As the world of cryptocurrency changes pretty much as regularly as I change my underwear (just to be clear mum, that is a lot, I promise), one of the very common questions we are asked by prospective managers looking to set up a new crypto focused fund is whether they can take in subscriptions in a digital currency of some form, whether that is from their own wallet or from an outside investor’s stash.
In today’s environment of high-profile hacks and cyber security breaches, it’s not a huge surprise to me that the majority of my fund manager clients who trade digital-assets have a distrust of institutions that claim that they can safeguard their assets. In addition, despite the exponential growth of managers trading digital-assets over the past few years, there is still a dearth of service providers willing and able to service the industry (custodians included) which means the prices that institutional custodians currently charge are not yet at levels that can be tolerated by emerging managers. Finally, there’s the question of frequency of trading; by placing their digital-assets with a third party, many managers feel that this will slow down their ability to react to market volatility and take advantage of arbitrage opportunities between different exchanges.
The combination of these factors (perceived security risks, high costs and a reduced speed of trading) means that the majority of my fund manager clients trading digital-assets prefer to safeguard their own assets through the use of cold storage e.g. by sharding their private keys, putting them on individual thumb drives and, sometimes, even placing them in different safety deposit boxes in various locations. The number one question I get asked by my clients at the beginning of any engagement is can they self-custody their assets and, if so, should they do this? With this mind, I thought it would be helpful to set out the regulatory requirements (from a BVI and Cayman law perspective) together with what we see as current market practice.
The phenomenal rise in the price of bitcoin during the course of this year mirrors the extraordinary amount of enquiries (and subsequent instructions) that our team has received in relation to the formation of cryptocurrency funds and digital token launches.
As cryptocurrencies and digital tokens continue their aggressive push into the mainstream investment world, regulators and lawyers worldwide are grappling with how to fit this square peg of digital assets into the round hole of the existing legal and regulatory framework. As a result, this is one of the most exciting (and, if I am honest, slightly scary) times in my legal career and my day-to-day mindset amusingly mirrors the extraordinary fluctuation in the price of most of the cryptocurrencies this week. I know my colleague Oliver Bell will be blogging about this next week and so for now, I’ll focus on one of the narrower areas our team has been trying to get its collective head around.