Hedge funds structures don’t work in crypto

In January earlier this year, 11 of the world’s biggest asset managers entered the crypto space, mostly through Bitcoin (BTC) exchange-traded funds. This opened up billions of dollars of new money from institutional investors who had previously hesitated to invest. As they got into the crypto space, many of these asset managers found that their tried and true methods, developed in traditional markets, didn’t work as well in this market.

How hedge funds work

With their regulated offshore structures and established auditing procedures, hedge funds work for traditional assets. They provide investors with a sophisticated and secure framework to generate alpha (returns above the market) through various strategies. However, when applied to the crypto markets, several fundamental issues arise.

First of all, offshore structures don’t match crypto’s regulatory environment. Traditional hedge funds are often based offshore, where regulatory scrutiny is less intense, allowing for more flexibility in investment strategies. However, in the crypto market, assets traded through these funds must be sent to unregulated exchanges. This is a considerable risk, as funds are moved into environments with no oversight like traditional markets. In other words, the hedge fund wrapper is more cosmetic than functional in crypto; it is just a thin layer of security.

Another problem with hedge funds is their lack of timely reporting. Most hedge funds provide performance data only after their monthly or quarterly audits are completed, which is 45 days after the fact. In the fast-paced crypto markets where prices can move 10% in hours, this is unacceptable. 

By the time investors get the results of a trade, the market conditions that caused those results may have changed entirely. To put it in perspective, applying this delay to traditional markets like Nasdaq would be like waiting five months for performance results. In a volatile market, this is impossible.

Hedge funds also move slower; unlike traditional markets with defined trading hours, the crypto market is open 24/7. This requires constant monitoring and quick decision-making. With their slower pace and periodic reporting structures, hedge funds are not designed for this environment. Crypto native traders who are used to this can adapt to market changes quickly. Traditional hedge fund managers can’t keep up with the more volatile and faster-paced crypto market.

The SMA solution: Custom, clear, and timely

Separately managed accounts, or SMAs, could be a more suitable alternative to hedge funds for crypto investments. Unlike hedge funds, SMAs give users direct ownership of assets, real-time reporting, and a custom approach to investment management that is more aligned with how the crypto market works.

One of the main benefits of SMAs is that you own the underlying assets directly, unlike hedge funds, where assets are pooled and commingled. With SMAs, there is no commingling of funds—each account is traded as a separate entity, so you can see exactly where your money is and how it’s performing at any given time. This level of transparency is especially important in the crypto market, where fraud and mismanagement are always a concern.

Additionally, SMAs offer real-time reporting. Since each account is managed separately, investors can get minute-by-minute data on their portfolio’s performance. This is a big advantage over hedge funds, where performance reports are often weeks or months behind the actual market activity.

The ability to use bespoke investment strategies is another benefit of SMA’s. Unlike the one-size-fits-all approach of hedge funds, SMAs allow investment managers to customize strategies to each client’s specific needs and risk tolerance. This is especially important in the volatile and ever-changing crypto market, where the ability to adjust strategies quickly can mean the difference between profit and loss.

Institutional investors benefit the most from SMAs’ flexibility. For example, SMAs allow for tax optimization strategies like tax-loss harvesting, which can be especially useful given the volatility of crypto assets. SMAs also allow for asset diversification within the crypto space, so investors can build bespoke portfolios that align with their overall financial goals.

Being able to trade at any time and keep your assets safe without leaving them in the hands of a third party also creates a strong case for using SMA’s. SMAs are well suited to crypto trading, giving institutional investors the flexibility and speed they need to navigate this continuous trading environment. This is a big difference from traditional finance hedge funds, which are limited by market hours and the delays associated with quarterly audits and reports.

Off-exchange settlements are another reason to like SMAs in crypto. Eighteen months ago, off-exchange settlements didn’t exist. Now, companies like BitGo, Zodia, Fireblocks, and Copper.co are filling this gap. Copper.co was the first to offer a secure off-exchange settlement service, which allows institutions to trade without exposing their assets to unregulated exchanges. These services add an extra layer of security so assets remain in cold storage with regulated custodians.

Interestingly, each of these companies does things differently. Copper.co is all about trust in their platform, Zodia is trust based custody who allow all assets to be held in trust for the client significantly mitigating counterparty risk. Fireblocks has been criticized for pooling client funds into one account, so you can’t track individual assets. However, the rise of off-exchange settlements shows the importance of transparency and security in crypto—two of the core principles of the SMA model.

SMAs are the future of institutional crypto investments

Regulation is also moving in favor of SMAs over hedge funds. For example, Singapore’s Monetary Authority introduced new rules requiring crypto exchanges to hold customer funds in a trust, a move to protect assets and investors after the FTX collapse. MAS is also banning staking and lending for retail investors and allowing it for institutional investors. This move towards more regulation and investor protection is in line with the SMA model, which is all about transparency, security, and individualized management.

Additionally, when FTX collapsed in 2022, investors across the globe were left scrambling, but in Japan, the story was a little different. Unlike other regions, FTX Japan’s users are getting their funds back. Why? Because Japan insisted on a specific regulation that required crypto exchanges to keep customer assets in separate accounts—exactly the kind of safeguard that aligns with how SMAs work.

The way it works is that, in Japan, exchanges had to segregate customer deposits and store them with a third-party bank or trust. This prevented the commingling of customer and business funds, a problem that contributed heavily to FTX’s downfall elsewhere. It’s the same idea behind SMAs—investors maintain direct ownership of their assets, and those assets aren’t pooled together with everyone else’s, making it way harder for something shady or careless to happen​.

So, while FTX’s global customers are still fighting to recover their investments, Japanese investors are already seeing their funds returned. This isn’t just a coincidence—it’s a clear example of how the right regulations, similar to the principles in SMAs, can offer a huge layer of protection. If more places adopt this approach, we could avoid another FTX-style meltdown in the future.

Hedge fund structures may have worked for traditional assets but are increasingly out of sync with crypto. Delayed reporting, offshore structures, and 24/7 trading make hedge funds a bad fit for crypto. SMAs offer a bespoke, transparent, and timely solution for modern institutional investors. SMAs will soon be the investment vehicle of choice for institutions looking to acquire digital assets. Direct ownership, real-time reporting, and bespoke strategies.