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Crypto funds, lending and market manipulation

It is not easy to be a manager of a crypto fund. Along with undisciplined markets and elusive valuations, there is increasing competition and pressure on charges. And the performance of the funds was also weak: the Vision Hill report for the first quarter showed that, on average, active funds this year were lower than market returns.

The bear market in 2018 provoked the closure of many crypto funds, and a report published last week by PwC showed that at the moment the number of active funds has decreased significantly.

The report also indicated that with an average management fee of 2% and an average fund size of $ 4 million. Operational sustainability is difficult: $ 80,000. Regular income of such a fund is not enough to cover salaries and other overhead costs, especially given the likelihood of increased fees from regulators. However, in this study, one potential source of income was missed: crypto lending.

Given the growing demand for crypto-credit services, this income stream may be enough to give a number of funds a better chance of survival, as well as bring liquidity and diversity to the sector.

Further in the article we will consider the main and potential sources of income of crypto funds and analyze whether the industry has real prospects in the future.

Basic earnings fund fees

Before we look at this risk in more detail, let’s look at the downward trend in fees.

According to the PwC report, the average market fee is almost 2%, which corresponds to fees for “traditional” hedge funds. The interest lies in the fact that now there are all signs that the funds are beginning to lower fees for their services. The report says that the average charge for a crypto fund is 1.72% and continues to decline steadily.

Genesis mining
Genesis cloud mining

The pressure becomes even more acute in mutual and index funds, where fees are approaching zero. Last year, investment management giant Fidelity offered a mutual fund with no management fee at all. And at the beginning of this month, the SEC allocated funds to Salt Financial asset manager, who promised negative fees.

Hope of the industry the growth of crypto-lending

Despite the reduction in fees, the demand for crypto lending is growing at an amazing pace, as evidenced by the influx of funds into credit start-ups and the demand from various institutions. This has potential consequences for the whole sector, both good and bad.

The positive point is that an increase in lending can increase the speed and, as a result, the disclosure of prices for cryptoactives, since a greater number of transactions facilitate the market expression of their views. In addition, the growing demand for short sales, aided by the lending of assets, will somewhat increase the liquidity of the market.

However, in this increase in liquidity the risk of market manipulation may leak out.

Suppose I manage a crypto fund that invested in altcoin A, and suppose that I borrow part of my share to counterparty X. In traditional finance, most securities loans can be withdrawn at any time, so suppose I can do the same. I recall an Altcoin A loan, and counterparty X must return it to me. Regardless of whether the counterparty used the loan for a short sale or lent it to counterparty B, he will now have to repurchase the asset on the market, which is likely to increase the price.

Now let’s go on the other side and think that if I knew about this pattern and used it as part of a strategy to improve the valuation of my fund? Most likely I would not be able to take profits by selling altcoin A and not pushing the market down. But such actions could help fix the higher value of the fund on a certain date, which would increase my performance indicators and, in turn, could stimulate investments in my fund.

Transparency is the key to success

One solution to this problem may be regulation. You can set rules for transparency and oversight, as is the case with traditional finance. But regulators still master cryptocurrency and do it carefully.

In the absence of clear rules, the sector should monitor developments in the administration of the crypto fund, and in the lending of crypto assets. After all, it is in his own interest to provide a strong and stable market.

Genesis mining
Genesis mining

But self-regulation has its own risks and is difficult to implement in such non-transparent activities as lending to cryptoactive assets. True, blockchain-based transactions are available for everyone to see, but most of the credit for cryptocurrencies is likely to be carried out off-chain, like an agreement between two parties.

Spreading such practices without any guidance can increase systemic risk. As traditional markets in 2008 showed, an intertwined network of assets, consisting of opaque lending mechanisms, making institutions vulnerable.

There are many different obstacles to crypto markets on the path to universal acceptance. First of all, market participants should not allow hidden and potential risks to pass into the stage of real problems.

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