With over 850 crypto funds out there how do you choose one you can trust?
For investors looking to add crypto to their portfolio there are a lot of options out there. For many who want to maximise their return on investment without having to trade themselves, a crypto focused investment fund makes for a good option.
Choosing what type of fund and which fund to trust with your capital isn’t a simple task especially when there are over 851 cryptocurrency funds in the industry, some are hedge funds, venture capital funds, or private equity and they all run varied strategies. Thankfully we will be sharing some questions you can ask a fund manager about crypto custody that should set your mind at ease or have those alarm bells ringing.
According to PricewaterhouseCoopers research crypto hedge funds globally held nearly $3.8 billion under management in 2020*. The next annual PWC Crypto Hedge Fund Report is expected to be released next month and we anticipate that figure to be a lot higher this time around. With that amount of money being managed by funds that have in many cases only existed since 2017 it’s important that investors do their due diligence. Thankfully the Standards Board for Alternative Investment (SBAI) released a memo last November that gave pointers for institutional investors to consider when it comes to Operational Due Diligence Requirements across blockchains, exchanges and DeFi.
In a separate article here, we wrote about how the SBAI report would affect DeFi funds and how those funds could implement the recommendations using TrustVault, our institutional grade cryptoasset custody solution.
The key areas of the Operational Due Diligence Standards that we covered were:
-
Custody
-
Trade processes
-
Valuation
-
Asset verification
-
Conflicts of interest, and
-
Regulatory risk
To recap here, there was a huge emphasis on Know-Your-Customer (KYC) and Anti-Money-Laundering (AML) procedures as well as a focus on the importance of custody for digital asset management. The report concluded in Standard 17a.4 that one or more third parties, independent of the manager, should be appointed to be responsible for the safekeeping of the property of the fund.
In their minimum standards section for custodians, they asked that custodians be qualified with a ‘state’ licence and also be insured, including for insider theft. They concluded that coverage could be immaterial to the value of the assets; however, noting that investors could gain comfort from the knowledge that reputable insurers were willing to underwrite the risk, regardless of the level of cover.
As of October 2021, Trustology has been registered as a cryptoassets firm with the Financial Conduct Authority (FCA) in the UK. We've also secured insurance coverage brokered through Marsh. We also have integrated controls for AML, KYC & KYT which means that a fund using our solution can protect your investment from financial sanctions.
Why does this matter?
More investors are demanding that their wealth managers and funds add crypto to their offerings. For some traditional funds the regulatory landscape and the additional risks have meant they haven’t moved quickly into the market. This has left the door open for hundreds of micro-cap crypto funds to emerge.
A lot of these new funds don’t have the expected three years of performance track records that investors in traditional markets like to see. This is why due diligence on the part of the investor is so important in the crypto markets.
Having answers to the questions below, as well as the reassurance that the fund is custodying your assets with an institutional grade crypto asset custodian like Trustology, will bring some comfort to investors, who are having to put their trust into these newer funds.
With Trustology our crypto and DeFi custody solution does more than just protect your digital assets and the funds private keys. It gives fund administrators the tools to monitor transactions for AML compliance, track and audit all of your assets and transactions and ensure that there are authorisation rules in place to protect your investment as well as maintain the funds trading strategy.
We call this value-added custody and if you are looking for a safer, faster and easier way to manage a crypto fund talk to us.
With that said, what are the questions you should be asking a crypto investment fund apart from who is your custodian?
Questions to ask your Crypto Fund
Investment Mandate
-
How are crypto assets going to be reported to investors? Will they be appearing in the risk reports or in a monthly newsletter?
Custody
-
How is the fund manager custodying the assets? Will they be using third-party custodians or self-custodying them and if so how will they be secured? (note the SBAI doesn’t recommend self-custody).
-
Does the custodian have any licensing or regulatory registrations?
-
Does the custodian have insurance? How much does this insurance cover and which firm is providing the insurance?
-
What procedures are in place for the generation of private keys and how they are stored?
-
How does the custodian protect against collusion and coercion?
-
Has there ever been a failure of their security controls or their key backup process?
-
What are the business continuity plans for the custodian, how would they recover the private keys in the event of a loss or disaster event?
-
How do the fund managers access the private keys, does it require multi-factor authentication?
-
Has there previously been an event that required the recovery of a private key and was the recovery successful?
-
Are there controls in place to make the recovery process safe and who can use them?
-
How does the custodian prove exclusive control of private keys to auditors?
-
Are wallets segregated or commingled at the custodian?
To answer some of the questions surrounding Custody of digital assets you can see in this table how Bitpanda Custody's (formerly Trustology) TrustVault solution meets the SBAI requirements.
Valuation and Asset Verification
-
Are the crypto assets in the portfolio considered liquid or hard to value?
-
If there are illiquid assets how is the manager valuing them?
-
Can the fund auditor and the fund administrator independently verify the crypto assets in the portfolio?
-
Who manages the complete list of wallet addresses and how are the addresses verified?
Regulatory Risk
-
What does the fund manager believe are the biggest regulatory risks to the fund?
-
Is the crypto fund trading any assets that might be classified as securities by the US SEC?
AML and KYC
-
Is the manager conducting detailed due diligence on the exchanges and DeFi protocols that are being used?
-
How is the manager conducting AML and KYC checks on addresses and transactions?
-
Will the manager be able to prove they are sticking with their strategy and the designated exchanges and protocols?
Crypto Assets and Responsible Investment
-
Do the crypto assets in the portfolio rely on Proof of Work for mining or Proof of Stake?
-
What is their ESG strategy?
Want to find out more?
If you are managing a crypto fund, or you are an investor with one and would like to use the leading DeFi crypto custodian to meet the above requirements, get in touch with us.
Related readings
Trustology Acquired By Bitpanda
Trustology Gets Full FCA Registration as Cryptoassets Firm
TrustVault. The Safest Crypto Account for Institutional Investors
High Yields Ahead - New Voyager DeFi Fund Backed By Trustology Custody
TrustTalks
Stay up-to-date with the latest crypto news, events, and crypto custody with Trustology. Over 2000 subscribers receive our monthly round up of what made the headlines, upcoming events that institutions need to know about and the latest developments in crypto custody and to our TrustVault platform. Be in the know, sign up today.
