hedge fund

CRYPTOCURRENCY: Deciphering the $2.26B of Blockchain venture and the $3.39B raised via token offering projects in 2019 so far

According to reports by Inwara and the Crypto Valley Association, as many as 583 token offerings were launched during the first half of 2019, raising a total of $3.39 billion, whilst traditional venture funding into Blockchain-first companies raised $2.26 billion. We think the token offering figure is inflated despite our attempts at scrubbing it, and reserve the right to revise. Quality of the data continues to decline, and several projects self-reported raises in 2019 are suspicious. If anything, our intuition is that real (rather than aspirationally self-reported) ICO funding is below the venture number. 

Let's break down the token offering figure. The $3.39B is made up of 69% Initial Coin offerings (ICOs), 21% Initial Exchange Offerings (IEOs), and 10% Security Token Offerings (STOs) -- see figure below for the distinction between them. Projects stemming from China raised the lion's share ($1.18 billion or 33.2%) of the total, helped by Hong Kong based Bitfinex's $1 billion IEO raise. The USA, trailed behind China raising $255 million or 7.6% -- supported by Algorand's $122 million. Trading and investing (including crypto exchanges) has been the vertical receiving the majority of investor attention with $1.25 billion raised, and core Blockchain projects following within $338 million.

Unsurprisingly, the rise of regulator "friendly" IEOs and financial services "friendly" STOs, has meant that the number of ICO projects have declined 74% to a mere 403 in the last year. IEOs have grown from 6000% to 123 projects, and STOs 16% to 57 projects. The growth of IEOs and STOs "emphasizes a higher degree of institutionalization of large crypto exchanges around the world as cornerstones of the global Crypto Finance infrastructure – and may also be seen as a response to established exchanges moving into crypto".

So is this enough to maintain a consistent growth trajectory for the crypto industry as a whole? Hard to say, but it seems that tokenizing securities tied to real estate, and repackaged ICOs sold via exchanges may or may not result in better capital markets infrastructure, democratization and roboadvisor-led asset allocation. And second, the crypto economy needs non-financial activity to succeed. People should be building software using the global decentralized computer of Ethereum (or R3 Corda or Dfinity or soon-to-be-launched Calibra) and paying for it using the global decentralized currency Bitcoin. More crowdfunding ain't that.

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Source: Crypto Valley & PWC (5th ICO/STO Report), Inwara (Half-Yearly Report H1 2019)

CRYPTO: 80% Down, Ethereum and Crypto Fund Performance.

Ether, the second largest cryptocurrency by marketcap and enabler of $20+ billion of ICO issuance, got beat up quite conclusively this week. At one point, it was down over 82% off the year's high, recovering to 78% off the year's high. Yeesh, for anyone who wants this Crypto thing to do well. And for many, Ether's fall is confusing because (1) the number of developers building on top of the platform is increasing, (2) the number of ICOs on the platform has not meaningfully slowed down, (3) ConsenSys has dozens of enterprise and public projects that move the ecosystem along, and (4) it has a first mover advantage. The underlying qualities of the systems are, in theory, better than same time last year.

One driver is the negative sentiment in the Crypto fund community. We point you to the sources below, particularly a Tetras Capital paper that uses the store of value / money velocity argument to short Ether, and a strong-willed rant from the CEO of a crypto derivative exchange about the weak hands of Venture investors entering the trading game. While we agree that sentiment is a major driver, especially as funds buy and sell together, we disagree with the money velocity arguments. However, the ICO phenomenon did hurt Ether's function as currency. To use a project on the Ethereum platform, users have to buy and pay with a third party token that was issued primarily for fundraising. They don't use ETH to pay for the service. This in turn makes ETH less versatile, and less useful as a unit of account or medium of exchange. And second, ICOs that have raised ETH as their currency of choice have to sell it to fund operations.

Sure -- Ethereum could have scaled faster, traditional banks could have opened their doors instead of putting up regulatory walls, the SEC could have approved an ETF earlier. But investor sentiment now seems to disregard the steady and positive contributions by developers and entrepreneurs. Maybe this is because most of the 370+ crypto funds formed at the middle of last year, and missed out on the early boom. Looking at the self-reported performance of some funds in our database shows the extent of the damage. We have two samples: July 31st and April 30th. In each case, we compare them to the BITA 50 index, which tracks the top 50 liquid coins. The first chart shows both the returns and the index, the second chart just shows the difference. The reported outperformance averages around 20%. Given the BITA 50 index is now down about 70%, we expect that most crypto funds are at least 50% underwater for this year. No wonder so many are rushing to hedge through shorting.

