Since the market downturn in March 2020, hedge funds have increasingly entered the cryptocurrency space in search of profit. Firms like Galaxy Capital, Grayscale, and Pantera now dominate the crypto hedge fund market, collectively managing approximately $60 billion in assets. Their clients seek exposure to Bitcoin and Ethereum without directly purchasing or holding these cryptocurrencies.
With Bitcoin’s price doubling over the past 12 months, this trend is hardly surprising. More notably, the behavior of these institutional investors is altering the crypto landscape. While many early adopters viewed buying crypto as a way to support favored ecosystems and benefit from price appreciation, hedge funds operate with a clear profit motive—without sentimental attachment to any particular asset.
According to Eurekahedge, crypto hedge funds achieved returns of 116.8% in the first quarter of 2021, outperforming Bitcoin’s 104.2% gain. How did they do it? By placing bets—and in some cases, driving downward price movements—to profit from market volatility. As these funds grow in size, so does their ability to influence relatively small markets in terms of circulating supply.
What Are Crypto Hedge Funds?
While most retail traders invest their own money based on Bitcoin price predictions, hedge funds operate differently. They are asset managers catering to ultra-high-net-worth individuals and institutional investors. To invest in a hedge fund, one typically needs a net worth of at least $1 million (excluding primary residence) and an annual income of around $300,000—though exact requirements vary by jurisdiction.
Fund managers then have full autonomy over investment decisions. A famous example is Michael Burry, the hedge fund manager portrayed by Christian Bale in The Big Short, who bet $1 billion against the housing market. Although his gamble paid off, his investors had little power to intervene.
Unlike mutual funds, which are regulated by the SEC and subject to investment restrictions and reporting requirements, hedge funds enjoy greater freedom in their strategies. This flexibility allows them to engage in unrestricted trading—and an increasing number of managers like Burry are now entering the crypto space.
It’s important to distinguish crypto hedge funds from other financial entities, such as Grayscale’s Bitcoin Trust. The latter offers a digital currency investment product that individual investors can buy and sell through brokerage accounts. It is registered with the SEC and complies with regulatory reporting. Pure hedge funds, by contrast, operate with minimal regulatory oversight and are considered high-risk, high-reward investment vehicles.
Lyxor Asset Management notes that as more hedge fund managers embrace digital assets, simple long positions in Bitcoin, Ethereum, or Ripple are giving way to sophisticated strategies. These include crypto-indexed swaps, futures, options, and bets on revenue generated by blockchain technology. This increasing complexity is transforming the crypto market.
Types of Crypto Hedge Fund Investors
The composition of hedge funds highlights their varied approaches and objectives when entering the market. According to a PwC report, crypto hedge funds break down as follows:
- Quantitative (48%) – Funds using automated trading rules rather than human analysis.
- Discretionary Long-Only (19%) – Long-term investments based on belief in price appreciation.
- Discretionary Long/Short (17%) – Strategies that allow funds to take both long and short positions depending on market conditions.
- Multi-Strategy (17%) – A combination of the above.
Among these funds, the vast majority trade Bitcoin (97%), followed by Ethereum (67%), XRP (38%), Litecoin (38%), Bitcoin Cash (31%), and EOS (25%).
About half of all crypto hedge funds engage in derivatives trading (56%) or active short selling (48%). Derivatives enable traders to speculate on future price movements without owning the underlying asset, while short sellers intentionally bet on price declines.
Why Volatility Attracts Hedge Funds
Bitcoin’s volatility—a measure of how much its price fluctuates—hovered around 2.5% for much of 2020. During the bull market, however, it climbed to as high as 6% in March and April this year.
Raoul Pal, a former Goldman Sachs hedge fund manager, observes: “Without that volatility, you couldn’t have a 230% compound annual return. In this context, volatility is your friend.”
This volatility is precisely what attracts risk-hungry hedge funds, which thrive on market turbulence.
Bitcoin demand is largely speculative and sentiment-driven, rather than based on fundamentals like everyday adoption as a payment method. Moreover, supply can be artificially constrained beyond algorithmic limits.
This dynamic has drawn major players into the market. Brevan Howard, one of Europe’s largest hedge funds, recently announced it would allocate a portion of its $5.6 billion fund to Bitcoin. It joins firms like Galaxy Digital and Tudor Investment Corp, which have quietly acquired billions of dollars in Bitcoin, effectively tightening supply.
Research firm Chainalysis estimates that 60% of Bitcoin’s supply is being hoarded, while 20% is lost or inaccessible.
Glassnode reports that this squeeze is intensifying as more hedge funds enter the market. The tighter the supply, the easier it is to move prices—and hedge funds are well aware of this.
Dan Morehead, CEO of Pantera Capital—the first U.S. Bitcoin hedge fund—wrote in an investor note: “Cryptocurrencies are beginning to trade independently of other assets. When most asset classes fell, cryptocurrencies rose… Would you rather have your savings in Lehman Brothers in 2020, or in tokens you control?”
How Hedge Funds Profit from Market Making
Thanks to this volatility, hedge funds have leveraged their positions to create new revenue opportunities—most notably by acting as market makers. Here’s how it works:
Hedge funds look for discrepancies between the spot price (current market price) of an asset like Bitcoin and the value of derivative contracts expiring months later. This is known as basis trading. For example, at the time of writing, Bitcoin’s price is around $55,000. Yet some futures contracts, such as those offered by CME Group, predict a price of $60,000 by July.
A hedge fund can buy Bitcoin at the spot price and sell July futures, meaning the derivative contract gains value if Bitcoin falls. This creates a “spread” between today’s price and tomorrow’s bet. When these gaps widen over time, they can generate substantial returns.
This strategy is now spreading to Ethereum, driving its price to new highs this month thanks to investors achieving returns as high as 700% using similar methods.
However, these activities are not without risk. If a market maker faces a margin call, the game can unravel quickly—as seen in traditional markets when Archegos, managed by Bill Hwang, collapsed and caused billions in losses for major banks like Credit Suisse.
With Bitcoin’s volatility on the rise, the question remains whether cryptocurrencies can sustain the risk appetite of hedge funds.
Frequently Asked Questions
What is a crypto hedge fund?
A crypto hedge fund is an investment vehicle that pools capital from high-net-worth individuals and institutions to trade cryptocurrencies. These funds employ various strategies—including quantitative analysis, long/short positions, and derivatives trading—to generate returns regardless of market direction.
How do hedge funds influence crypto prices?
Hedge funds can impact prices through large-volume trades, short selling, and derivatives activity. By hoarding supply or placing coordinated bets, they can amplify volatility and create momentum in either direction.
Are crypto hedge funds regulated?
Most crypto hedge funds operate with less regulatory oversight than traditional investment funds. However, they still must comply with anti-fraud and securities laws in their operating jurisdictions.
What are the risks of investing in crypto hedge funds?
Risks include extreme volatility, regulatory uncertainty, counterparty risk, and the potential for significant losses. These funds are suitable only for investors who can bear substantial financial risk.
How can I gain exposure to crypto without buying directly?
Besides hedge funds, investors can use regulated products like Bitcoin trusts, futures contracts, or ETFs—where available—to gain indirect exposure to cryptocurrency price movements.
Why is volatility important for hedge funds?
Volatility creates trading opportunities and price disparities that hedge funds exploit for profit. In calm markets, it is harder to generate alpha, but crypto’s inherent volatility offers fertile ground for sophisticated strategies.
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