So You Want to Manage a Cryptocurrency Fund? U.S. Regulatory… | THSH

As of October 2017, the number of hedge funds that trade cryptocurrencies such as bitcoin reached over 100, according to newly data from Autonomous Next, a leading fiscal technology ( fintech ) research provider. As more investment managers look to enter the cryptocurrency space, both extra rule and increased enforcement of existing regulation can be expected. many questions arise regarding which regulative agencies have jurisdiction over this evolving market and what implications such regulation will have on the funds and managers that participate .
Are digital tokens securities under the jurisdiction of the U.S. Securities and Exchange Commission ( SEC ), commodities contracts over which the Commodity Futures Trading Commission ( CFTC ) has jurisdiction, or a unlike form of fiscal instrument topic to other regulations ? The answer to these questions could trigger a host of regulative implications for funds investing in bitcoin and other virtual currencies and the managers of these funds .

SEC Regulation

In deep July 2017, the SEC issued steering bespeak that digital tokens can be regulated as securities under federal securities laws. The SEC provided this guidance in its Report of Investigation pursuant to Section 21 ( a ) of the Securities Exchange Act of 1934, in which the SEC reported on its probe of a 2016 offer of digital tokens sold by The DAO, an unincorporated on-line organization ( the “ SEC Report ” ). [ 1 ] The DAO sought to raise capital by exchanging DAO tokens for other cryptocurrencies through an initial mint offer ( ICO ). ICOs are an increasingly democratic, but ( for now ) largely unregulated, method acting used by start-ups and other ventures to raise capital through customs digital coin offerings. In an ICO, supporters of the venture purchase request cryptocoins ( referred to as “ tokens ” ) using decree, or as in The DAO case, virtual currency. These tokens are exchangeable to the shares of a party which are sold to investors in an initial public put up ( IPO ). The tokens are intended to be used as a method of payment for the products or services being developed by the company issuing them ; investors are motivated by the hope that their tokens will increase in prize .
The SEC Report states that, depending on the facts and circumstances, the put up and sale of digital assets may be treated as trading securities and fall under the federal securities laws. If classified as securities, the issuers of the applicable digital assets must register offers and sales of such securities unless a valid exemption applies. The SEC did not create a blanket regulation that all tokens are securities, but quite stated that it will consider the facts of each position on a individual footing to determine whether an offer of a particular cryptocurrency qualifies as an propose and sale of a security system. The SEC Report found that DAO tokens were securities and, therefore, subject to the union securities laws. however, the SEC did not pursue any charges against The DAO for failure to register the offer of DAO tokens, but released its finding “ to caution the diligence and marketplace participants ” and advise those that use blockchain [ 2 ] engineering for capital raise to take the necessary steps to ensure submission with the securities laws. The SEC Report sets a precedent for the entire blockchain diligence.

How does the SEC Report affect investment managers looking to start and manage cryptocurrency hedge funds ? While most funds will not be looking to launch an ICO, if the SEC treats cryptocurrencies as securities, managers of funds that invest in cryptocurrencies may need to register as investment advisers with the SEC under the Investment Advisers Act of 1940, as amended ( the “ Advisers Act ” ). The Advisers Act defines an investment adviser as any person or firm that for recompense is engaged in the business of providing advice to others, or issuing reports or analyses, regarding securities. A firm that meets the definition of “ investing adviser ” must register with the SEC unless sealed exemptions or exclusions apply or it does not meet a understate size doorsill. If cryptocurrencies are treated as securities, investment advisers that invest in these products on behalf of their advisory clients must determine whether they are required to register with the SEC .
furthermore, the classification of cryptocurrencies as securities can create a unique complaisance effect for SEC-registered investment advisers ( RIAs ) trade these instruments. RIAs are required to adopt a code of ethics which requires employees to report their personal securities trade activities to the RIA ’ mho headman complaisance officeholder and to provide brokerage house statements and reports to confirm such personal trades. As tokens and cryptocurrencies are broadly not traded on public exchanges or through registered broker-dealers, these trades can not be confirmed in the traditional sense. An RIA that invests in cryptocurrencies, or whose employees make these personal investments, should update its code of ethics to address these issues .
In addition to RIA adjustment issues for investment managers, the SEC Report has regulative implications for the individual funds that invest in cryptocurrencies. Under the Investment Company Act of 1940, as amended ( the “ Company Act ” ), an investment company is broadly defined as an issuer that is “ engaged chiefly, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities, ” and owns or proposes to acquire “ investment securities ” having a respect exceeding 40 % of the prize of such issuer ’ south sum assets. If cryptocurrencies are considered securities, a fund that holds a significant amount of these instruments may be deemed an investment party, triggering regulation under the Company Act absent an applicable exemption .