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REGULATION: Crypto Funds, RIAs, Regulations in a Box

The cost of launching a startup has fallen from a few million to a few thousand dollars. Why? Amazon and its cloud have collapsed the needed IT infrastructure to a cheap off-the-shelf subscription. Stripe Atlas has made corporate and payments gateway setup a breeze. But what if you're starting a financial entity, and not a software company? What if you're starting a Registered Investment Advisor, and not a wealth tech platform, or if you're starting a hedge fund offering a crypto index, and not a blockchain of blockchains? For that, let's take a look at compliance in a box. 

One of our favorite companies in the independent wealth management space is RIA in a Box. It does what it sounds like -- it sets up a Registered Investment Advisor entity, registers it with the SEC and the appropriate States, and manages ongoing compliance requirements as an affordable service. So if your advisory practice manages $5 million or $500 million, this solution can get you started. In fact, out of 12,000 RIA firms in the US, RIA in a Box has 3,000 as clients. Not surprisingly, Aqualine Capital Partners just acquired the firm through an LBO at an undisclosed price, which tells us that the firm is a cash cow -- an LBO requires a slug of debt that can be serviced by reliable, steady cashflow. And if you control the compliance reporting aspect of a financial entity, it's a very short reach to start selling regulatory, administrative and value-add software.

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Now think about crypto funds. It's the same problem -- nobody has any idea how to structure them, which regulatory jurisdiction to pick, what bank to use, or how crypto assets are treated. Traditional counsel could easily cost over $100,000 to go through the motions. Enter the Crypto Fund-in-a-box companies! Take Vauban, which provides an interface to select a type of investment fund, its jurisdiction, target size at launch, while a real-time entity structure is built on screen indicating the cost of setup. Other similar plays include Fundplatform, Otonomous, and Bluemeg (note: we don't know or endorse any of these). Could the ease of solving this international puzzle lead to a similar growth outcome for crypto fund entities? Looking at the data, the first 5 months of 2017 saw 40 new crypto funds; there were 45 new entrants over the same period in 2018. Market volatility has not deterred fund formation. That doesn't mean funds won't fail (e.g., Apex Token Fund shutting down after failing to raise $25mm), but it does mean more will keep trying if it's as easy as clicking a button.

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Source: RIABiz (RIA in a box), Crypto Fund in a Box (VaubanFundplatformOtonomousBlueMeg), Financial Planning (RIA totals), Autonomous NEXT (Crypto Fund totals), Stripe Atlas

CROWDFUNDING: Jan 2018 Initial Coin Offering and Crypto Fund Numbers

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2018 is off to a bumpy start for the trading of large cap crypto assets. But we hold the view that pricing accuracy of $100B+ tokens isn't particularly meaningful for the technology progress in the space. It measures sentiment, which perhaps reflexively prices the market, but isn't all that helpful for figuring out what's happening in the world. On the other hand, the flow of resources -- from capital, to human, to corporate -- indicates something more real. When people choose a new way or a new product, the super structure may change. 

We updated our ICO and crypto fund data as of Jan 2018. The first finding is that ICO funding, which is a metric for the early stage entrepreneurship in the space (like Angel and Series A funding), is looking quite healthy. 2017 ended with $5.4B of ICO proceeds going to projects raising over $1mm+, and the one month of January already has $1.4B in flows. That doesn't include either Telegram's $1B+ planned ICO, or Overstock's $250-500mm raise, so we expect this level to continue through the year.  It may be harder for an individual ICO to raise capital given higher standards and competition, so in that sense, the market is equilibriating with the Venture Capital market. Vesting schedules, performance targets and covenants are becoming standard as the early crypto funds are joined by mega venture like Andreessen. Traditional early stage investors are writing equity checks into blockchain companies, but those numbers are less than 20% of the overall equation.

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Coindesk makes the point that in Ethereum terms, actually the funding levels are fairly stable and not increasing. From our view, that's the whole point! The crypto Cambrian explosion was driven by capital gains in Bitcoin relative to fiat. Of course people are taking risk at the edges, using their winnings to fund more work. But there is indeed some danger that if the smart token platforms collapse in value, ICOs will have less purchasing power and thus facilitate less development. This is a real risk. And given that an increasingly large proportion of the ICO proceeds are funding utility tokens (magenta in the graph) and fewer platforms/currencies, actual economic activity within the apps has to appear for investment value to exist. 

