Some Crypto Funds Rather Not Let Investors Go — Lockups in Crypto Hedge Funds

4 min readJul 31, 2023

This article uses the 21e6 Crypto Fund Database to analyze the lockup policies in place by crypto hedge funds.
Authors: Jan Spörer, Maximilian Bruckner

Introduction

We often associate crypto with financial freedom. People familiar with on-chain transactions trade and spend their crypto as they please. Nobody can interfere, the system is censorship resistant.

But regulated financial institutions play a different game. Crypto hedge funds, a popular choice for professional investors, must follow similar rules as traditional hedge funds. Fund managers determine subscription and redemption policies when creating a new crypto hedge funds.

Sometimes, investors cannot redeem their holdings from crypto hedge funds whenever they wish. In this article, we analyze how many funds lock their investors in for a certain period of time and whether they do so using a fixed redemption freeze window (“hard lockup”) or penalty payments for early redemptions (“soft lockup”).

Not all lockups are created equal. Some funds, instead of prohibiting their investors from redeeming their investments for a certain period of time, only charge an extra penalty redemption fee during the soft lockup phase. In contract to this, hard lockups prevent investors entirely from redeeming during the first months (and sometimes years) after placing their investment

Figure 1: The most common lockup policies for crypto hedge funds

Justifications and Reasons for Lockups

We have calls with crypto funds every week, and they usually refer to the recommended holding period of their fund to justify their lockups. Managers tend to claim that their funds are only suited to long-term investors, who may not mind being locked into an investment.

This superficial explanation, however, does not explain why crypto funds are incentivized to put lockup clauses in their subscription contracts. Oftentimes, the primary reasons for lockups are the following:

Funds think that they can maximize their overall assets under management if investors are prevented from redeeming. This increases revenue for the manager and improves the signaling to outsiders.
Funds want to reduce administrative burden associated with subscriptions and redemptions. Subscriptions and redemptions typically create costs for partner banks and administrators that are passed on to the fund, even with smaller ticket sizes.
Funds want to reduce transaction costs associated with redemptions. When a fund receives new money, they need to convert this cash into crypto assets to balance the overexposure to cash that the new liquidity would otherwise cause. Likewise, they often have to liquidate existing tokens (or crypto derivatives) to meet redemptions. This creates transaction costs that may harm the performance of the fund. Furthermore, fund traders faced with redemptions and subscriptions need to spend more time on mundane rebalancing tasks instead of on improving and executing on their strategies.
Funds are actually concerned that investors should not invest shorter than the recommended holding period, and want to keep investors happy by “forcing” them into this recommended holding period. They want to avoid having disgruntled short-term investors that may get impatient after a few months of bad performance.

Funds Without Lockups

Passive investment products are overrepresented in the bucket of lockup-free funds. The administrative burden for rebalancing passive investment products is often lower than for active products. Subscriptions, redemptions, and portfolio rebalancing can be extensively automated for passive crypto funds. In recent months, investors in actively managed crypto hedge funds have become much stricter with their liquidity requirements as well. Investors typically prefer no lockups.

Funds With Soft Lockups

Soft lockups incentivize investors to stay invested in the fund for a minimum time period, without completely prohibiting them from redeeming their fund shares. We noticed that there is no clear pattern for why funds use soft lockups. Funds from different categories employ soft lockups, i.e. discretionary funds, yield funds, futures funds, and fund of funds. It could be seen as a middle ground between a hard lockup and no lockup at all. The money can be redeemed at any time, against a small fee. This should incentivize investors to only redeem before the soft lockup period is over, if it is truly required.

Funds With Hard Lockups

Early-stage, venture-like crypto funds are the most likely fund category to implement hard lockups into their investment terms. These funds invest in small token projects that are often still illiquid. Therefore, unplanned redemptions may leave these funds in situations where they cannot spontaneously liquidate their investments at acceptable execution prices.

Conclusion

Depending on a fund’s strategy and size, there may be good reasons for a fund to add redemption lockups into their terms. Funds need to balance the investor-friendliness of a no-lockup approach with the benefits that a lockup may bring.

Some investors have liquidity requirements. A lockup could be a hard barrier that prevents investors from working with a fund. While the benefits of a lockup seem compelling, they should accommodate investors’ concerns for liquidity as best as possible.

Investors should further notice that some funds have long redemption notice periods of up to 90 days. This is quasi a 3-month lockup, since faster redemption is not possible.