European Union: Lucy Frew's FinTech Column: February 2018

Last Updated: 12 February 2018
Article by Lucy Frew

Developments in regulation of cryptocurrency funds

The surge in global cryptocurrency markets over the last year has been remarkable. From a legal perspective, it is notable that the response of worldwide regulators is not only inconsistent but in flux.

Regulatory impact on price

There have been a number of regulations and policy statements from with the US, Asia and the EU, including the UK. Each represents a meaningful share of global participation in cryptocurrencies. The starting point has been currently that cryptocurrencies are generally unregulated. Interestingly, a major contributing factor in rapid price fluctuations in cryptocurrencies is the ongoing changes in regulation of cryptocurrencies throughout the world that impact investors' ability to buy and sell cryptocurrencies.

Although regulators are voicing concerns over the potential risks and challenges of investing in cryptocurrencies, in many cases they also acknowledge potential benefits. This tension between risk and benefit, together with the very real challenges of regulating this revolutionary new asset class, means that worldwide regulatory developments are not easy to predict. For the most part, regulators have been reluctant to introduce bans and in some cases have made marked efforts to be regarded as cryptocurrency-friendly. Overall, however, it is hard to imagine that there will not be a marked increase in government oversight and regulation of cryptocurrencies going forward. For now, at least, continuing volatility resulting from worldwide regulatory developments seems inevitable.

So where does that leave investment managers and advisors?

Volatility is not necessarily unwelcome for investment managers who have the expertise to incorporate it into their strategies. While cryptocurrency investment divides opinion between investment managers, cryptocurrency funds (in other words funds that trade in cryptocurrencies and related products) have generated very strong results in recent months and there has been an increasing trend in such funds being launched. We also are seeing a number of fund managers wishing to go a step further and accept subscriptions and offer redemptions in cryptocurrency.

Until now, however, there has been little specific regulation or guidance from regulators to assist investment managers, advisors and distributors (or their legal and compliance staff) on how to deal with cryptocurrency investment in practice. In the UK, managers and advisors are subject to regulatory requirements and must work out how these apply in the context of cryptocurrency and related investments.

Lead regulators' response

Although the UK's FCA has been at the forefront of regulating financial innovation in recent years, it is now the US Securities and Exchange Commission (SEC) that is taking the lead in developing a detailed regulatory approach to cryptocurrency investment. Throughout 2017, the SEC issued various investor alerts, bulletins and a statement on cryptocurrencies and ICOs.

On 18 January 2018, the SEC's Division of Investment Management issued a letter that addresses a number of granular issues arising from funds focused on cryptocurrency-related products. The letter suggests that the SEC remains open to cryptocurrency funds, especially beyond the retail market. However, before being willing to move ahead on cryptocurrency funds aimed at the retail sector, the SEC requires feedback from the industry on a number of specific questions relating to cryptocurrency funds including the valuation, liquidity and custody of their underlying assets. While the SEC raises questions rather than providing answers, these questions, some of which are discussed below, provide a good indication of the way the wind is blowing. The SEC's main concerns from an investment perspective are in the areas of valuation, liquidity and custody. These are likely to be where investors require assurance too.

Operational challenges

The legal and regulatory framework at the level of the cryptocurrency fund is the same as for other types of alternative investment funds (AIFs). Nevertheless, a cryptocurrency strategy does present particular administrative and operational challenges that must be addressed both in practice and in legal drafting. The concepts around the traditional hedge fund services of administration, audit, custody and prime brokerage all require rethinking to reflect the fact that cryptocurrencies are virtual assets. A small but ever increasing minority of service providers are offering specialised services to cryptocurrency funds. This is a fast developing area.


