Bitcoin Hedge Fund: Overview of investment fund structures to block digital currencies
Bitcoin Hedge Fund has been back in the news due to the strong results in the last two months recently. Bitcoin and other digital currencies have been a bit of an edge phenomenon in the investment management industry since its inception.
However, the power of the idea of distributed / locking computing has been evangelized in various parts of the technology industry and has attracted a considerable amount of institutional investors in various digital currencies and its related infrastructure. See Not surprising then asset managers to explore this space either through products dedicated funds or through separate side pockets investing from traditional products. This paper discusses the various structural, regulatory and operational issues that arise for managers investing in these instruments.
Foundational article definition
For the purposes of this article, we provide references to the term Bitcoin Hedge Fund and digital currencies. These references generally refer to other currencies block-based block and / or digital tokens, sometimes called cryptocurrencies or alternate currencies. There are several government agencies looking to define this space and to regulate it, and the CFTC has specifically defined the term “bitcoin” as follows:
Bitcoin is a “virtual currency”, defined here as a digital representation of the value that is used as a bargaining, computing unit and / or a value retention means, but not legal status in any jurisdiction. Bitcoin and other virtual currencies differ from the “real” coins that are the coin and paper money of the United States or in another country that is ordered as a legal cash, circulated and used, and often accepted bargaining into the country of the exhibition. [See 2 of the Order of the CFTC Note, which is discussed below.]
Another important element of this passage is when Bitcoin is a “security” under the securities laws, or a coin under the laws of commodities or both, or anything else. We discuss this issue thoroughly under regulations, but for general purposes of this article, we take the position that is no security bitcoin regulated by the SEC or by federal securities regulators. We will also consider the position that Bitcoin is probably a coin that (in some cases) is subject to regulation by the CFTC.
Structural considerations on the formation of funds
While there are unique bitcoin functions (not acting as security, and it is questionable whether it acts as a commodity / currency), large picture structural considerations for a fund manager in this space will not be significantly different than a traditional hedge fund In values and / or raw materials.
• Hedge funds or private equity strategy. Bitcoin for funds with which we have worked tend to be strategies more hedge-fund-stylish private equity. This usually makes sense of the relatively “fluid” nature of the instrument. If a fund is invested directly in companies invested in the ecosystem of digital currency, or when a fund establishes operations for the mine to Bitcoin, it may be the need sleeve sides style private equity within a larger liquid zargent bag.
• Use of the fund. Usually we see reference to style background standard cover; As well as costs and fees, which are generally similar to standard fund programs such securities (in any case, as prices may be higher from management and performance by the new strategy / manager deep background in cryptography, math and tend to coding). Provisions contribution will also be standard. However, we tend to limit greater efforts to see withdrawals. Such measures could close longer term retirement (60-90 days) termination and using the dock level or back level doors. Custody is a big problem, and the assessment has the potential to become a problem. The use of leverage is not usually an important part of this investment strategy.
• Structures onshore / offshore. As with other non-traditional hedge funds, the structure will be affected by the taxation of the underlying investments and the nature of the investor. From now on, we are not aware of any adverse tax implications for digital currencies for US investors; Therefore, a structure of the limited liability company Delaware national standard shall suffice. If the fund is tax exempt from the United States investors, the internal structure should be sufficient if the fund does not use leverage. To the extent that the tax code change in the future will specifically tax to digital coins, structural considerations may change.
If the complex fund wants non-US investors, the manager will choose between a structure of mini master or master feeder structure. The jurisdiction of an offshore structure is likely to be the Cayman Islands or the British Virgin Islands. We have not seen and do not necessarily believe that there would be a reason for a complex of fund structures to introduce SPV investments in digital currency, but if that happens, such structuring would be based on normal factors such as state of the underlying, etc.
Regulatory considerations and other considerations for Bitcoin Investment Managers
There are a number of questions emerging for fund managers investing in this space. Due to the relatively new level of these tools, managers and service providers are developing the following problems and how these issues should be dealt with in the near future.
• Federal regulation system and state.
SEC – bitcoin and other digital coins are probably not values; But the SEC is currently investigating how to deal with bitcoin and other digital currencies. The main question is whether these instruments are securities or other assets subject (or subject to) regulation. If these digital coins are values, then the SEC has the responsibility to regulate the instruments and the transfer of such instruments (including the regulation of each exchange facilitates this transfer). As the SEC posted every definitive lead on the issue, Coinbase, a large portfolio bitcoin and exchange platform, has released the following discussion of how digital coins fit into the regulatory landscape of the SEC. Until we receive definite guidance or even informal advice to the SEC, the discussion Coinbase framework is probably the best reference material in relation to this particular subject.
CFTC – While it is clear that bitcoin is different from normal currency is fundamentally on the interbank and foreign exchange markets, which is significantly less if and to what extent the CFTC have jurisdiction over the instrument and the markets are traded. Unfortunately, the answer is not quite clear and uncertainty is, partly gave originates from parts of the Dodd-Frank Act the CFTC’s new jurisdiction over parts of the foreign exchange trading systems in force in the United States. Due to certain technical aspects of the trading currency both in the spot market (interbank) and in the future, and how this technical report the court’s scope of the item of the CFTC Dodd-Frank, part of this discussion is theoretical nature (what What a depot provides a digital currency ? Does it differ from the imprisonment of a password?). While our law firm at the CFTC is being debated as to whether a direct digital currency (as opposed to a digital foreign exchange deal or future), a contract is subject to the jurisdiction of the CFTC, now we feel that buying a bitcoin digital currency Or the like would not be subject to the supervision of the CFTC (which would require managers of private funds as CPO and CTA enrollment or exemptions). Notwithstanding the foregoing, some types of Bitcoin instruments are subject to products subject to CFTC Supervision-please Coinflip CFTC first order. In this order, a number of issues were raised that led to the determination of regulatory oversight (product swaps are taken into account, specifically CFTC referred to as forward contracts OTC Bitcoin and other contracts which may be subject to the jurisdiction of the CFTC, see Note 4).
CFTC and SEC? – In the future, you are likely to start tied products and services based on Bitcoin to see both the characteristics of a security product as product futures and possibly future instruments in the jurisdiction of the CFTC and SEC. We would expect future legislation both to define the nature of the digital currencies like any derivative and to define the scope of the CFTC’s competence and the SEC for these products.
State – does not belong to any order, action or state interpretation involved Bitcoin. We hope that the regulation of these assets is driven by federal authorities, but not from the fact that many government securities regulators (especially on the west coast) are taking aggressive positions with regard to new products.
• Regulation of the management company. Depending on where the manager fit in the regulatory spectrum discussed above, the manager may be subject to oversight and regulation. Considering that the manager is a investment adviser, or CTA and / or CPO, based on the above, the manager would be subject to normal registry and compliance frameworks. Managers who invest in other funds bitcoin or criptoxicidad definitely invest in securities (a private fund is worth), so a bitcoin fund manager is considered a investment adviser and would (or be required to be registered within a exemption from registration) with the SEC Or Federal Securities Commission. While we have seen some significant investment in the space, we recognize that the sector is still in the children’s shoes and is likely to begin to see more institutionalization among managers in this space.
• Custody. Perhaps the biggest problem with regard to these instruments is how and where they are held, and how and where passwords, keys or other information pertained to the property of the test. We believe that each manager must develop his own methods, address the issue of detention, and that these methods should address the risks of ownership or specific currency (such as Bitcoin under the Securities Act, each instrument has a unique property). In addition to managers with whom we have worked, we have had anecdotal stories about the various ways that managers could store and protect real estate funds and proof of ownership of digital currencies, including the use of USB sticks and banking security boxes.
• Risks. A background in this area must be focused on the risks involved in some private investment vehicle normal risks, but there are other risks to the strategy-related, including: overall risk for digital currencies, liquidity cover capacity, volatility, private key loss, technology And security issues, the risk of switching (eg Mt.Gox), lack of protection FIDC or SIPC.
• Service provider. Typical service providers in this area (lawyers, administrators, audit) have worked together to find ways to address the new and unique topics of these instruments.
• Other matters. There are a number of other issues that arise in this space, which are eliminated over time. This includes infrastructure for administrators and the general security of passwords. The valuation has the potential to be a problem depending on the exact nature of the digital currency, and if the coin is fungible and traded on different stock exchanges has different rates. The assessment can also be a problem when it is established that it is not a public market or exchange for the instrument. Taxation of the profits of these instruments may also change in the future (at this time presumably taxed according to § 988 of the IRC). In addition, capacity bottlenecks can arise as a large number of investors begin to accumulate in these investments, even if the derivatives markets take ownership.
We have worked with different groups in this area over the past two years, we have seen a strengthened interest in managing a private fund invested in bitcoin and digital currencies. We believe that interest comes from the high returns of Bitcoin, and the growing acceptance of alternative currencies. We also believe that a general increase in Bitcoin exposure has contributed to the interest in investing in digital currencies. As these investments are more standardized and regulated, we will continue to grow in this area.