The springing up of “crypto” hedge funds in proportion to the rising market cap in 2017 led many to truly believe in the “institutionalization” of the asset class. A year later, few have survived, and those who are active have been facing an inevitable existential crisis, opinionated Anthony Pompliano via a blog post on November 21, 2018.
Unstructured Funds Face Issues
Popularly known as “Pomp,” Pompliano is the founder of cryptocurrency hedge fund Morgan Creek Capital and runs blockchain-focused podcast “Off the Chain.” In a recent episode, Pomp discussed the grim reality of fund payouts for employees and managers in hedge funds, and how 2018’s prolonged bear market serves to deprive many of their ostentatious positions.
Most crypto-funds are structured similarly to a traditional fund, such as incentivizing traders with a standard 20 percent management fee if the value of total assets under management (AUM) exceeds the value of the preceding period.
But with the cryptocurrency market cap losing $650 billion since January 2018 and cryptocurrency prices falling by 60 – 70 percent, fund employees are dealing with a fallacy that serves to deprive them of any meaningful income; fund AUMs have decreased by multiples of ten and leave no opportunity for performance fees to be paid out.
Pomp believes most fund managers have recognized the problem and are proceeding to shut down their business, return initial capital to investors, and “wait out” until a bull run returns. Also, he believes most crypto-funds are run by young and inexperienced traders
Another implication of 2017’s bull run was the rise in initial coin offerings (ICO), and subsequently, “private” rounds for ICOs where crypto-funds and high-net-worth individuals invest vast amounts of capital at a discounted rate before public sales.
However, the above has caused several million dollar investments to face the inevitable classification of a “bad” deal, as most tokens have fallen to pre-ICO levels and fail to attract interest from the general public. The fundraising mechanism also is facing the wrath of the U.S. Securities and Exchange Commission, which unveiled two new regulations last week to govern ICOs; deeming most tokens as unregistered securities and stating projects found violating the law would be charged hefty fines.
ICO Regulations Spell Doom
Such regulations could spell doom for new companies raising money via token issuances. For example, a project raising $1 million via ICOs will be liable to pay investors an equivalent amount if found in violation. However, most token startups raise money via bitcoin and ether, meaning they will end up paying extra money to investors, in form of cryptocurrencies, to meet the U.S. dollar price of investments when originally raised.
The above is not a problem when crypto prices are rising through the roof each week, but in a bear market like 2018, ICO projects are unlikely to have enough funds in USD levels to cover investor losses; or eventually file for bankruptcy. Both ICOs and crypto-funds are immensely affected by all of the factors as mentioned above. The former does not have money to pay, while the latter has investments and AUMs that are below acceptable levels for generating revenue.
If ICO projects begin filing for bankruptcy, crypto funds will have to start writing investments to zero at an accelerated rate. The compounding effect of the high water mark issues and deepening losses should be quite discouraging for fund managers and limited partners alike. As both ICOs and funds begin to shut down, it is easy to see a future feeling of panic and desperation spreading across parts of the market.