In this edition of the Hugely Popular Cummings Pepperdine Crypto Questions, we revisit the first episode where Claire Cummings is joined by Ian Gobin, Partner for Cummings Pepperdine and they talk about the issues with what to watch out for when you’re setting up a Crypto Asset Fund.
Claire and Ian discuss risk warnings, fund custodians, valuations, insurance and bank accounts for your crypto fund.
The topic is as relevant now as it was when it was first recorded.
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Cummings Pepperdine is a unique leading legal advisor on crypto and alternative assets, advising a large and diverse global client base and the only firm to provide a complete solution building on the three key areas of law, tax and FCA with legal underpinning at every point.
Visit www.cummingspepperdine.com for more information.
In this edition of the Hugely Popular Cummings Pepperdine Crypto Questions, we revisit the first episode where Claire Cummings is joined by Ian Gobin, Partner for Cummings Pepperdine and they talk about the issues with what to watch out for when you’re setting up a Crypto Asset Fund.
Claire and Ian discuss risk warnings, fund custodians, valuations, insurance and bank accounts for your crypto fund.
The topic is as relevant now as it was when it was first recorded.
--------------------------------------------------------------------------------
Cummings Pepperdine is a unique leading legal advisor on crypto and alternative assets, advising a large and diverse global client base and the only firm to provide a complete solution building on the three key areas of law, tax and FCA with legal underpinning at every point.
Visit www.cummingspepperdine.com for more information.
Hello and welcome to the Cummings Pepperdine hugely popular crypto questions. I'm Claire Cummings from Cummings Pepperdine and we're an advisory firm based in London and we work with helping our clients with the three key areas of law, FCA and tax. And in this edition of our hugely popular crypto questions, I'm going to be talking to Ian Gobin about the main issues that somebody who's setting up a crypto fund needs to bear in mind and how we can solve them. Now, a word of background here, Ian and I have known each other now for about 20 years. I can't tell you what we were both wearing when we met. That's another story. But Ian, hello. Tell us about you.
Ian Gobin:Thank you, Claire. That's hilarious. known each other for the best part of 20 years and the first sort of 10 years of our relationship we never actually saw each other.
Claire Cummings:It was so weird when we met I had to close my eyes.
Ian Gobin:Anyway, we digress. So today we're here to talk about the issues with what to watch out for when you are setting up a crypto asset fund.
Claire Cummings:So Ian, you and I have been working on the structuring and growth of hedge funds for many years. And then a few years ago, at the same time, we both ended up working on crypto matters when they were quite nascent, really. And we started that early on setting up. crypto funds in Cayman. Now, I think a lot of what we talk about is going to be based on how you set up a hedge fund because there's a good sort of set of precedents there and it all works. But before we go on to talk about then the additional and the extras that you need to think about crypto, tell me more about Cayman and crypto funds.
Ian Gobin:Yeah, you're right, Claire. You know, I think that's what's important is that, you know, fundamentally, these are registered hedge funds or mutual funds in the Cayman Islands, or they could equally if they're closed ended, they could be registered under the Private Funds Act. But either way, they're going to be registered entities in the Cayman Islands. We both got into this space about eight years ago with our first crypto fund that was just buying. Obviously, now things are significantly more sophisticated. The market has evolved hugely. So with a crypto fund, you're looking at all of the standards or relatively standard considerations that you would look at for mainstream asset class, although we're all in the alternative asset space here, but still relatively mainstream. In addition to that, You've got the crypto sleeve of considerations that we're going to run through today on top of the usual stuff.
Claire Cummings:Okay, and on that crypto sleeve, which I think is a rather nice way of putting it, I like that. How about, can we start, there are a few things to think about, but first of all, shall we start about thinking about the risk factors? Now, there is a view. sometimes rightly, sometimes wrongly held that crypto is inherently more risky and inherently more prone to money laundering. This, of course, has to be dealt with in the offering memorandum for the fund so that all investors know about the risks that are inherent. And not only is that sort of thing. information which investors do need to have. It also protects the fund manager as well, so it works for all parties to have a good set of risk warnings and everybody know what they're doing. Can you talk a bit more about the kind of risk warnings that you and I have drafted and looked at for some of the Cayman crypto funds we've worked on together?
