How to Start a Hedge Fund — The DeFi Way.
Source: Acquisition International
In Decentralized Finance, the pace of innovation has been mind-boggling. This wave of innovation has given individuals the freedom and ability to participate in this new financial market in ways only institutions could participate in Traditional Markets.
One unique offering that institutions have in traditional markets is the ability to create hedge funds and similar investment vehicles. Before we get into methods to start a hedge fund in decentralized finance, let us understand what hedge funds are, how they operate, and how they can be formed in different geographical jurisdictions.
What is a Hedge Fund
A hedge fund is an investment vehicle that allows investors to pool funds together and invest in various liquid assets. Hedge funds can use complex investment instruments, trading techniques, portfolio management, and risk management techniques. For example, hedge funds often take both sides of a trade, going long and short an equity or option. Hedge funds also can invest using leverage in equity or derivative markets. The goal of most hedge funds is to make outsized returns.
The first hedged fund was founded in 1949 by Alfred Winslow Jones1. While hedge funds have evolved, the core concept still stands — allowing fund managers to create investment plans to enable investors to enjoy outsized returns. Typically hedge funds have a 2-20 fee structure — meaning a fee of 2% of assets under management annually and an incentive fee of 20% of profits above an agreed hurdle rate.
How to start a traditional hedge fund
The requirements necessary to start a traditional hedge fund differ depending on the jurisdiction you wish to operate the fund. The requirements will also vary based on the jurisdiction of target investors. For example, hedge funds typically exclude small investors and only accept money from accredited investors.
Let’s examine the steps necessary to begin a hedge fund in some significant jurisdictions:
United States of America
The United States offers one of the most friendly environments to hedge funds. The industry enjoys several tax breaks and other regulatory benefits. To begin a hedge fund in the United States of America, you need to take the following steps:
File the Articles of Incorporation for the Hedge Fund Firm - Hedge funds in the United States are mainly formed as limited partnerships, with a key investment advisor acting as a primary partner and a group of investors acting as secondary legal partners. Thus, the hedge fund is registered as an entity, and the investment advisor is registered as another.
Create the corporate bylaws that will guide the hedge fund - The corporate bylaws will usually contain a mission and vision statement, a code of conduct, a compliance manual, a manual guiding supervisory procedures, and an advisor portfolio management agreement.
Register the representative of the hedged fund as an investment advisor.
Register the funds offering with the United States Securities and Exchange Commission.
Ensure compliance with all consumer protection laws - Fund managers with less than $25 million in assets under management are not required to register with the Securities and Exchange Commission. Moreso, according to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, there are strict compliance and reporting hedge fund managers must abide by.
Begin to market your hedge fund 😎
Once you can meet all the earlier requirements, you can legally run a hedge fund in the United States.
Canada
Registering a hedge fund in Canada is more complicated than registering one in the United States of America. This is because the Canadian Securities Administrators(CSA) is the association responsible for overseeing the activities of hedge funds in Canada. Unlike the United States, where the securities and exchange commission is responsible for regulating all investment activities across the country. In Canada, however, regulation of investment activities is done by territories and provinces; these states then come together under one umbrella to form the CSA. As a result, most registration requirements in territories and provinces across Canada are similar except for the Quebec region.
The required steps to register a hedge fund in Canada are:
First, register the hedge fund in the province or territory you wish to operate. As part of the registration procedures, regulators will often consider the investment decision-making prowess of the fund managers.
Meet all ongoing reporting requirements.
Meet the minimum capital requirements to start a hedge fund in the province or territory where you reside. For example, in Ontario, the minimum capital requirements for hedge funds to meet are
CAD 25,000 for a portfolio manager,
CAD 50,000 for an exempt market dealer, and
CAD 100,000 for an investment fund manager.
Hedge funds are also only allowed to solicit funds from accredited investors who can make a minimum required investment.
See also starting a hedge fund in The United Kingdom.
Starting a Hedge Fund, the DeFi way
Decentralized finance offers unique ways for emerging fund managers to create investment vehicles similar to hedge funds for cryptocurrencies. Unlike traditional finance, most tools that allow asset managers to create structured products do not have minimum fund requirements. Thus, the participation rate amongst retail investors can be significantly higher than in traditional finance markets.
These are the tools you could use to start a hedge fund-like investment vehicle focused on digital assets and other cryptocurrencies:
TokenSet
Tokenset is one of the favorite platforms digital asset managers use to create investment products. The protocol is currently available on ethereum, optimism, and polygon. Tokenset allows users to create sets and earn revenues from designated management fees in a quasi-anonymous manner.
Tokenset hosts structured products created by powerhouses like Bankless, DeFi Pulse, and other structured product providers. For example, the DeFi pulse index has more than $80m in assets under management.
GalleonDAO is an affiliate of tokenset seeking to create a guild of asset managers; thus we can continue to expect high-quality products for investors to take advantage of.
Mudrex
This is an excellent alternative to Tokenset. Although the platform does not replicate the plug and play model and quasi-anonymity Tokenset offers, it allows users to connect to a wide range of Centralized Exchanges(CEXs).
Source: Mudrex
The platform provides a wide range of Coin Sets covering several essential sectors.
Asset managers can quickly build strategies for the community to invest in.
Source: Mudrex
Currently, Mudrex has $20 million in assets under management and is an excellent tool for asset managers and investors to offer and take advantage of hedge fund-like strategies applied to digital assets.
Investin
Investin offers a similar plug-and-play strategy with Tokenset. It is a decentralized fund management protocol built on Solana, and it allows users to be on board as either investors, fund managers, or both.
Source: Investin
While the range of tokens available is not as wide as on Tokenset, it is an easy platform for gaining exposure to the Solana ecosystem.
Zignaly
Zignally offers what I consider to be one of the best approaches for newbies who wish to piggyback on successful traders.
Source: Zignaly
While anyone can become a trader, new entrants into the crypto markets can deposit funds with traders and only pay when in profit. You can also assess the track record of a trader before deciding to deposit funds with the trader. The downside is that several of the traders that newbies can copy denominate their investments in USDT, which I am not comfortable with.
Asset managers can take advantage of Zignally and easily offer either spot or futures-based digital products.
Source: Zignaly
Final Thoughts
The tools available to emerging managers and investors in decentralized finance and crypto are innovative and groundbreaking. I feel that an aggregator service — that brings services like tokenset, zignaly, mudrex, investing, and other asset management platforms under one roof — will make it extremely easy for asset managers to create structured investment products focused on the digital asset markets.
I look forward to a bright future for asset managers focused on digital assets.
Don’t forget to hit me up on Twitter or drop a comment if you have any thoughts on this.
Thanks.
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