depending on the Hedge Fund different strategies are followed: some funds are investing long only while others are executing market neutral or short strategies that allow investors to obtain gains even during down markets.
2022 has been a very difficult year for cryptocurrency Hedge Funds. The failure of Luna and its stable coin Terra initiated a cascade of liquidations which culminated with the bankruptcy of Three Arrows Capital and the blow up of Sam Bankman Fried’s Alameda Research trading firm and his exchange FTX. The turning market sentiment unveiled an enormous amount of leverage that was inherent to the system and brutally exposed the most vulnerable firms leading eventually to their bankruptcy.
Understanding Cryptocurrency Market Cycles
So far the price history of cryptocurrencies can be divided into several boom and bust cycles. The most recent market cycle started with the bottom in December 2018 and culminated with Bitcoin’s all time high in November 2021. The next market bottom which is not yet confirmed occurred supposedly in November 2022.
However, several altcoins such as Litecoin ($LTC) reached their prior cycle highs already in May 2021 and experienced the lows of this cycle in June 2022. Also Ethereum ($ETH) the second largest cryptocurrency by market capitalization experienced its latest market cycle bottom in June 2022. The last market cycle eventually created a new asset class inside crypto: NFTs. NFT volume decoupled from the overall market and peaked in the second half of 2022. Nevertheless NFTs are only a tiny fraction of the overall cryptocurrency market.
Following the perspective of the altcoins several cryptocurrency analysts argue that the actual top of the 2021 cryptocurrency bull market occurred in May 2021 and the November highs were essentially just a double top that did not significantly exceed prior highs. Based on this analysis the time measured from the peak to the bottom would equal exactly 13 months while the prior ascend from December 2018 to April 2021 took 28 months. If we extrapolate this cycle length to the future the next peak for the cryptocurrency market would be due in October 2024. However, past cycle performance is only one of many variables to consider when forecasting future price performance.
The Impact of Liquidations and Bankruptcies on the Performance of Cryptocurrency Hedge Funds
The bankruptcy of FTX massively impacted the 2022 performance of cryptocurrency Hedge Funds. Multicoin Capital was among the funds betting big on the Solana ecosystem and other cryptocurrencies within the realm of FTX. On top a significant part of the fund’s assets were held on FTX. In the two weeks of the FTX melt down alone Multicoin Capital lost more than half of its liquid assets under management.
Despite massive drawdowns in 2022 several funds still remain overall massively in the green. For example Pantera Capital’s Early Stage Token Fund was down by more than 70% in the first three quarters of 2022 and yet returned a positive yield of more than 370% measured since inception.
Analyzing the Long Term Performance of Cryptocurrency Hedge Funds and Tying it to Total Cryptocurrency Market Capitalization
The reason for the positive long term performance is best illustrated in the chart of total cryptocurrency market capitalization. Despite large corrections along the way, total cryptocurrency market capitalization has so far been growing and always exceeded prior highs.
The total cryptocurrency market capitalization reached around 14 bn$ during the 2014 peak. In the 2017 bull market it went on to increase to 740 bn$ growing by more than 50 times compared to the prior high. In 2021 the total market capitalization reached almost 3 trillion $ (3,000 bn$) exceeding more than 4 times the valuation in 2017. As we can see on this chart the returns in comparison to prior market cycles are decreasing. However, they are still outstanding and without comparison to the traditional financial markets. Hedge Funds that invested into cryptocurrencies with a 5 year plus time horizon have been therefore solidly in the green so far.
When Is the Best Time to Allocate Money to a Cryptocurrency Hedge Fund?
The likelihood to discover the cryptocurrency asset class for a new investor is highest during a bull market when prices are going through the roof and the industry is all over the media. However, investing right after a down year was generally a very profitable strategy for cryptocurrency investments in the past.
| Year | Return |
| 2011 | 1467% |
| 2012 | 187% |
| 2013 | 5870% |
| 2014 | -61% |
| 2015 | 35% |
| 2016 | 124% |
| 2017 | 1338% |
| 2018 | -73% |
| 2019 | 94% |
| 2020 | 302% |
| 2021 | 60% |
| 2022 | -61% |
Bitcoin Annual Returns 2011-2022
The prior two years when Bitcoin yielded negative returns (2014 and 2018) were followed by three years of positive returns. If the past pattern would repeat itself the years 2023 to 2025 would yield positive returns.
What to Expect from Investing into a Cryptocurrency Hedge Fund?
Investors allocate their capital to a fund because of the prospect of obtaining a positive return. However, it is important to be aware that the cryptocurrency space is a very volatile sector to invest in. So far those investors with a long term time horizon have been rewarded tremendously by the market. In exchange they needed to make it through extended periods of drawdowns at which they lost significant amounts of their capital. This space is therefore best suited for the not so risk averse minds with a long term investment time horizon.