Ian Gobin:Sure. You know, you're, you're right. You know, disclosure is key and no one should be afraid of, of sort of disclosures. They are a good thing. It's, it's important to tell your investors everything in terms of what you're going to be doing with this fund. You're not going to be giving away the the secret source of proprietary trading information, but you are going to be telling investors. Everything you're going to be doing with them, how potentially it could be lost and everything associated with the fund going up or the fund going down. That's standard with any fund. But there are crypto specifics that Clive's mentioned that we need to go through. So fundamentally, we need to disclose away the legality of the digital assets. We know that this is a unregulated market. And we need to disclose the fact that we're buying assets that are unregulated. We're buying them on exchanges, which are fundamentally unregulated. That's, we also know that there can be liquidity issues. We're not going to be disclosing, as I mentioned, the investment strategy ins and outs, but we are certainly going to be saying what we're trading, where we're trading. And what we're trading. Yeah,
Claire Cummings:and I think then there are the other things which are additional and only crypto. So it's things like staking mining issues going, going wrong. Inevitably the sort of the theory of theft and whether an asset is itself proper. A proper property, if that makes it right, which it is now in the UK, but it isn't, but it isn't everywhere.
Ian Gobin:No, and everything that you're doing in terms of, you know, whatever your policy is on custody, valuations, insurance, coin provenance. Everything is, is disclosable, both as this is what we're doing and then the corresponding risk factor.
Claire Cummings:Well, can I pick you up there on the, on the issue you just mentioned in particular, if we could just talk a bit about custody. Obviously a fund needs to have a custodian. And we spend quite a bit of time in the UK thinking about how a custodian custodies within wallets and the UK money laundering regulations on wallet providers, you know, when they're in the UK, it's an EU thing really, but you know, we're working in the UK. Can you tell me a bit more about the custody issues for a crypto fund and how they are sold? Because it's, it's fine for us to sit here and take it, get everybody worried, but actually. We're in the job of providing solutions. So what are the issues? How do we solve them?
Ian Gobin:Sure. So custody has evolved a lot over, over the kind of, over the last eight years, you know, eight years ago, we set up the fund that was, that was trading Bitcoin and, and the, the phrase self custody was the one that, because no one was providing custodial services, the regulated banks. Couldn't touch it. And no one else was in the space. Over time, crypto custodians have, have
Claire Cummings:evolved. And they've come and gone as well, haven't they, actually? Not everybody who started is still, is still there.
Ian Gobin:They've been bought by other shops, or they've, or they've gone out of business for various reasons. But you, you know, that, that's all part of the evolution of this market, you know? Yeah, yeah, very
Claire Cummings:much so.
Ian Gobin:But I, I think that... You know, again, fundamentally, it's about what are you doing with security and how are you trading your, your, your assets? You can't just leave them on an exchange. Exchange can be hacked. We all know that depending on which exchanges you're on, et cetera. So it's all about setting out just what your trading strategy is. That's the first thing to do. And
Claire Cummings:you're absolutely right. Yeah. The trading itself is, I mean, I know the one custodian we do a lot of work with, you, you can go within a walled garden to trade. So you've got an extra layer of security. Trading itself is still an area of concern and potential theft. Yeah. I
Ian Gobin:think that, you know, a few people now are involved in in self custody, you know, that the, The exchanges, again, I keep using the word fundamentally and sophisticated, but fundamentally the exchanges are now more sophisticated and many offered custodial solutions too. You've now got US national federal banks that are licensed to take on crypto custody. So there's been a huge evolution. You look at Bitco, Coinbase custody, Digivolt, Gemini, these are all giant digital custodians in the space now. Very, very sophisticated offerings. There's no excuse anymore in terms of, Oh, I'm just going to self custody., it doesn't work and investors are not going to run with that.
Claire Cummings:Yeah, put it this way, would you invest in a crypto fund that was self custodying? I wouldn't.
