For people familiar with the cryptocurrency sector, it’s common knowledge that institutional investors such as hedge funds largely shy away from the area. The crypto sector is mainly driven by retail investors and individual activity rather than institutional, large-scale activity, unlike the stock market where it’s vice-versa.
Among institutional investors, hedge funds, in particular, have avoided betting on cryptocurrency and the situation has prompted questions from many. Why do hedge-fund managers refrain from investing in bitcoin and other cryptocurrencies? There’s no single answer to this question, but a group of factors entwined with each other. However, we can say the main factor is high volatility, and let’s explain that.
Cryptocurrencies such as bitcoin are known for their high volatility. They can swing far upwards or downwards in relatively short times than institutional investors are used to, even for hedge funds that tend to make risky bets. Bitcoin has high volatility because of its limited supply and the lack of a central banking institution governing it, leaving it at the mercy of holders scattered across the globe. Given that these holders are decentralized individuals or institutions not working in tune with each other, everyday chaos in how they act makes the price of bitcoin swing up and down like a raging water wave.
Due to high volatility, hedge fund managers shy away from bitcoin because they’re gauging risk. Imagine you had $10 million under management and invested all of it in bitcoin, and the price drops 30% in one day, and then you have $7 million, having lost $3 million of your clients’ money, in one day. That can cause trouble. On the other hand, there can be upsides that’ll let you make quick gains, but clients aren’t usually comfortable with their money going into cryptocurrency because of the high-risk ratio.
There are other significant reasons that fund managers refrain from investing in cryptocurrencies. They include:
Personal Dislike
There are many dissenting opinions regarding cryptocurrency, but it boils down to personal sentiment when a fund manager makes investment decisions. Some fund managers dislike the idea of cryptocurrencies as their subjective opinion regardless of whatever investment prospects they may have.
Some think it’s a bubble; some think it’s prone to fraudulent activity such as “pump and dump” schemes and the likes; some think it offers no good utility. If they dislike cryptocurrencies in general, then investing in them is ruled out.
Take an example of a famous hedge fund manager that dislikes cryptocurrency. Ken Griffin, the founder of Citadel LLC, one of the most successful American hedge funds, has frequently slammed crypto, including calling it a “jihadist call” against the dollar.
Lack of Regulation
Lack of firm regulations from governing authorities is another primary reason fund managers avoid bitcoin and other cryptocurrencies. Because of their decentralized nature, cryptocurrencies are famous for having little or no regulations.
The lacking regulation makes them susceptible to activities that’ll be illegal if done with regulated securities such as stocks and bonds, e.g. “pumping and dumping”, activities that give malicious actors undue advantage over other traders.
Also, lack of firm regulations means no insurance or coverage if something goes wrong and your cryptocurrency goes missing. For example, suppose a regulated broker gets hacked, and some assets are stolen.
In that case, there’s mandated insurance from the broker or the government that’ll cover those losses. But if assets are stolen from a compromised non-regulated exchange? You can wave your coins goodbye, and understandably, hedge funds try to avoid such a situation.
Lack of Support from Trading Platforms
Hedge funds often trade large amounts of assets, and it’ll be the same with crypto. Because the adoption of bitcoin and other digital currencies is relatively new, many trading platforms don’t support them.
Some platforms have plans to, but some don’t, leaving fund managers who want to trade cryptocurrencies with limited choices for the trading platform they pick. This lack of support by software vendors they trust makes hedge funds averse to trading cryptocurrencies.
Unlike the other problems, this one is at least solvable. As the day goes, several trading platforms are adding support for institutional trading of cryptocurrencies. One example is MetaTrader 5 for hedge funds, a well-known institutional trading platform that now supports cryptocurrencies.
Right now, the crypto sector is still in its early phase, and things look wild and stormy. Understandably, institutional investors managing other people’s money are careful before they jump into new stuff.
Still, we can say they’re watching closely and getting friendlier towards crypto as time goes on. For example, a recent study conducted by money manager Fidelity showed that seven in 10 institutional investors expect to buy digital currencies in the future.
Hedge funds refrain from investing in cryptocurrencies for a myriad of reasons, some of which we’ve shown you. However, we predict that they’ll become friendlier towards cryptocurrencies as time goes.