By Olga Kharif

January 30, 2019, 5:41 AM PST

As cryptocurrency prices continue to languish, hedge funds investing in digital assets are increasingly starting to look more like venture capitalists.

Polychain Capital, which reached more than $1 billion in assets right before the 2018 market crash, just raised $175 million for a fund with a seven-year lockup period, Chief Executive Officer Olaf Carlson-Wee said. BlockTower Capital recently hired Eric Friedman to lead the firm’s venture strategy. Arca Funds is considering taking equity stakes in struggling crypto projects.

“There’s going to be a lot of opportunity in distressed buying and even activist investing,” said Jeff Dorman, partner and portfolio manager at Los Angeles-based Arca. “Often you can buy below even the cash value of the company."

The line is being blurred in the wake of the collapse of the initial coin offering market, where startups were bypassing traditional venture funding by selling tokens directly to investors. But with a regulatory crackdown raising the risk of forced refunds, and with coin prices plunging as much as 90 percent last year, many investors want out -- allowing the funds to come in and make purchases for cents on the dollar.

About 125 venture funds that usually provide capital in exchange for an ownership stake were launched last year, compared with 115 hedge funds that primarily act as investors, the first time the number has exceeded the total investment partnerships in the embryonic sector, according to Crypto Fund Research.

“Funds have silently transformed from hedge funds into venture funds as their liquid portfolios shrank in value, making a very high percentage of AUM illiquid," said Kyle Samani, managing partner at Multicoin Capital Management in Austin, Texas. Multicoin has traditionally done venture deals in addition to investing in tokens, he said.

Many funds are focused on acquiring SAFTs, or Simple Agreements for Future Tokens, which entitle them to future coins from startups that plan to issue tokens once their product are ready, often at steep discounts of up to 80 percent.

"If you are able to have a discount, and de-risk it that way, then it’s very very helpful," said Paul Veradittakit, a partner at Menlo Park, California-based Pantera Capital Management. He expects to see more companies raising capital this way, and that Pantera’s fund that invests in coins ahead of ICOs “is getting a lot more similar to venture.”

Crypto hedge funds posted losses of about 70 percent on average last year, according to Eurekahedge Crypto-Currency Hedge Fund Index. While 42 crypto funds closed in 2018, there are still another 740 or so worldwide, according to Crypto Fund Research, a consultancy run by a former Merrill Lynch analyst. The funds universe may shrink even further.

“2019 is going to be the year of separating the wheat from the chaff, and that’s applicable to both projects and funds," said Travis Kling, founder of the Los Angeles-based crypto hedge fund Ikigai, which is evaluating SAFTs.

Even with the closures, some hedge fund managers say they’re seeing investor inflows.

“We are talking to a lot of institutional investors," said Samani of Multicoin, which in a recent report pointed to private-equity firms as role models. “A lot of smart people who’ve been interested in crypto for a year, two years, and were waiting for it to cool down, are now looking at the space activity."

Unlike the quick money made during the ICO boom, investors will have to be patient, and not expect quick returns. Many of the new funds now have lock-ups of two, four or even -- as is the case with Polychain -- seven years.

“Like any investment in an early stage technology and in an early stage company, it can often feel like an overnight success when it is successful, while it takes a long time to deploy these technologies," Polychain’s Carlson-Wee said in a phone interview.

— With assistance by Sarah McBride, and Alastair Mars