The cryptocurrency realm witnesses an influx of hedge funds, investment platforms typically laden with a hefty capital. The involvement of a hedge fund in the crypto industry is akin to a double-edged sword. Its potential benefits juxtapose against various detriments. CryptoMode explores four compelling reasons why the engagement of hedge funds could tarnish the allure of the cryptocurrency landscape.
Exorbitant Fees and Substantial Losses
Every hedge fund is notorious for its high fee structures. According to a study by Forbes, the typical management fee for a hedge fund is about 2% on every dollar invested. There’s also a 20% incentive fee on profits. On a $100,000 investment, a crypto investor could pay nearly $4,000 in fees alone. This excessive fee structure diverts a significant chunk of investment from the actual market. It is particularly concerning in the cryptocurrency domain, where long-term holding has historically been beneficial.
Furthermore, the high-risk nature of hedge funds translates to substantial losses when the market faces a downturn. The phrase “when you lose in a hedge fund, you lose big” succinctly encapsulates the financial peril that investors might find themselves in. That rings especially true in a market as volatile as that of cryptocurrencies.
Hedge Fund Market Manipulation and Short Selling
Hedge funds have a knack for aggressive trading strategies. A significant aspect of their involvement in the crypto market is the tendency to short-sell. Short selling, a strategy employed to capitalize on an anticipated decline in a security’s price, can exacerbate market volatility and potentially lead to market manipulation. This aggressive trading strategy might deter the average investor from engaging in the crypto market, fearing substantial losses due to market manipulation.
The prevalence of short selling and other aggressive trading strategies by hedge funds could also distort the price discovery mechanism of cryptocurrencies, making it challenging for individual investors to ascertain the intrinsic value of crypto assets amidst the heightened market volatility.
Over-Professionalization of the Crypto Space:
Initially, the crypto market was a domain explored predominantly by private investors and individual traders. However, the incursion of hedge fund players and other institutional investors has led to the over-professionalization of this space. The influx of hedge funds has led to a problematic trend. 63% of the 150 most significant global crypto hedge funds were launched between 2018 and 2019, indicating a shift towards institutionalization.
This shift could alienate individual investors, making the crypto market less accessible and appealing to everyday investors. The original ethos of decentralization and individual empowerment that underpins the cryptocurrency space might be overshadowed by the institutionalization brought about by hedge fund involvement.
Regulatory Uncertainties and Reputational Risks
A traditional hedge fund faces many regulatory hurdles when venturing into the crypto space. As per a Forbes report, 82% of hedge funds cited regulatory uncertainty as a significant barrier, while 77% were concerned about client reactions or reputational risks. These regulatory ambiguities and the associated reputational risks might hinder the growth and global appeal of the cryptocurrency market5.
Moreover, the cautious stance of hedge funds, due to regulatory and reputational concerns, may signal to individual investors that the crypto market is fraught with legal and reputational hazards, thereby reducing its allure.
Conclusion: A Hedge Fund Isn’t Beneficial
It is worth noting a hedge fund, with its propensity for shorting markets, can create negative price pressures on cryptocurrencies. By actively shorting the crypto market, hedge funds contribute to price volatility. That can induce panic selling among retail investors. Overall, there are more downsides than upsides when these entities get involved.