CFTC Regulation

While the SEC Report helps to clarify the SEC ’ sulfur position on ICOs, it remains unclear where this leaves other regulators like the CFTC. Currently, the CFTC does not treat investments in bitcoins or early virtual currentness units as “ commodity interests ” under the Commodity Exchange Act of 1936, as amended ( the “ CEA ” ). The CFTC, however, write out orders in 2015 and 2016 in which it found that futures, swaps, and other CFTC-regulated derivatives that reference digital currencies are “ commodity interests ” that ( absent an applicable exemption ) would require registration by a coach as a commodity pool hustler ( CPO ) and commodity deal adviser ( CTA ) in orderliness to trade such derivatives in a store .
In September 2015, the CFTC released an enforcement military action and settlement order ( the “ Coinflip Order ” ) against an unregistered on-line trade platform for facilitating the trade of bitcoin options and futures contracts without required registrations. [ 3 ] The operator of the platform made available for trade, put and call option contracts in which bitcoin was the reference asset for the options contracts and the hit and pitch prices were denominated in U.S. dollars ( premiums and settlement payments were to be made in bitcoin at the spot exchange rate ) .
In the Coinflip Order, the CFTC concluded that “ bitcoin and other virtual currencies are [ encompassed in the definition and ] by rights defined as commodities. ” As a result, options contracts that reference a virtual currency qualify as “ commodity options ” and “ commodity option transactions. ”

The Coinflip Order provides that derivatives ( including futures, options, and swaps ) that reference point cryptocurrency units will be treated as commodity interests ( not the actual cryptocurrencies themselves ). These instruments will, consequently, count towards the CFTC Rule 4.13 ( a ) ( 3 ) de minimis exemptions and may require a director of a investment company that invests in derivatives that reference cryptocurrencies to register as a CPO and possibly as a CTA. As the Chicago Mercantile Exchange ( CME ) and CBOE Futures Exchange have announced that they intend to launch bitcoin futures by the end of this year ( or early next year ) and Nasdaq recently announced that it intends to introduce bitcoin futures in the first half of future year, this publish will become more significant for fund managers .
In the consequence the CFTC determines that bitcoins or other virtual currentness units fall within the definition of a “ commodity concern ” under the CEA, investing managers of funds that invest in such instruments may be subject to extra rule under the CEA and CFTC. such managers may be required to register as a CPO or CTA with the CFTC, become a extremity of the National Futures Association and be submit to extra regulative requirements with obedience to funds that they manage, including with respect to disclosure and report requirements .

State Regulations

tied if a coin or token is not deemed to be a security or a commodity concern within the jurisdiction of the SEC or CFTC, the legal document may still be treated as a security system under state law and/or may be subject to other state laws. New York is presently the only state of matter to implement regulations specifically designed to cover cryptocurrency action. New York has established a BitLicense Regulatory Framework which requires sealed participants in a “ virtual currency business activity ” to obtain a license to transact clientele within New York ( and/or with New York residents ). Under the regulations, “ virtual currency commercial enterprise activity ” covers transmitting, storing, holding, and maintaining control of virtual currency ; buy and selling virtual currentness as a customer clientele ; performing switch over services as a customer business ; or controlling, administering, or issuing a virtual currency. While New York ’ mho BitLicense requirement may apply to investment managers who issue digital coins or otherwise act as an exchange chopine depending on the facts and circumstances, it is improbable to implicate an investment coach who is only buying, selling and holding cryptocurrency coins for the accounts of its clients. however, such regulations demonstrate that states are beginning to look for ways to regulate the instruments .


investing managers looking to launch an investing fund that invests in bitcoin and/or other virtual currencies will need to consider the regulative impingement on the fund and the investment adviser. The SEC has recently indicated that it may treat digital tokens as securities and the CFTC has issued orders finding that derivatives that reference cryptocurrency units are treated as commodity interests. In lighter of these pronouncements, investment managers should proceed with caution in launching these funds to ensure that the managers and the funds themselves are in submission with all relevant regulations. As the cryptocurrency market continues to evolve, participants at all levels should expect the space to be subject to a higher degree of regulation and enforcement .
[1] Release No. 81207 / July 25, 2017.

[2] The public daybook on which bitcoin transactions are recorded .
[3] In the Matter of Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Docket No. 15-29 ( September 17, 2015 ) .
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