Gibraltar: Crypto Funds - Five Things To Put You In The Right Frame Of Mind

Last Updated: 20 November 2017
Article by Marcus Killick OBE

For those who do not wish to invest directly in cryptocurrencies or initial coin/token offerings, a plethora of funds are becoming available to enable you to invest in a range of these assets. These funds provide a convenient way to invest, help spread risk and, possibly, tap into the skill set of advisors who may have a higher level of knowledge. They may also get you access to pre-sales, so enabling you to acquire the coin/token at a discount.

Sound good? Well read the small print first. Here are five things for potential investors to consider before jumping in. The list is not exhaustive but I hope that it at least gets you thinking.

1. Heads they win; tails they win

Performance based fees can kill your profit. These fees arise from the operator of the fund taking a cut of any increase in the fund's value. Sounds reasonable until you realise they join you in any profit (possibly up to 25%) but are absent if the fund goes down. This means they cannot lose, and let's not forget that given the huge volatility of these funds, they are likely to benefit far more than you will.

To give a simple example: you invest $100. After the first year the value has risen 20% and is worth $120. You get to keep $15. They get $5. But, what the hell, you still made 15%. In year 2 the fund drops 20%, you are now left with $92 ($115- $23). Ok but at least no performance fees to pay. Then, in year 3 it is back up 20% ($18.4). Take out their 25% ($4.6) and you have made $5.6 in the three years. But the operator of the fund has taken $9.6 at NO risk.

Performance based fees stack the game against you in volatile funds. The higher the fee and the more frequent the charges are taken, the worse the stacking. Something to look for in the small print is whether the performance fees turn negative if the fund goes down in value. For what it's worth, also look for 'protections' such a hurdle rates (minimum return expected) and high water marks (which will require the operator to make good previous losses before being paid a performance fee - in other words, performance cannot be paid on an increase in value which only restores previous losses).

If  your fund doesn't have any of these, then it is 100% profitable, just not for you.

Oh, and if you are concerned how the operator will survive when they don't earn a performance fee, see if there is a "discretionary" management charge. If they don't make a turn on performance, can you guess when they will exercise their discretion?

2. What about conflicts of interest?

Is the operator also an adviser to any of the offerings they are putting the fund into? If so, do they get a fee (normally a % of the money raised)? Some advisors are sector specialists, others are there to bring in investment. If the operator gets a cut from any investment they bring in, are they sharing it with the fund investors or keeping it to themselves? If the latter, in whose interest are they investing your money? Check to see if there is a disclosure in the investment documentation, if not, ask.

3. Is it worth what they say it is?

How is the fund valued? Many token/coin investments are not that liquid. This can lead to a difference between the price they are listed on the market at and what you can actually sell them for, particularly if you are in a hurry or have a lot to shift. Is the fund therefore being valued on its realistic sale price or on what it would cost to buy the assets? Also who is actually pricing the tokens/coins and is anyone auditing the fund? Where you have a fund with high performance fees, all these matters are critical.

Not all funds are created equal. For that reason, another point to bear in mind from a regulatory perspective is that if a fund will be investing in coins/tokens, and the tokens are found to be securities, the fund could be indirectly affected if the token issuers are found to be in breach of securities laws. The token issuer's activities could be permanently suspended, which would in turn mean that those tokens could be rendered worthless or the fund could incur liabilities if it knowingly invested in a security being sold as a token and was doing so by way of business.

4. Remember: you are on your own

Is the fund regulated? Probably not. Most are private funds. These cannot be publicly sold but rather are targeted to a limited number of investors. Nothing wrong with that but it means they are often outside any regulations or regulatory oversight. Therefore there is no one to turn to if things go wrong, apart from the courts or the police.

5. Who do you trust?

Who is actually operating the fund? Are they experts? Have they a track record? As these funds are generally unregulated no one has checked the bona fides of the people behind them. Are they a Buffett or a Madoff? How much do you trust your character assessments?

A key point to consider in the trust stakes is how robust a fund's safekeeping arrangements of the crypto assets are - remember that these assets are not physically held anywhere, in the same way as cash or securities would be in a more traditional fund model.

Funds that invest in crypto assets are a way forward, with many benefits for the investor. But these are early days and, in the map of the crypto world, this is one area that should currently be marked "Here be monsters".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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