Structuring and Launching Cryptocurrency Funds & ICO’s - The Growing Trend of Cayman Fund Launches by David Charles Lloyd.

Hedge funds that trade cryptocurrencies reached over 100 for the first time, according to new data from fintech research house Autonomous NEXT, of which more than three-quarters launched in 2017. Assets across the 110 funds rose to $2.2 billion.

Following the conception of Bitcoin in 2008 and its subsequent development, a flourishing ‘crypto’ eco-system has developed utilising Bitcoin’s underlying technology – the blockchain.  This eco-system challenges traditional concepts of currency and capital as well as the mechanics and expectations surrounding the attribution of value. 

Initial Coin Offerings (ICO’s) have become so frequent over the last year as a method of raising capital, that they have become the new norm in the industry for FINTECH projects. Etherum launched in 2014 via an ICO and now has coins or tokens in circulation worth in excess of US$2.2 billion. As a result of this and other initiatives we have seen regulators place extensive focus on how to regulate such sales. For example, the US Securities and Exchange Commission (SEC) issued the Decentralised Autonomous Organisation Report (“DAO Report”) in July of this year. The DAO Report resulted in coins/tokens be classified as securities in accordance with the US Securities Laws and the SEC stressed that blockchain technology could not be used to bypass existing laws and regulations. As a result, other jurisdictions have followed suit. For example, Singapore, Canada, China, Hong Kong, United Kingdom, South Korea, Australia, to name a few.

Other services providers are entering the market including custody services specifically focused on the growing trend of cryptocurrency investment funds. 

Bitcoin Futures and Options Contracts

The Chicago Mercantile Exchange (CME Group), the World’s Largest Options Exchange, announced they will begin trading in Bitcoin futures by the end of 2017, pending regulatory approval. CME Group is the largest options and futures exchange in the world, and owner of Chicago Mercantile Exchange, Chicago Board of Trade, New York Mercantile Exchange, Kansas City Board of Trade and part-owner of the Dow Jones Indices.

Following the announcement, Bloomberg reported that CME’s imprimatur makes Bitcoin “legit” in the world of mainstream finance. CME becomes the latest mainstream player to jump on the Bitcoin bus, following the Chicago Board Options Exchange’s (CBOE) announcement that they will trade Bitcoin options and futures, and LedgerX’s opening of their regulated Bitcoin futures market.

Exchange Traded Funds (ETF’s)?

The trading of Bitcoin futures on regulated markets, particularly by major entities such as CBOE and CME, make it exceedingly likely that a Bitcoin exchange-traded fund (ETF) could be possible in the near future. When the SEC rejected the Winklevoss Twins’ attempts to register such an ETF earlier this year, the regulator pointed out that it might revisit its decision if regulated futures markets should arise.

The Future

With Bitcoin’s increasing acceptance by Wall Street financiers and traders, the sky is quite literally the limit for the digital currency. While Bitcoin’s $116 bln market capitalization is large by the cryptocurrency world’s standards, it’s minuscule in comparison to the $639 tln derivatives market. If even the tiniest fraction of those funds were to enter Bitcoin, its value would be inconceivable.

Forming a Cayman Fund Focused on Crypto Currency

The Cayman Islands is a leading jurisdiction for alternative investment funds and we have worked with many clients over the last year on advising them on launching investment funds in the crypto currency and block-chain space, working on innovative fund structures. 

When contemplating launching a fund, there are certain aspects that you will need to consider. We have highlighted a few below, as follows:

1.     The location of your investors (countries targeted).

2.     The type of investors e.g. institutional, family and friends, family offices, private wealth clients.

3.     The number of investors you expect to raise capital from and your distribution methods to investors.

4.     The fees to be charged e.g. management, performance (incentive), distribution fees etc.

5.     The strategy of the fund and how the fund will allocate the capital raised.

6.     Whether the fund will be open-ended or closed-ended.

7.     If the fund is open-ended, how frequent will the subscriptions and redemptions be.

8.     If open-ended, will there be a lock-up period for investor capital? If yes, will there be a redemption penalty and what will this be?

9.     If closed ended, how frequent will the capital closing take place

10.  Service providers forming part of your fund – legal counsel, fund administrator, auditor, custodian bank independent directors, board support, compliance, registered office and corporate services.

The Benefits of Cayman Funds

1.     Reputation:very well-regarded offshore financial centre for establishing an investment fund, with many of the world’s leading financial institutions managing funds based in the jurisdiction.

2.     Tax Neutral:a Cayman fund is not subject to any taxation. No corporation tax, no capital gains tax, no income tax, no with-holding tax.

3.     Speed & Efficiency:establishing a Cayman fund is quick compared to other jurisdictions.

4.     Flexibility of terms:strategy, asset classes, fees and overall structure of the fund strategy. 

5.     Professional Service Providers: the Cayman Islands has highly respected, regulated and professional service providers and institutions to accompany financial services providing a very high level of service. 

Fund Legal Structures

1.     A Cayman Company that issues share’s, to investors: typically, the Fund will issue participating shares to investors. The fund manager will hold the voting, controlling or founder shares.

2.     Exempted Limited Partnership (ELP):the Fund will be a partnership with a General Partner (GP) and Limited Partners (LP) then investing for partnership interests.

Fund Structures

1.     Stand-alone Fund Structure:one investment fund legal entity and then multiple investors.

2.     Master-Feeder Fund:Master fund and then usually a Cayman Islands feeder fund for non-US taxable investors and a US feeder (usually in Delaware) for US taxable investors.

3.     Umbrella Fund (Segregated Portfolio Company (SPC)): used to create segregated funds under one legal entity. This enables the SPC to launch separate funds with varying strategies and fund terms.

4.     Single Investor Funds:a stand-alone Fund but for one specific investor.

Forming a Cayman Investment Manage Company (Manco) for Managing Your Crypto Currency Fund

The Cayman Islands Securities & Investment Business Law (SIBL) provides a light-touch regulatory regime for creating a management company (Manco) to accompany your investment fund. The benefits of this are that the Manco receives the fees associated with managing the fund, the Manco is tax-neutral and not subject to taxation and there is no requirement for you to have employees for the company though it is prudent for the Manco to have some substance. The management company is required to have a Money Laundering Reporting Officer (MLRO) and CIMA registered directors.

Fund Governance – Independent Oversight

Independent Directors are these days appointed to the board of most funds with a requirement that a CIMA registered fund has at least two independent directors. Investors and regulators have increasingly focused on the benefits attributed to appointing experience directors to the board to provide oversight, avoid conflicts of interest, improved transparency and provide a level of protection to ensure investors are treated fairly. 

David Charles Lloyd

https://www.davidcharleslloyd.com