Thread by @APompliano

1/ Many crypto hedge funds are going to shut down in the next 12 months but not for why you think.

Time for a thread 👇🏽👇🏽👇🏽

2/ Crypto hedge funds are just like traditional hedge funds.

They manage investors money, usually trade actively, and charge a management fee & incentive fee.

3/ A hedge fund’s management fee is usually charged on assets under management (AUM) and calculated on a periodic basis.

Traditionally hedge funds try to charge 2% management fees.

4/ A hedge fund’s incentive fee is calculated at the end of the year on the profits that were generated by the fund.

Traditionally hedge funds try to charge 20% incentive fees.

5/ Crypto hedge fund manager benefited greatly in 2017 from the structure of their fund’s incentive fee.

The calculation of the incentive fee was in December 2017....the height of the bull market.

6/ If a crypto hedge fund raised $20M initially and it turned into $100M by December 2017 (5x), the fund manager would take home ~$16M from their incentive fee.

Not a bad pay day for a year or less of work.

7/ Most hedge funds have a “high water mark” clause in their legal documents.

This states that a fund manager can’t take an incentive fee unless the fund is above any previous year’s high water warm.

8/ The high water mark is the highest amount of value that the fund was previously worth. In the example above, the fund’s high water mark would be $100M.

So if the fund was below $100M in December 2018, the fund manager would not be rewarded their incentive fee.

9/ The 70%+ drawdown in the crypto markets makes it highly unlikely for crypto fund managers to beat the high water mark of 2017. This means no incentive fees for crypto fund managers this year.

10/ So what can a crypto fund manager do? They have three options:

- Raise more capital
- Ride the bear market out
- Shut down the fund

11/ Many crypto hedge fund managers are trying to raise more capital right now because this new capital would not be subject to a previous high water mark.

It is “new money.”

New money means the fund manager can get an incentive fee this year on some of their AUM.

12/ Some crypto fund managers will ride out the bear market. In some cases, they need to 4X or more from current levels in order to break even and be eligibile for an incentive fee again.

This is unlikely in 2018 and who knows what 2019 brings.

13/ If a crypto fund manager can’t raise new capital and thinks it will be hard to 4X+ their fund in next 15 months, they are likely to shut down.

Rather than work for next 15 months for salary only, they can return capital to investors & live to fight another day.

14/ If crypto fund managers begin shutting down their funds, some will start new ones. Others will join projects. And a few made enough money to retire.

None of this sounds as fun as running a high flying crypto fund helping to build the future though.

15/ My guess is we haven’t seen too many funds shut down yet because the managers don’t realize the problem they’re facing and/or they still believe they can get back to the high water mark.

This will all change in Dec 2018 when managers don’t get paid what they were expecting.

16/16 The moral of the story is to enjoy the good times.

Life comes at you fast and things that are too good to be true rarely last.