Potential ‘Buying Opportunity’ for LPs in Distressed Digital Assets

Though there have “obviously been some well-publicized failures of crypto hedges funds” over the past 12 months, allocators this quarter have turned their attention to additional digital asset strategies, an attorney told Blockworks.

In a recent interview, Scott Beal, a New York-based partner at the law firm Barnes and Thornburg, said there’s been “decent interest” of late when it comes to launching liquid institutional strategies keying in on a number of digital asset sectors. 

There’s also been a 2023 uptick when it comes to getting cryptocurrency-focused fund of funds vehicles off the ground, Beal said in unpacking a Barnes and Thornburg study from May on the outlook for fund managers this year. 

The study is based on a February survey commissioned by the law firm that tallied “125 limited partners, sponsors and service providers,” representatives for the firm said in a May statement. 

A veteran of Wall Street fund formation, Beal said he’s been eyeing a number of trends lately when it comes to the adoption, as well as the diversification, of crypto assets into traditional finance portfolios.   

Beal assisted in putting the survey together and said that “last year reinforced the volatility of the asset class,” adding that it is “fair to say that a certain set of investors looked at the drawdown of crypto assets last year” in fleshing out their portfolios. 

Since the fourth quarter of 2022, though, when crypto markets were rattled, Beal said there’s been a resurgence of interest in what allocators “viewed to be higher quality assets as something of a buying opportunity.” 

Distressed specialists may be eyeing digital assets

Part of the last dropoff in traditional finance investors backing crypto portfolio managers at scale, industry participants have said, can be attributed to liquidity. 

Barnes and Thornburg found that “cryptocurrency is a risk many are still willing to take” in its study.

A full 52% of respondents said “the current state of cryptocurrencies has significantly impacted their company in a negative way,”  the survey found. “Yet even as regulatory scrutiny picks up, the majority are still considering or actively deploying capital in the space in 2023.” 

But that view “hasn’t stopped many of them from actively investing or considering investing in the space,” the law firm said. 

Beal is the co-chair of Barnes & Thornburg’s Private Funds and Asset Management Group — and he’s worked in compliance roles for a number of buy side fund operators, as well as in external compliance functions. 

In the US, Wall Street appetite for closed-ended crypto funds, including venture capital and acceleration capital vehicles, generally declined toward the end of last year. Mounting state and regulatory concerns at the time were said to have played no small role.

Regulators including the SEC and the CFTC could still use “to give a little bit more guidance” to current and prospective digital asset fund managers, Beal said. 

The law firm’s survey cited a March 17 note from Coinbase’s institutional research arm. It cited a number of macro factors in making the exchange’s case that “the medium to long term outlook for cryptocurrencies has been reinforced to the upside.” 

And Coinbase researchers at the time drew unfavorable parallels to the downfall of Silicon Valley Bank (SBV), as well as a number of ensuing banking implosions. 

“The technology behind open trustless blockchains and transparent smart contracts stands in stark contrast to the poor risk management practices that led to the turmoil witnessed in the US banking sector this week,” Coinbase researchers then wrote. 

RIAs still wary of SEC oversight

Beal said his practice is continuing to advise registered investment advisers (RIAs) overseen by the SEC to “have some understanding on the risk you are taking,” considering that a “substantial portion” of crypto assets “may ultimately be deemed securities, even if the SEC hasn’t come out one way or the other.” 

Fewer hedge and venture fund capital survey respondents — 46% and 40%, respectively, reported being “negatively impacted” by cryptocurrencies broadly. 

In the study, Jahan Sharif of Barnes and Thornburg wrote that “hedge funds are definitely paying close attention to the cryptocurrency sector.” 

Added Sharif: “For instance, the FTX bankruptcy — with its multiplicity of involved entities and their competing claims — could create opportunities for distressed funds to find value in potential recoveries.”

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