How Blockchain is Revolutionizing Hedge Funds
by Mashum Mollah Technology 17 August 2018
Given the growing interest in the blockchain technology, more and more hedge funds are starting to adapt their management strategies in order to include digital assets. This is not a very easy task, since digital assets are still new to the investment world, and they are transitioned in a completely different way from conventional assets. Moreover, they are also incredibly volatile, so they require complex risk management systems. Nonetheless, blockchain and all digital assets that have to do with it are here to stay, and their benefits cannot be ignored by the hedge fund industry. So, we can expect a lot of changes in the following years regarding the ways that hedge funds manage themselves.
Short intro to blockchain hedge funds :
Blockchain investments were adopted by hedge funds, not only due to the promise of high investment returns, but also due to the fact that they improve investment and process optimization. The majority of the existing blockchain-centered hedge funds only invest in cryptocurrencies. A cryptocurrency hedge fund can be risky since digital coins are incredibly volatile. In fact, dozens of such funds have closed in the first few months of 2018 due to the plunging returns of crypto investments. However, digital coins seem to be raising back in value, and while market fluctuations are still to be expected, in the long run, digital coins are here to stay. Now is just a matter of which currencies will bring more profit. Aside from the funds that manage just crypto investments, there are also funds that invest or buy companies that use blockchain tech. Finally, there are funds that invest in all types of blockchain assets, and also use the tech itself to improve the administrative processes.
Blockchain in private investments :
More and more private investment funds are starting to use this tech to provide a more simple and accessible investment and process optimization. To avoid losses due to market fluctuation, many funds trade crypto coins while also investing in blockchain-centered companies. As we already mentioned, there is also a handful of funds use the tech for administrative purposes. There are also a few that use crypto assets to pay data scientists who are in charge of the investment analyses. The most popular funds that use these strategies are Polychain Capital, Lending Robot, the Northern Trust and Intellisys.
Blockchain for administration :
Due to its transparency and security, this technology is ideal for improving administrative procedures, but also for compliance optimization. The tech can be used to completely automate most of the trading procedures. One example of such a fund is Lending Robot, whose whole system is based on the blockchain, and they also invest in lending marketplaces. The trading algorithm is very flexible in order to accommodate the risk preferences of each investor. The transparency of the transactions is ideal, as it allows the fund to abide by the highest compliance standards.
There are also many associations when it comes to blockchain investments. Consortiums are very common, but there are also partnerships based on the commercial use of the technology. Such is the case of IBM and Northern Trust whose collaboration allows for an efficient private equity administration. There are still many problems due to the lack of regulations in regard to the blockchain tech, and this is particularly tricky in the private equity sector. Other challenges frequently encountered by private equity funds can also be easily eliminated with blockchain. Fragmented, duplicate or lengthy investments are all in the past, as blockchain has opened the way for a new era in the trading industry. For instance, instead of the conventional transactions which called for several document copies that needed to be reconciled, blockchain allows all parties to access a single version of the contract, which can be updated in real time if there is the need for reconciliation.
Another great use of this technology is for the back-office administration. By easily recording all transactions in real time, while also automatically storing all the necessary documents, private equity funds can dramatically cut down their administrative tasks, while also saving a lot of time. Transactions are also a lot more secure when blockchain technology is used, and the transparency of the trades is of great use to the investors.
Blockchain and evolving technologies :
As we already mentioned, blockchain can be implemented in many industries and it can be used in combination with other technologies. Many funds invest in companies that use blockchain in combination with other technologies, but there are also funds that do this themselves. For example, Numerai uses AI and big data for converting trading data. By using a learning machine for processing financial data, to improve the precision of their predictions and for optimizing trading strategies, Numerai can significantly decrease the risks of their investments.
Overall impact :
The blockchain is indeed a revolutionary technology, which has changed the way in which we use the internet, and it is slowly but steadily changing the financial world as well. By digitalizing currencies, by improving the security of transactions and by optimizing the administrative processes behind financial procedures, blockchain is completely changing the financial world, and its impact on hedge funds is significant. Sure, it is still an evolving technology which makes blockchain-based investments highly risky and volatile. But we have to admire the irony of the fact that the technology itself can be used to decrease the risks of blockchain investments.
Another impact of this technology in the hedge fund industry is the fact that it increases the competitive pressure in this industry. All funds are trying to come up with innovative management strategies to accommodate the changes brought about by blockchain in the financial world. New trading algorithms, state-of-the-art trading platforms, instant and transparent transactions are just a few of the many changes that private funds have implemented due to blockchain technology. All of this competitive pressure is raising the standards of the trading world, and this is all in the benefit of the investors. The only downside is that the implementation of this new technology has increased the fees for most funds, but as long as the returns are high, investors seem to have no problem with the exorbitant fund fees.
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