The second data point is that the number of funds continues to grow. We point to crypto capital markets volatility as a positive for the plethora of trading, quant and index funds entering the market. In total, we are tracking 225 crypto funds across 7 strategy types (hey there Salt's credit fund), and see assets in the space being between $3.5 billion and $5 billion. The diversification of strategies point to an earlier observation that crypto has collapsed all asset classes into software, putting hedge fund managers and venture investors into the same exchange. No wonder there's pandemonium.

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BLOCKCHAIN: How to Set Up a Crypto Fund

We don't do this often, but we'd like to give a major shout-out to HFM Week by summarizing their excellent webinar on Demystifying Cryptocurrency: Best practices for trading digital assets. Go listen to the replay now -- featuring a crypto focused lawyer, a crypto hedge fund operator,a CPA who audits crypto funds, and the president of Gemini Hedge Fund Services, which provides back-office support to hedge funds (can you tell we love financial infrastructure). So how similar or different are crypto vs. conventional fiat hedge funds?  

In many ways similar. First, human psychology is always the driving force in the markets, which we’re seeing it play out “in overdrive” right now. Second, when setting up a crypto fund, as with a fiat fund, service provider diligence is key. Find an auditor, attorney, and other partners who truly understand crypto. The market for such providers is expanding dramatically, and there are too many faux "experts". As with any investment fund, carefully describing the fund’s strategy and paying close attention to disclosures (and making sure they evolve with the asset class) is paramount. Tax considerations are similar to those for fiat funds, at least in the US. Fee structure is also shaping up to be similar, with a 2/20 structure becoming most common. On liquidity, many crypto funds are aiming to be fairly liquid with side-pockets for investing in less liquid assets. As a side note, we know that about a third of the funds are traders, a third are venture investors, and the rest are indexes and quants.
 
As far as differences, the main one is that crypto has yet to find a formal custodian mechanism. The few attempts out there are small and not suitable for a large market. This is a problem that will need to be solved, especially if the instruments are deemed securities, as it makes a fund unable to comply with the custody rule. Following on this, how can an auditor verify the existence of assets without a reputable custodian? Blockchain-based transactions allow for transparency and record but not necessarily validation of control (although there are third-party confirmation of wallet services that are helping solve this problem). Solutions to these problems are evolving, and it’s reminiscent of the 1994 internet, which also created questions around accounting and auditing.  

Some of the other outstanding questions without answers: (1) Tax treatment: Crypto currency is treated as property by the IRS (so if you sell, you incur a capital gain or loss). But if you use crypto to buy into crypto denominated share class and never touch fiat, what is the tax treatment? (2) What type of insurance is available for the sector? Right now, there’s no mass market product. (3) With no central clearing of pricing, how should mark to market be handled? (4) When does an ICO have market depth to be priced and to be marked to market? And the question we have is how long do these funds have in the market before ICOs are heavily regulated and a large asset manager vacuums up assets with an ETF!

BLOCKCHAIN: Rise of Crypto Capital

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An alien spaceship has landed on Earth. Its technology is superior to ours. Its pilots speak a different language. Do we fire our regulatory weapons at it? Do we build bridges and find ways to adopt its technology? Do we berate it for being alien? Or do we think it is a hoax, operated by some Wizard of Oz behind the curtain? Such is the entry of the crypto economy into our financial system. We have been tracking closely the response of the financial industry, and to many participants (120 crypto funds in fact), this spaceship is a savior that helps them ascend to another plane (i.e., not be destroyed by passive ETF roboadvisors).

Financial infrastructure is maturing. First data point is LedgerX, an institutional derivatives platform for crypto currencies regulated by the U.S. Commodity Futures Trading Commission that has completed swaps and option trades with exposure over $1 billion in a single weekCBOE and Gemini will do the same. Second data point is Overstock and its announced ICO for tZero, an alternative trading system approved by the SEC, leading to 150% appreciation in its public equity. Remember also the planned $50mm IPO for NexBlock Global, the Tapscotts' liquid venture crypto fund. Third point is Airswap, the decentralized exchange ICO coming out of ConsenSys that has just raised $36 million to move trading from a central counter party to smart contracts themselves. There are other decentralized efforts as well. And last, CoinList has officially sprouted out of AngelList and will champion the SAFT Agreement and crypto as venture capital, rather than day trading.