Ian Gobin:I think that plenty of people have because the investors in the
Claire Cummings:space. Now, yeah, but now, I think in the past, yes, but when there weren't solutions and it was probably, you could argue that it was the safest option. Now, I think that third party, an extra pair of eyes, a third party provided that, that, that custodian is secure. So, for example, you know, Gemini is, is regulated in the, in the UK. Copper is regulated. I find it hard to believe that you can do self custodying, which is as strong as those guys.
Ian Gobin:It's going to be the first red flag that comes up on a DDQ from an investor. Yeah, it is, yeah. And, you know, if the answer is, oh, I've got an account with Anchorage, great. That's it. You've ticked that box. Move on. If you, if you say no, it's all self custody. It's, it's, it's, it's one eyebrow up. It's like, well, why are you doing that? And I can't think of a single reason that would justify a self custody for a fund these days.
Claire Cummings:Yeah, exactly, nowadays, yeah. The other, the second thing you mentioned, actually, you talked about custody and then valuations, insurance, a couple of others. Let's, shall we talk a bit more now about valuations, because one of the critical things to get right in and fund offering memorandum is how, is what the fees are and how are they calculated. And you can't calculate the fees without calculating the NAV. Now, under AIFMD included, the investment manager has to be responsible for this, although inevitably the administrator is the person who helps a great deal. Can we talk a bit about whether our crypto assets, and I know that's a sort of a huge sort of covering term, are they hard to value, are some hard to value? How do, how do, how do you and I find a solution for people on the valuations?
Ian Gobin:Yeah, look, I, I think that it's, again, it's just down to disclosures and, and also the,
Claire Cummings:the risk And pick your, counterparts
Ian Gobin:as well. Yeah, so, you know, clearly there's, there's going to be a, a risk factor on arbitrage, different exchanges pricing things differently. These are all unregulated exchanges. I think that will, that will change everything. But right now they are unregulated, so there can be, as we've seen, wide movements of pricings.
Claire Cummings:Yeah. And that's another, and that's also another one for the risk factors, isn't it? So, and,
Ian Gobin:and for reasons that all, all of that falls into your valuation, you policies, and you, you, you'll work with. Both your onshore lawyer, your auditors, in order to work out what and how your valuation strategy is going to operate. Just make sure that you use it and you apply it and you never away from it.
Claire Cummings:Yeah, because, yeah, because it's not as if, you know, in, in the hedge or PE world, it's not as if the, you know, the fund world doesn't understand hard to value, doesn't understand fast moving dynamic markets. It's just the question of making sure you've got the wording right. You've got counterparts. And, and functionaries who can do it. And you do actually say what you're going to do. So you haven't got investors coming back later saying that there was something fraudulent.
Ian Gobin:No, with this asset class, although there are some unique features to it, you know, at the end of the day, this is still an investment fund and all the usual things that occur in an investment fund will occur with a crypto
Claire Cummings:fund. Yeah. And there's so many sort of established ways of, of, of gaining prices that Yeah, I mean, you know, sometimes, sometimes it's I find it's quite useful just to refer, refer back to some of the ista wording and use that Yeah.
Ian Gobin:Every have a, a, a liquidity risk factor. So will crypto. Yes. So it, it's nothing to be particularly worried about it. And if you are an, I just gotta get it right though, haven't you? You've already looked at it. You know what that's, what that should be saying, making sure that that's the policy that's being
Claire Cummings:adopted. And then insurance, Ian, that was the, that was the other, that was one of the other points that you mentioned. Yeah. It's been, it's been, it's been an interesting one, but there have, you know, again, huge developments in the world of the insurance that's available for
Ian Gobin:people. And you know, obviously at the end of the day, the market has needed the global insurance providers to, to kind of get interested in this space. And they have done that, which is why it's evolved. It started off with the concept again of self custody. So the manager was self custody, right? Okay. The exchanges would self custody or it was, we're, we're balance sheet protected, but we heard all that. I believe.
Claire Cummings:Yeah,
Ian Gobin:exactly. Where it's gone now, look that there are some really good options, but again, it depends on the pricing for your, for your crypto insurance is going to depend on what your strategy is and which exchanges you're trading on. Yeah.
Claire Cummings:How good your counterparts are, how good the whole model is, who are the functionaries you've got in place. Yeah. They're on
Ian Gobin:Bifinance, Coinbase, Gemini, these are all exchanges that are, that carry insurance. So they only, they only have insurance because they have outstanding cyber security protections.
