There’s a sense of optimism among digital asset fund managers, stemming from a variety of factors like a bullish market, several favorable developments, and the recent approval of Bitcoin exchange-traded funds (ETFs). But for those looking to navigate the complexities of fundraising in the innovative world of cryptocurrency, a few key details are worth examining.
One of the critical elements to consider is the need for a digital asset fund manager to register with the Securities and Exchange Commission (SEC). If your business sponsors funds that invest in digital assets, some of which may be securities by SEC definitions, you may need to register as an investment advisor. However, there exist certain exemptions that first-time digital asset fund managers can leverage.
The first exemption revolves around the private fund advisor exemption, which allows investment advisors who only manage private funds with total assets under management below $150 million to dodge registration. The second exemption applies to venture capital fund advisors, offering exemption from registration regardless of their assets under management. These exemptions can prove beneficial for liquid digital asset managers and those choosing to invest in startups.
However, even advisors not required to register with the SEC must comply with anti-fraud rules as per the Investment Advisers Act (source). Further compliance planning may be advisable, especially regarding policies surrounding books and records requirements, as well as conflict of interest management.
It’s worth noting that the SEC has put out new rules affecting private fund advisers (source). Despite a lawsuit from various industry groups questioning the SEC’s authority to bring forward said rules, the matter is still pending before the US Court of Appeals for the Fifth Circuit.
Digital asset advocates face an additional set of challenges related to the Custody Rule under the Advisers Act. The rule requires private funds to have all funds and securities custodied with a qualified custodian subject to an annual audit. Some qualified custodians may be ill-equipped to deal with certain digital assets, complicating matters for those needing to register.
Advisors will need to monitor any significant amendments proposed to the Custody Rule by the SEC (source), given the amount of attention this proposal has garnered from the digital asset industry.
Fund managers must also consider engaging with service providers, such as a counsel, a fund administrator, and potentially a fund auditor. They also need to account for varying costs based on the investor base and structure. These costs are typically borne by the fund as organizational expenses or ongoing fund expenses, with the sponsor being reimbursable from the fund upon its launch.
Lastly, putting a timeline on the launch can be tricky as factors like the complexity of the structure and the composition of the investor base significantly influence the duration. The fundraising process for a simple fund structure with only US individual investors could take as little as two months. However, the timeframe can stretch when dealing with offshore funds and institutional investors who might hire their own counsel and negotiate for specific rights in the fund documents.