This is how crypto hedge funds miscalculated

Travis Kling was brimming with self-confidence three years ago when he spoke about the prospects for the crypto market in an interview with US TV broadcaster CNN. Bitcoin is the “hardest currency in human history” and a hedge against “the monetary and fiscal irresponsibility of central banks and governments,” he said, quoting from the Old Testament during the conversation. Kling founded the crypto hedge fund Ikigai Asset Management a year earlier, at a time when countless such funds were springing up.

On Monday a week ago, there was nothing left of Kling’s self-confidence and his customers’ money. “Unfortunately, I have some pretty bad news to share,” the Ikigai founder wrote on his Twitter account.

Kling’s crypto hedge fund lost access to most of its investor funds in the wake of the bankruptcy of FTX, one of the world’s largest cryptocurrency exchanges. An attempt was made to withdraw funds from FTX after the panic broke out in the market, but got “very little” out of it. “Now we’re stuck with everyone else,” he wrote in a tweet.

High-risk investment strategies for wealthy investors

Ikigai is one of numerous crypto hedge funds that have posted huge losses in the wake of the FTX collapse. Experts are assuming a total of billions.

There are several hundred such investment vehicles worldwide. Their goal is to get the maximum return from the already risky crypto market with complex and at the same time high-risk trades. The strategies range from investments in newly created cryptocurrencies, taking advantage of price volatility to arbitrage transactions. The risks of such transactions are considered high, even compared to traditional hedge funds.

The crypto hedge funds are accessible to investors willing to invest hundreds of thousands if not millions of dollars. According to a survey by the consulting firm PwC from spring 2022, very wealthy private individuals (“high net worth individuals”) and so-called family offices are among the most important customers of crypto funds. They pay operators a management fee averaging 2 percent and, if successful, a performance fee averaging 20 percent; The latter represents an incentive for the fund operator to achieve as much return as possible.

As long as key interest rates were low and the prices of Bitcoin and other cryptocurrencies were rising, this strategy worked well. With the onset of the crypto winter since the beginning of the year, i.e. the price collapse of many crypto currencies, and the bankruptcy of FTX, many crypto hedge funds are facing difficult times.

Industry service Crypto Fund Research estimates that 25 to 40 percent of crypto hedge funds and crypto venture capital funds are directly impacted by FTX’s demise. “Some funds had only very modest exposure, while others kept a large part of the assets in the stock market.” On average, it is about 7 to 12 percent of the assets under management.

A case with high losses is Galois Capital: As the “Financial Times” recently reported, around half of all assets under management of the crypto hedge fund, estimated at 100 million dollars, are blocked on FTX. Galois co-founder Kevin Zhou wrote in a letter to investors that it would take years to recover a certain percentage of the assets.

But fund operators who did not do business via FTX are also likely to be sucked into the debacle: the defunct stock exchange was linked to companies worldwide that are now facing bankruptcy themselves as a result of the collapse. Added to this are the increased losses in value of Bitcoin and other cryptocurrencies as a result of the FTX debacle.

Optimism still prevailed at the beginning of the year

Only at the beginning of the year did the operators of the hedge funds surveyed by PwC show optimism that the crypto boom would continue even after the interest rate turnaround. All respondents indicated that the price of Bitcoin will be higher by the end of the year than at the time of the survey ($40,000). The fund managers expected a median bitcoin price of $75,000. In fact, it’s currently $16,000.

Crypto hedge fund investors seem to have had enough for now: Crypto Fund Research expects them to withdraw a record $2 billion from the funds over the next few months.

Ikigai founder Kling wrote in his Twitter thread that he still doesn’t know how his company will continue. He was at a loss for words given the “dung heap” permeating the crypto economy. “So many damn sociopaths have been given the opportunity to do so much harm. It’s hard for me to imagine that the industry will recover quickly from this. Too many have burned themselves too badly.”