Claire Cummings:So in other words, due due due diligence. On who you will have as your, as your counterparts and that due diligence needs to include what their insurance is.
Ian Gobin:Yeah, you know, you'll talk to Copper and say, okay, so tell me what, what, how, how my assets are going to be insured with you and for what? Because that'll put that's part and parcel of the disclosures you're going to make in your offering documents. Yeah. It's going to tell you the, the, the insurance providers, you know. Aon roughly covers about 50 percent of the insurance market for Cryptac. So when you're chatting with them, you're going to be telling them which exchanges you're trading on, which coins you intend to buy, etc. What coin provenance software you're going to use. They, they are then going to price up the insurance. Now, it may be that you don't want insurance. That you feel that it's, it's not of value because of the exchanges you're trading on. That's fine. Tell your investors that. Yeah,
Claire Cummings:you've got to disclose that. Yeah. Yeah. Investors need to know that it's not there. It would be an act of omission not to tell them. Yeah. And
Ian Gobin:then it's a question of, you know, what is being insured and how? Is, is it in specie insurance , or not? So we, we, we can get in the ins and outs of, of, of, of all that kind of stuff, but it's, you're, you're not going to be insuring for the, for the values going up or down. You're, you're, you're really going to insuring for the cyber at the end. Yeah, for safety. Yeah. Frankly, in my view, it's important to have, in addition to what the exchange covers, you've got a, effectively, you have double insurance if you're trading on the main exchanges.
Claire Cummings:And well, just where we're talking about cyber hacks and so on, one quick, one other question which you and I both get asked all the time, what about a bank account?
Ian Gobin:Yeah, again it's something which was, at the beginning of this market, very, very challenging. Actually at the beginning, it wasn't so challenging, a lot of people were offering bank accounts.
Claire Cummings:That was, that was the problem. There were too many of them. And then, yeah, and then the bad boys disappeared. And
Ian Gobin:ICO boom, that's when everyone ran for cover on in the banking world. There are, there are providers out there that provide insurance and that they're specialist.
Claire Cummings:bank accounts as well. Yeah.
Ian Gobin:Yeah, absolutely. Now, often it will depend who you are and just how much you have as to whether they're interested in you or not. But there are solutions around banking.
Claire Cummings:Yeah, definitely. So I think then if we could just come on to my last question. question for you in our crypto questions. And they're, they're kind of related, really. How do you deal with, or how do you advise people deal with coin provenance? And that ties in with in species subscriptions, because it's really not unusual with it, with a crypto fund, to have a non fiat, but an in species subscription.
Ian Gobin:Look, it's my favorite question.
Claire Cummings:And it's, you know what, nobody can see you apart from me, but you're there sort of with your head in your hands.
Ian Gobin:Yeah, because it's not for me because I, I really like this and I, I push it hard, but I get pushback from people on it.
Claire Cummings:You are so right. And there same thing here. You push, you push, you push because you've got to know all the way through, haven't you? The whole life cycle's got to be open, dis disclosed, transparent, and look right now,
Ian Gobin:do you wanna be buying, do, do you want to be selling up a fund where you are buying coins that are linked directly or indirectly to the Kremlin? No, you do not. So it's about coin provenance you can find, you can. Follow the chain. You can find out where, where they were mined, who's held them. And the CoinProvidence software that's out there with the likes of CoinPath, Global Ledger, Chainalysis, Coinbase Analytics, there's a whole rack, there's a whole industry. They can risk rate the coins for you. It mitigates your risk. And they
Claire Cummings:can do it. So, I mean, I, I, I was, I was Chainalysis had just popped something up. Way back, one person, a few years ago, is something as simple as, maybe 20 years ago, they, they, they were late on their poll tax or something, it's so sophisticated now, so, yeah, there's no, there is, there's no, there's no excuse, really, for playing dumb, when we, as also, we all know that, yeah, this is, The bad boys send the money for things like child pornography, the North Korean Missile Program, the Kremlin, it's, you know, it, nobody wants to be part of that.
