PwC 2023 Cryptocurrency Hedge Fund Report: Traditional Funds Polarized, Cryptocurrency Funds Remain Confident
This article is from PwC's "PwC Global Crypto Hedge Fund Report", translated by Odaily jk.
Summary
The proportion of traditional hedge funds investing in crypto assets has decreased to 29%, a decrease from 37% last year. However, currently no traditional hedge fund plans to reduce its investment proportion in crypto assets in 2023.
Due to the regulatory environment in the United States, 23% of traditional hedge funds are re-evaluating their crypto strategies, while 12% of crypto hedge funds are considering relocating from the US to jurisdictions that are more crypto-friendly.
93% of crypto hedge funds expect the market value of crypto assets to be higher by the end of 2023 compared to 2022.
31% of traditional hedge funds believe that tokenization will be the biggest opportunity in 2023; 25% of traditional hedge funds (including those that currently do not invest in crypto assets) say they are exploring tokenization.
Although the proportion of traditional hedge funds investing in crypto assets has decreased from 37% in 2022 to 29% in 2023, confidence in the value proposition and long-term sustainability of crypto assets seems to remain strong.
According to the 2023 Global Crypto Hedge Fund Report, traditional hedge funds currently investing in crypto assets indicate that they will increase or maintain their investment allocation regardless of market volatility and regulatory obstacles that have weakened confidence in this asset class.
The report, compiled in collaboration with PwC, the Alternative Investment Management Association (AIMA), and CoinShares, includes the findings of two surveys - one focusing on traditional hedge funds and the other on crypto hedge funds.
The report also found that the average allocation of crypto assets managed by traditional hedge funds surveyed has increased from 4% to 7% over the past year. Meanwhile, 93% crypto hedge fund respondents expect the market value of crypto assets to be higher by the end of 2023.
When asked about their plans to increase investment allocation, over one-third (37%) of traditional hedge funds that do not invest in crypto assets express curiosity but are waiting for the assets to mature, a proportion that has increased from 30% last year. Meanwhile, 54% of respondents indicate that they are unlikely to invest in the next three years, an increase from 41% last year.
John Garvey, Global Financial Services Leader at PwC, stated:
"Despite market volatility, cryptocurrency price declines, and the collapse of some crypto businesses, investment in crypto assets is expected to remain strong in 2023. Traditional hedge funds with long-term commitment to the market are not only increasing their managed crypto assets, but also maintaining or increasing the amount of capital they invest in the ecosystem. However, regulatory uncertainty and obstacles are evidently impacting investment decisions for many funds, with over half of respondents indicating that they will consider investing once a clear regulatory framework is established."
Regulatory clarity is crucial for investor participation
Crypto hedge funds dedicated to investing in cryptocurrency assets require greater transparency and regulatory requirements to mitigate investor risks and enhance confidence in this asset class, which was proposed after some crypto businesses collapsed in 2022. These requirements include mandatory asset segregation (proposed by 75% of all respondents), mandatory financial audits (62%), and independent reserve asset reporting (60%). Liquidity was previously considered as the primary factor when choosing a trading platform but is now seen as equally important as platform security: among the surveyed crypto hedge funds, 21% selected liquidity as the most important consideration, an increase from 10% last year. In response to the impact of market events in 2022, over half (53%) of crypto hedge funds reported upgrading their counterparty risk management processes.
Traditional hedge funds that have already invested in cryptocurrency assets are also expressing concerns about the evolving regulatory environment, particularly in the United States. Among them, 23% state that it will have a substantive impact on them or cause them to reassess the feasibility of their cryptocurrency asset positions. Over half (54%) of traditional hedge funds confirm that they will change their approach and become more interested in this asset class if perceived industry barriers and uncertainties are resolved, an increase from 29% last year. In contrast, crypto hedge funds seem relatively indifferent to these regulatory developments, with only a third of respondents expecting higher legal and compliance costs, and 12% of respondents believing that the current regulatory environment in the United States may lead them to move to more crypto-friendly jurisdictions.
