How crypto funds shape the development of the digital asset market

A look at the role played by crypto funds in providing essential capital and liquidity, propelling the growth and expansion of the crypto market.

A crypto fund is an investment fund that primarily focuses on investing in cryptocurrencies or digital assets. It allows investors to gain exposure to the crypto market without having to purchase individual coins or tokens themselves. Instead, these funds pool money from multiple investors to purchase various cryptocurrencies, often including Bitcoin (BTC), Ether (ETH) and other popular tokens.

Crypto funds can also be categorized based on their investment strategies. For instance, some funds may invest exclusively in Bitcoin, while others may invest in a diverse range of cryptocurrencies or focus on investing in tokens that have promising underlying technology or are backed by established companies. Additionally, some funds invest in crypto-related companies like mining or trading firms.

Investors in crypto funds may include high-net-worth individuals, family offices, institutional investors and retail investors. Some crypto funds may have minimum investment requirements, while others may be open to smaller investors.

Rachid Ajaja, founder of decentralized finance (DeFi) platform AllianceBlock, told Cointelegraph, “Crypto funds are an important element of the crypto ecosystem. First and foremost, they provide stability for selected projects to continue building, no matter their market conditions.”

“They’re usually composed of industry veterans, so they know what trends to invest in to drive the most value for the sector. Their levels of investment and capital mean they can offer a more comprehensive level of risk management that otherwise could not be cultivated by individual traders.”

Crypto funds face unique risks, including the volatility of the crypto market, the potential for hacking or fraud, and regulatory uncertainty. To mitigate these risks, crypto funds may use various risk management strategies, such as diversification, hedging or holding cash reserves. Crypto funds are investment vehicles that expose investors to the crypto market.

How crypto funds shape the market

Crypto funds play a significant role in shaping the crypto market’s development. They are investment vehicles that expose investors to the crypto market by pooling money from multiple investors and using it to purchase a diverse range of cryptocurrencies. Crypto funds can be structured differently and employ various investment strategies and risk management techniques.

For example, the Asia-based crypto fund HashKey Capital is an institutional asset manager investing exclusively in blockchain technology and digital assets and has managed over $1 billion in client assets. Other notable crypto funds include a16z (Andreessen Horowitz), with over $4.5 billion in management; Polychain Capital, with $2 billion in management; and Coinbase Ventures, with a $6.6 billion portfolio.

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One of the primary ways crypto funds impact the market is by providing liquidity. They facilitate the buying and selling of cryptocurrencies, hence raising trade volumes and dampening volatility, both of which attract institutional investors. Additionally, crypto funds can drive demand for cryptocurrencies as they invest in these assets and help to create positive sentiment around them.

Deng Chao, CEO of digital asset investment group HashKey, told Cointelegraph, “Crypto funds can impact market liquidity in many ways. Firstly, by helping projects to scale and grow, crypto funds help take projects to a level where they have enough users and network effects to have more liquidity. Typically, better network effects equal better velocity, which equals more liquidity in the market.”

Chao continued, “Asset liquidity and VC investment are usually inversely related. VCs [venture capital firms] typically invest in illiquid startups with the hope that their growth will turn those investments into liquid assets. This is a form of liquidity/time arbitrage. Crypto VCs will handhold their portfolio projects until they have sufficient size and credibility so that other players — such as a corporation, private equity or crypto exchanges — can step in and provide additional liquidity.”

Ajaja added that funds can “create new efficiencies in the market. For example, Jump Trading influenced tighter bid-ask spreads and efficient price discovery and participated in arbitrage, making smaller price discrepancies across exchanges.”

“When funds trade derivatives and similar instruments on major platforms like BitMEX and Deribit or participate in DeFi platforms like Aave and Compound, the entire market’s liquidity rises for the tokens traded and adds to the market stability, which benefits everyone,” he said.

Crypto funds can also encourage innovation in the crypto market. By investing in tokens with promising underlying technology, they can support the development of new projects and technologies, ultimately benefiting the entire crypto ecosystem.

Another way crypto funds impact the market is by providing access to smaller investors. By pooling money from multiple investors, crypto funds can provide access to the crypto market for smaller investors who may not have the resources or expertise to invest in individual cryptocurrencies. This can help democratize crypto market access and increase its overall reach.

Finally, crypto funds can shape the regulatory landscape around cryptocurrencies. As they become more prevalent, they can help create a more structured regulatory framework for the market, increasing investor confidence and attracting more institutional investors.

Current legal challenges for crypto funds

Crypto funds face a range of regulatory challenges that stem from the unique characteristics of cryptocurrencies and the lack of a consistent regulatory framework across jurisdictions.

Many countries have yet to define a clear regulatory framework for cryptocurrencies, and those that have done so often have different and sometimes conflicting regulations. This can make it difficult for crypto funds to navigate the regulatory landscape and comply with local laws.

Ajaja said, “The main challenges faced by these crypto funds revolve around maintaining compliance in an ever-changing environment. It takes a proactive, concerted effort to ensure consistent compliance and active participation with these governing bodies that make the rules.”

“This relationship with the regulators is necessary to ensure that participation rules contribute to a growing, thriving crypto economy. These funds must focus on compliance with MiCA Regulation and FATF rules, even though it will create higher operational costs and more complex business processes. This regulatory environment is ever-changing, shifting with financial and political winds. Any funds should be approached with proactive and cooperative compliance with key bodies.”

However, compliance can be difficult for crypto funds due to the pseudonymous nature of cryptocurrencies. Funds may need to implement additional measures, such as blockchain analysis tools, to ensure they don’t fall afoul of regulations.

Chao noted, “Crypto-related technologies evolve at an extremely fast pace. Innovation in the crypto space always outpaces regulations. This ends up being a challenge from the regulatory perspective. However, regulators will sooner or later catch up and might regulate it a few years later in a friendly or hostile manner. Saying this, funds need to carefully consider how future regulations might look and how regulations might impact the market.”

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The tax treatment of crypto assets is another area of uncertainty for crypto funds. Different jurisdictions may have different tax treatments for cryptocurrencies, which can create compliance challenges for funds operating in multiple countries. Additionally, the taxation of crypto assets may be subject to change as regulators and tax authorities grapple with emerging technology.

Crypto funds play a crucial role in shaping the crypto market’s development. They provide liquidity, drive demand, encourage innovation, professionalize the market, provide access to smaller investors, and shape the regulatory landscape. As the crypto market evolves, crypto funds will likely become even more important in determining its future direction.