Get Ready For Mass Shutdowns Of Crypto Hedge Funds - Morgan Creek's CEO

The co-founder of Morgan Creek explains why many crypto hedge funds might close down at the end of 2018.

On Monday, November 19, Anthony Pompliano, co-founder of Morgan Creek Digital, published a blog post warning that we might witness a wave of cryptocurrency hedge funds shutdowns at the end of 2018. He argues that numerous crypto-related businesses are in big trouble and that pretty soon they might close their doors as a result of this year's dramatic price collapse.

The current digital assets bear market has been taking a heavy toll on many crypto businesses, including hedge funds and ICOs, and poses further serious risks to them, according to Pompliano, a highly respected person in the crypto space. Ironically enough, a good many of crypto hedge funds might shut down at the end of 2018 not because they haven't made enough money but because they had made too much money earlier.

This is due to the so-called issue of high water mark (HWM), Pompliano explains further. Apart from regular small management fees charged for administering and trading investors' funds, fund managers also receive an incentive fee, which depends on their performance.

As a rule, it is calculated at the end of the year and amounts to about 20% of the profits generated by the fund. However, there is an HWM rule stipulating that managers only can receive their incentive fee if the net asset value of the fund is higher than its highest value in previous investment periods.

This is why fund managers are about to face a big challenge. Last year was really good for the crypto market considering the stunning bull run, with Bitcoin rallying from under $1,000 to over $20,000. This allowed crypto managers to increase their funds’ worth and benefit greatly. However, this lucrative investment period ended in December 2017, which turned to be the top of the bull market.

"We have seen 50-80% decreases in net asset values in some funds since then. This means these fund managers will not receive a performance fee in 2018, which drastically reduces the income of the individual manager", Pompliano says.

This year, against the backdrop of the sustained bear market, it will be absolutely impossible for hedge funds to enhance their last year's performance, and managers won't meet the HWM criteria.

As a result, they might prefer just to close down and return money to investors. Moreover, Pompliano adds, they might prefer to stay on the sidelines for the coming months because, according to his estimates, they won't be able to achieve the desired levels of profits until at least 2020 or even longer.

These mass shutdowns might happen in December when frustrated fund managers will realize they have been deprived of the lion's share of their compensation, Pompliano suggests adding that "many of the managers are young/inexperienced and they won't realize the issue until they don't receive their performance fee for 2018."

He goes on to say that similar problems have been brewing in the ICO projects segment, which was booming last year. However, it might also face some devastating consequences of the crypto assets' price crash coupled with a regulatory crackdown. 

"Regulators require teams to issues refunds to investors (if the investors would like one), at the US dollar price when the investor invested… Normally this wouldn't be a big problem, except crypto prices are down 50-90% since the all-time high. It is unlikely that an ICO project has enough funds, based in US dollars, to pay investors back… The only options they have is to raise more capital (unlikely) or declare bankruptcy," Pompliano explains.

Anyway, he concludes, such periods of bear markets should be considered as an excellent way to get rid of idle "tourists," which only makes room for genuine professionals building long-standing values.

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