In particular, custody of assets for a cryptocurrency fund is very different to that for a standard fund. It is not, technically, cryptocurrency itself that is held in custody. Rather, it is the unique private key in respect of any cryptocurrency transaction that is the true asset. Loss of a private key is an unacceptable scenario for a fund manager as there is no other way of accessing the cryptocurrency. The SEC states that it is "not aware of a custodian currently providing fund custodial services for cryptocurrencies". However, in fact certain specialist custodians have established themselves as leaders in institutional custody of digital assets, although at this stage service offerings cover only a small subset of the universe of cryptocurrencies. Given the costs and limited nature of institutional custodianship, some fund managers in the space have opted for self-custody, but this is a complex and time consuming exercise.

The SEC asks:

"... how would a fund intend to validate existence, exclusive ownership and software functionality of private cryptocurrency keys and other ownership records? To what extent would cybersecurity threats or the potential for hacks on digital wallets impact the safekeeping of fund assets?"

Auditors of cryptocurrency funds need to be highly specialised, not only in audit but also blockchain technology, in order to be capable of verifying ownership of cryptocurrency.

Cryptocurrency derivatives

CME Group has recently launched bitcoin futures trading on its platform, aiming to get an early movers' advantage in the volatile but fast-growing asset class. The SEC states that:

"While the currently available cryptocurrency futures contracts are cash settled, we understand that other derivatives related to cryptocurrencies may provide for physical settlement, and physically settled cryptocurrency futures contracts may be developed. To the extent a fund plans to hold cryptocurrency-related derivatives that are physically settled, under what circumstances could the fund have to hold cryptocurrency directly? If the fund may take delivery of cryptocurrencies in settlement, what plans would it have in place to provide for the custody of the cryptocurrency?"

At least some custody-related challenges may be overcome by investing in cryptocurrency-based derivatives rather than cryptocurrencies themselves.


The SEC asks:

"How would funds take into account the trading history, price volatility and trading volume of cryptocurrency futures contracts, and would funds be able to conduct a meaningful market depth analysis in light of these factors? How would a fund prepare for the possibility that funds investing in cryptocurrency-related futures could grow to represent a substantial portion of the cryptocurrency-related futures markets? How would such a development impact the fund's portfolio management and liquidity analysis?"

The SEC's concerns relating to liquidity arise primarily in the context of funds offering daily redemptions, which is uncommon outside the context of retail funds. Liquidity is also an issue outside the retail fund context, but there are a range of mechanisms available that are traditionally used by AIFs to manage this.

The role of exchanges

Rather than working with large banks and traditional prime brokers, it is necessary for cryptocurrency fund managers to establish relationships with exchanges. Some cryptocurrency exchanges function as gateways between the fiat currency and cryptocurrency universes, while others operate only within the latter. Many exchanges cater to retail, as opposed to institutional, needs so managers may need to consider also working with brokers for over-the- counter transactions. Managers will wish to carry out extensive due diligence and spread assets across numerous exchanges to reduce risks relating to cybersecurity and server failure.

Exchanges are an area where regulators are able to at least partially regulate the entry and exit points – in other words converting fiat currency (dollars, pounds, euros) to and from cryptocurrency – to the cryptocurrency marketplace from the perspective of anti-money laundering (AML) and counter-terrorist financing (CTF).


Appropriate valuation is important because, among other things, it determines fund performance, what investors pay and what they receive when they redeem or sell. Funds must value their assets in order to strike a new asset value (NAV). Fund accounting and valuation are traditionally areas where an administrator provides expertise. The SEC asks:

"Would funds have the information necessary to adequately value cryptocurrencies or cryptocurrency-related products, given their volatility, the fragmentation and general lack of regulation of underlying cryptocurrency markets, and the nascent state and current trading volume in the cryptocurrency futures markets? How would funds develop and implement policies and procedures to value, and in many cases "fair value", cryptocurrency-related products?"

The role of fund administrator must also take into account that transactions are stored on blockchain. If it is intended that a fund should accept subscriptions and provide redemptions in cryptocurrency, more complex challenges need to be addressed and this is an area where administrators are showing caution.

Watch this space!

One of the many questions raised by the SEC is how would funds consider the impact of market information on cryptocurrency markets and potential for market manipulation. Regulatory developments have significant power to move cryptocurrency markets and "watch this space" in this context has real meaning.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions