Cryptocurrencies such as Bitcoin, Ethereum, Litecoin and other blockchain-based
currencies (“cryptocurrencies”) are all the rage right now.
As a result, private investment funds that raise capital from investors
to invest in cryptocurrencies are also emerging.
Cryptocurrency funds present a more traditional way for investors to invest
in this emerging asset class, while reaping the benefits of professional
management. Investors in cryptocurrency funds can still get exposure to
this emerging asset class but don’t have to worry about the technical
aspects of keeping track of their cryptocurrency investment. In addition,
the concept of owning a share of an investment fund is more familiar to
However, because of their novelty, cryptocurrency funds present unique
legal issues. These are discussed below.
- First, are the underlying cryptocurrencies securities? – The answer
to this question matters because if the cryptocurrencies are securities,
then the fund manager is by definition providing advice regarding securities,
and therefore the fund manager is considered an investment adviser. If,
however, the underlying cryptocurrencies are not securities, then no such
Whether a given cryptocurrency is a security could be the topic of an entire
article, but in most cases, for purposes of establishing an investment
fund, the underlying cryptocurrency is considered a security. This is
because the fund is purchasing the cryptocurrency for purposes of capital
appreciation or income which comes from the efforts of others. It has been
reported that the Securities and Exchange Commission is studying this issue.
If, on the other hand, the given cryptocurrency is only a payment method
within a closed ecosystem (for instance, it can only be used to pay for
goods or services on that given network or platform), then it may not
be considered a security. The various rights that cryptocurrencies can
include are described in this
In most cases, the cryptocurrency will be considered a security; almost
all funds are formed for the purpose of pooling investors’ capital
in order to purchase one or more cryptocurrencies that are expected to
increase in value or generate income.
In addition, the interests in the fund itself will definitely be considered
securities, and therefore an applicable exemption from the Securities
Act must be found. In most cases, this can be done, however, the way in
which the cryptocurrency fund will be marketed must be taken into account
as well as the types of investors that will be targeted.
- Second, do you have to be registered as an investment adviser? –
Most start-up cryptocurrency funds are not going to meet the minimum threshold
of $150 million for SEC registration as an investment adviser for private
investment funds. As a result, they will be subject to state investment
adviser laws and regulations.
These state laws and regulations are all over the map. Some completely
exempt certain types of asset managers from registration as long as they
have only a few clients. Others require that the adviser submit a state
notice filing as an exempt reporting adviser. Others require a full registration.
(If you are planning on advising individual investors, rather than a fund,
on investing in cryptocurrencies or other securities, then in most cases,
you will be required to register as an investment adviser.)
Note that the state law that applies is where the investment manager is
located, not the state in which the fund is formed.
- Third, what about custody arrangements? – This is a separate issue
from investment adviser registration, but it is related.
Registered investment advisers have to comply with custody rules, which
means that they have to deposit their clients’ funds and securities
in registered broker-dealers and banks. Although the adviser will have
access to the funds through its investment advisory agreement or general
power of attorney, having the fund’s assets deposited in a regulated
entity such as a bank or broker-dealer is a cornerstone of investment
adviser regulation. These custody rules are intended to provide another
layer of oversight and a paper trail in case of wrongdoing by the investment adviser.
However, again, these laws are across the board, and they depend on which
state’s laws apply, and also on whether the adviser is required
to be registered. Some states require that the adviser (even if it is
exempt from registration) follow the same custody rules that apply to
registered investment advisers. Others do not.
- Fourth, what about fee arrangements? – Again, this is a state-by-state
issue. Some states prohibit performance fees (i.e. a percentage of the
fund’s return paid to the adviser) unless the investor meets certain
criteria (net worth, amount invested with the adviser, etc.). Others have
no conditions. This is one of the first issues that we discuss with a
prospective client, because performance fees are what provide most of
the income for investment advisers.
This is just a summary of some of the most important issues that are to
be taken into account when considering starting a cryptocurrency fund.
There are other considerations as well, such as other assets to be held
by the fund (if any) and if the adviser will advise other clients or investment funds.
Are you ready to start your cryptocurrency fund?
Whitley LLP Attorneys at Law helps sponsors of private equity funds, hedge
funds, and alternative asset funds (including cryptocurrency funds). We
will help you in all aspects of starting your hedge fund, private equity
fund, or venture capital fund, including forming your fund, registering
with the necessary state and/or federal authorities, and preparing the
documents necessary to raise capital from investors. If you would like
to speak to a professional on this matter contact us
online, or at the following phone number (888) 252-8277.