Ian Gobin:Well, you wanna make sure that you're not buying that stuff and Themselves that the main exchanges do a really good job. But, but again, you, they, they're deploying such software. But you as a manager, you know, my view is that you should be ensuring that you are using coin provenance. The investors monies are not at risk with such, such coins or such coins being, being purchased by you. That ultimately could, if they have been stolen, if they are linked elsewhere, could suddenly become void. At the end of the day, in addition to the moral sort of factors and issues that I feel very strongly about, there is a risk that it will turn to dust. You, you have a producery as well as a legal obligation to ensure that what's being purchased is worth what it is.
Claire Cummings:Yeah, yeah, where it comes from, what it is, all its characteristics. Yep. And that's not just in what you're purchasing. It's a fund that takes in specie subscriptions as well, isn't it?
Ian Gobin:It's on the specie piece, you know, at the beginning of the market, we saw some of the fund admins, you know, take on in specie subscriptions, but mainly from the principles of the funds. How the principals would get their assets into the fund so others could share with. Well, it's often,
Claire Cummings:yeah, it's often their own money, own money trading built it up. Yeah. Taking it from other people is, is, is a slightly different line of entry.
Ian Gobin:And coin problems didn't really exist in those days either. So it was very much lucky in the whites of the eyes of somebody and sort of saying, okay, give me enhanced due diligence on yourself, your source of wealth, all that kind of stuff. Obviously now it's significantly more expensive sophisticated with the software that's in place. And on, on, on, on expense, it doesn't cost you up. You know, so it's just something that should be commonplace and everyone use it as an industry standard. In specie, subscriptions are still an issue. A lot of the main admins won't, won't sort of do that or if they do, there's a, there's a, there's a price tag. Yeah, there's a cost to it. And that's, well, who pays that? Should it be the investor that pays? Probably. And should it be the manager? It could be. Is it the fund? There can, could be situations where it's worthy of the, of the funds , to pay for , the enhanced. Costs for the diligence over an InSpecies subscription, so it's all on a case by case basis.
Claire Cummings:And I think also if there is that cost and it's, it's more than material and it's going to the fund and it's being paid by all investors, whereas you, and if you only have a couple who are making InSpecies, again, going back to what we said in the beginning, I think that's also a matter for disclosure, isn't it?
Ian Gobin:Yeah,
Claire Cummings:it totally is. And it'll turn up in the accounting. Get it out there before anybody comes in.
Ian Gobin:Yeah. You know, it's a conversation you need to have with your, with your, with your admin and your audits to make sure that people are comfortable that this is going to be happening and, and to stress test the, the policies and procedures that are in at the fund administrator to, to ensure that this can happen or indeed. If they have a blanket ban, no, we can't, we won't be doing that for you.
Claire Cummings:Yeah, and it does, and yeah, and I know that when you and I put fee proposals together for people, we do say it's going to be, it's going to actually cost, legally it's going to be a little bit more if it's not, if it's in specie, because of the work involved, but you know, it works for some people, it doesn't for others. It's very much a commercial decision that everybody makes depending on their own commerciality.
Ian Gobin:From a marketing perspective, it always looks kind of sexy. Hey, we'll take subscriptions in this BC. When it actually comes down to it, most of the people, most of the investors want to hold on to the crypto that they've got, and they're not looking to really settle it into a fund. Some may, but they're looking to spread their risk. They're investing in a fund to spread the risk. And the portfolio maintain the crypto that they've got.
Claire Cummings:Yeah. Yeah. It's like, it's like other types of commodity fund in a way, isn't it? Which I always think crypto is quite similar to that. You know, do you want, do you want to liquidate your commodity positions to go into cash to go into a fund or do you want to put, keep your positions and also make your own investment in cash? So yeah. Yeah. Ian, it has been so lovely to catch up with you. You're not looking any older. You're fully dressed.
Ian Gobin:I'm fully dressed, yeah. And now that I have two babies, it's, but the last two years have been very interesting for everybody.
Claire Cummings:Ian, thank you very much. And just for Cummings Pepperdine, it's cummingspepperdine. com and Ian and I both look forward to speaking to you. Thank you very much for listening and goodbye.