The work is of course not done. One open question is how to build traditional FIX connectivity into the new ecosystem and plug it into existing trading workflows. The lack of such infrastructure means plenty of room for automated arbitrage bots and dedicated AI/Quant crypto funds, of which there are at least 13. Exchange regulation and common data standards are yet to evolve, and projects like Messari will lay the groundwork for open-source financial data. Valuation frameworks are still speculative, but thinking from VitalikBrendan BernsteinEvan Van Ness, and Chris Burniske help move the conversation forward.

CRYPTO: How Many Crypto-Hedge Funds Can You Count?

Source: Autonomous NEXT

Source: Autonomous NEXT

As the cryptocurrency asset class becomes more mainstream, a financial services ecosystem is sprouting around tokens. Like wild mushrooms, crypto hedge funds have been taking root in the volatile and unregulated soil of the crypto economy. So we went digging, and digging and digging. With the help of our friends at Token Economy (also with shout-outs to Forbes and Daily Fintech), we have put together the list of currently-known crypto investors as of end of August 2017. 

There are generally three types of funds. The first comes in a traditional regulated hedge fund structure which happens to be buying up cryptocurrencies. Think macro or technical Wall Street traders. Second, there are early-stage funds that look like liquid venture capital. They target pre-ICO investments through community access, and can then quickly make a return once the token is trading. And last, we see a number of funds using the ICO structure itself to create decentralized investment management products (i.e., indexes, baskets, ICOs of ICOs). Good luck claiming that's not an investment contract to the SEC! There's a fourth kind of fund as well, but we'll leave that to next issue. 

Here are the 55 entities we found, with links to their websites, and below is a fun infographic we've put together on the space. Spread the word, and tell us if we've got it wrong, or are missing any names.

(1) 1confirmation, (2) Alpha Bit, (3) Alphabet Coin Fund, (4) Auryn Capital, (5) BKCM Digital Asset Fund, (6) Blackmoon Crypto, (7) Bletchley Park Asset Management, (8) Block View Capital, (9) Blockchain Capital, (10) BlockStack, (11) BlockTower Capital, (12) Blueyard, (13) CoinFund LLC, (14) Coinshares 1 LP / Global Advisors, (15) Crypto Asset Fund, (16) Crypto Assets Fund, (17) Crypto Fund AG, (18) Crypto Lotus, (19) Cryptochain Capital, (20) Cryptocurrency Fund LLP, (21) Cryptor Trust, (22) Cyber Capital, (23) Digital Developers Fund, (24) Ether Capital, (25) Exagon Fund, (26) FBG Capital, (27) Fenbushi, (28) Firstchain Capital, (29) General Crypto, (30) Grasshopper Capital, (31) Hyperchain Capital, (32) ICONOMI, (33) Iterative Instinct, (34) Kenetic Capital, (35) Logos Fund, (36) Medici Crypto, (37) Metastable, (38) Monkey Capital, (39) Multicoin Capital, (40) Pantera, (41) Placeholder Capital, (42) Pollinate Capital, (43) Polychain, (44) Rich Fund, (45) Satoshi Fund, (46) Science Inc., (47) Solidus Capital, (48) Soros Fund Management, (49) SuperBloom, (50) TAAS Fund, (51) Tezos, (52) The Token Fund, (53) Token Factory, (54) Unit Fund, (55) Venture One

*** Update for new funds that have reached out to us to be included:

(56) Base58, (57) Bitfin Capital, (58) Blackchain , (59) Blockweather , (60) CryptoLifeCapital, (61) Iterative Capital, (62) Kryptonite1 PLC, (63) MTDigital Assets, (64) NextBlock Global, (65) Protos Cryptocurrency Asset Management, (66) Shuttle Fund, (67) The Crypto Fund, (68) Vergio

*** Update for new funds once more:

(69) Alternative Money Fund LP, (70) Astronaut Capital, (71) BitSpread, (72) Galaxy Digital Assets Fund , (73) Mutual Coin Fund, (74) PlaceholderVC, (75) Swarm Fund, (76) Cypher Capital

*** We maintain an ongoing list for journalists, investors and clients. Please see the following page regarding the full list.