Market developments impact investor participation
Last year's crypto market events, including the collapse of some crypto asset service providers, were generally viewed as having a negative impact by traditional hedge fund respondents: 57% of funds stated that their prospects were negatively or strongly negatively affected. Among these funds, 70% managed assets over $1 billion.
Over two-thirds (71%) of surveyed traditional hedge funds currently do not invest in crypto assets, an increase from 63% last year..The four main reasons why traditional hedge funds do not invest in cryptocurrency assets remain consistent with last year's answers, including: (1) client reactions or reputational risks, (2) lack of regulatory and tax clarity, (3) insufficient or unreliable third-party data, and (4) outside the scope of current investment objectives.
In contrast, the surveyed cryptocurrency hedge funds appear unaffected by recent market fluctuations, with half (50%) indicating no impact. Nearly one-third (27%) hold an optimistic view of the current market, possibly due to increased investment opportunities brought about by the widespread depreciation of cryptocurrency assets. Given the events of last year, 53% of cryptocurrency hedge funds report having updated their counterparty risk management processes.
Tokenization as a Growing Development Trend
Compared to cryptocurrency hedge funds, traditional hedge funds show greater curiosity towards tokenized assets and securities, with a quarter of the funds exploring tokenization. In contrast, only 15% of surveyed cryptocurrency hedge funds reported exploring investment in tokenized securities. Tokenization holds the promise for funds to achieve faster settlement times, lower operational costs, improved efficiency, and reduced friction. Around one-third (31%) of surveyed traditional hedge funds identified tokenization as the biggest growth opportunity in the cryptocurrency asset space in the coming year.
Divergence in Investment Strategies between Traditional and Cryptocurrency Hedge Funds
"Diversification of asset portfolios" or "long-term excess returns" are the most common reasons why traditional hedge funds incorporate cryptocurrency assets into their portfolios. Over half (54%) of traditional hedge funds currently investing in cryptocurrency assets state their intention to maintain the same allocation level this year. 46% of the funds plan to increase investments in this asset class by the end of 2023, a decrease compared to last year's 67%.
The majority (91%) of traditional hedge funds that have already invested in cryptocurrency assets indicate holdings in the two largest cryptocurrencies by market capitalization and trading volume—Bitcoin and Ethereum. This proportion has increased compared to last year's 67%, reflecting a shift towards larger market cap coins and a more conservative investment approach.
None of the respondents stated investment in NFTs, whereas one-fifth of traditional hedge funds invested in NFTs last year, indicating a significant cooling of market enthusiasm for NFTs since reaching its peak in 2021.
In interviewed cryptocurrency hedge funds, market-neutral strategies remain the most popular strategy, despite a decrease in usage from 30% to 20% compared to the previous survey. Conversely, the usage of discretionary long-only cryptocurrency strategies has increased from 14% to 19%, while the usage of quantitative long-short cryptocurrency strategies has decreased from 25% to 18%. This evolution may be more related to the current market environment rather than a overall shift in long-term trading strategies. Apart from market-neutral strategies, all cryptocurrency hedge fund strategies have experienced losses.
Jack Inglis, CEO of AIMA, stated:
"The digital asset space has had to face flaws in its fundamental operations, including risk management and allegations of misconduct. Investor interest in the sector has shown resilience in some new areas, particularly tokenization, providing a foundation for industry participants to rebuild institutional investors' and traditional hedge funds' confidence in allocating to this asset class."
Alexandre Schmidt, index fund manager at CoinShares, said:
"Cryptocurrency hedge funds have demonstrated remarkable resilience in the complex environment of 2022. The majority of surveyed funds have generated positive Alpha returns, highlighting these firms' important role in the digital asset ecosystem. Moving into 2023 and beyond, regulatory agencies pose a recent obstacle, but this will pave a clearer path for long-term investment in digital assets and promote higher adoption rates from small retail investors to large institutional investors."
