Noelle Acheson is a 10-year veteran of company analysis, corporate finance and fund management, and is a member of CoinDesk’s product team.
The following article originally appeared in CoinDesk Weekly, a custom-curated newsletter delivered every Sunday, exclusively to our subscribers.
The concept of using blockchain technology to retool the hedge fund industry is gaining traction.
At least that’s the message conveyed in a report CoinDesk published last week on Melonport. The startup’s idea is to counter the high costs and onerous requirements of hedge funds, and make it easier to set up and manage portfolios.
Melonport is not alone. Several companies are taking a run at this space, from a range of angles. Some focus on the underlying platform; others focus on the returns, offering access to a managed selection of digital assets. Most seem to regard the hedge fund industry as their target.
But, I would argue the real target is elsewhere.
On the surface, blockchains and hedge funds seem made for each other. Setting up a hedge fund is expensive, not just because of the upfront legal and administrative costs, but also because of the amount of money needed to break even ($300m is considered ‘small’).
Furthermore, that amount is increasing, as rising regulatory costs, pressure on fees and lackluster performance are encouraging a consolidation of the industry. Times are tough – the first three quarters of 2016 saw the highest number of closures since 2008.
However, on a blockchain platform, the costs would be lower due to enhanced transparency, smoother data flows, efficiencies in custodianship and more automated compliance.
And the assets currently available, with their ‘alternative’ structures and relatively high risk profiles, seem to be right up a hedge fund manager’s alley: digitized representations of real-world assets, cryptocurrencies with no tangible value, digital ‘coins’ promising a share in future dividends, tokens granting holders access to a service, derivatives based on any of the above.
Yet while the proposals may make sense, it’s unlikely that this new type of hedge fund management will make a dent in its target sector.
Although consolidating, the hedge fund industry is still huge: approximately $3tn under management. With US President Donald Trump vowing to reduce financial industry regulations, managers have reason to be more cheerful. And hedge funds tend to love turbulent and inefficient markets.
Rather than fear the potential competition, it’s more likely that hedge funds will incorporate blockchain technology into their operations, improving the sector’s outlook even more.
That’s hardly ‘taking on’ the sector.
Where the blockchain asset management startups will make a difference is in another field entirely: venture capital.
Much has been written on initial coin offerings (ICOs) as an increasingly popular funding method for new companies, albeit one with unregulated risks and strategic disadvantages. Instead of having to undergo stressful rounds of presentations and negotiations, often giving up decision-making freedom, blockchain businesses can issue digital tokens that either represent a future utility or a participation in the earnings of the company.
At the moment, it is not simple for venture capital firms to invest in this new type of asset. Some have invested in digital token hedge funds, but that’s not the same as vetting and backing blockchain startups.
If the blockchain businesses working in the fund management space are able to launch solid platforms that make it easy to set up and manage a portfolio of digital assets, we could well see venture capital firms setting up their own ICO funds.
This would allow them to participate in this new funding trend, while still capitalizing on their expertise and vision.
In the process, they would add liquidity and respectability to a young asset class, while actually participating in the innovation and technological progress that they profess to actively seek.
In summary, the hedge fund industry will probably end up being supported by the blockchain.
But its overall structure and purpose are unlikely to change. Where we will see a greater impact, in processes and objectives, is in venture capital. This in turn could end up stimulating a new breed of startup, and encourage the growth of a new asset class that manages to both harness and promote the technology.
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