Retirement plans step in, aid hedge funds in navigating risky crypto ventures
Traditional investors, including pension funds like the one tied to US defense contractor Lockheed Martin, are stepping up to finance the operations of broker Hidden Road. This move is aimed at assisting hedge funds in the volatile world of cryptocurrency assets.
Based in London, Hidden Road has secured investments from players such as Citadel Securities and Coinbase, showing its critical role in bridging the gap between traditional investors and digital assets.
The broker is also emerging as a potential lifeline for the cryptocurrency market, which has been grappling with reduced trading activity and leverage due to various scandals, including the collapse of the FTX exchange.
In the realm of mature markets like stocks, prime brokerage is a common method used by traders to leverage their bets. However, this strategy poses risks. If a hedge fund borrowing money from a prime broker faces significant losses, the prime broker or its investors may end up bearing the financial burden.
“It is a very risky investment to make,” said Andrew Urquhart, professor of finance and financial technology at Henley Business School, as quoted in The Financial Times. “If my pension fund said we’re going to get into crypto, I’d be very worried about that.”
Although pension funds like Lockheed Martin's have been seeking ways to boost their returns through ventures into the cryptocurrency realm, some have faced setbacks. For instance, Ontario Teachers’ Pension Plan and CDPQ suffered losses in investments related to crypto exchange FTX and lender Celsius.
Hidden Road, founded in 2018, considers itself more aligned with private equity or investment firms that raise external capital for activities rather than traditional bank prime brokers, a source told The Financial Times.
The company's approach has found favor among market makers like Flow Traders and Virtu Financial. It has also received regulatory licenses from various countries for its services but does not cater to US investors.
Despite its approach, Hidden Road's size and relative balance sheet strength have raised concerns among executives. Some worry that the company's financial standing might not withstand a substantial market event, potentially requiring additional capital from investors.
“I have to look at it from an arm’s length distance to be comfortable,” the head of one crypto exchange told The Financial Times. “They’re intermediating credit with a pretty thinly capitalised balance sheet. To be taken seriously they need to have a significant degree more balance sheet behind them.”
To mitigate risks, Hidden Road imposes an "exchange risk spread" to guard against venue failures. The company's due diligence is regarded as strict by its customers.
However, the cryptocurrency industry has witnessed prime brokerages face challenges, as seen with the closure of Digital Currency Group's Tradeblock and the bankruptcy filing of Genesis' lending unit.
“It’s completely empty, the whole [crypto] prime brokerage, institutional broking space is wide open,” said Gautam Chhugani, senior analyst of global digital assets at Bernstein, as quoted in The Financial Times.
While the crypto prime brokerage space offers opportunities, experts highlight the difficulty of managing the inherent volatility in assets like bitcoin.
