Crypto Fund Governance: Priorities for Independent Boards

Crypto fund governance matters because investor confidence depends on it. Digital asset strategies carry volatility, custody and valuation risks on top of the usual manager risks, and investors now expect the checks they would find in an institutional hedge fund: independent service providers, an audited track record, proper disclosure and oversight by experienced independent directors.

Key takeaways

• Experienced independent directors are, in most cases, more important for crypto funds than for more traditional alternative strategies, because of investor confidence.
• The former exemption from CIMA registration for limited investor funds was removed in 2020, and such funds must now register with CIMA.
• Investors now look for proper due diligence, not simply reported returns.
• Independence, experience, qualifications, residence, regulation and capacity are the core questions when choosing a director.

Why governance matters more for crypto funds

Bell Rock provides governance support to digital asset funds, blockchain foundations and token issuance companies. Across that work, one point stands out: the need for experienced independent directors is, in most cases, greater for crypto funds than for more traditional alternative investment strategies. The reason is investor confidence.

How crypto funds were first set up in Cayman

Many early crypto funds launched in the Cayman Islands as emerging manager funds relying on an exemption from registration with the Cayman Islands Monetary Authority (CIMA). Because they were exempt, they were not required to appoint at least two CIMA-registered directors, an independent fund administrator or an auditor. A fund with a small number of investors, a majority of whom could appoint or remove the operators of the fund, was treated as exempt. In many cases the manager incorporated a company and nothing more.

Two things followed. First, these funds struggled to raise capital. Second, the law changed. The Mutual Funds (Amendment) Act, 2020 removed the exemption with effect from 7 February 2020, subject to a transitional period for existing funds that ended on 7 August 2020. Limited investor funds must now register with CIMA under section 4(4) of the Mutual Funds Act (As Revised), and many smaller funds closed rather than take on the additional running costs. Funds now registered with CIMA are subject to the board responsibilities described in CIMA's governance guidance for regulated funds.

Why investor confidence was the missing piece

It is likely that many crypto funds struggled to raise capital because investors lacked confidence in them. Pitch decks and marketing materials sometimes claimed very large returns from unaudited strategies, but investors were concerned that the absence of checks and balances added significant risk on top of the volatility of the underlying cryptocurrencies.

That concern was compounded by the risk of manager fraud, the risk of inadequate oversight or, in many cases, no oversight at all, and unmanaged conflicts of interest. It also meant limited institutional interest, because the due diligence normally carried out on institutional hedge funds could not be done and the usual comfort could not be given.

How crypto fund governance expectations have changed

This has fundamentally changed, driven largely by investor demands and by the expectations of counterparties in the crypto funds market. Investors now carry out proper due diligence rather than looking only at returns reported on a metric that only the manager can provide, or that cannot be provided at all because of the DeFi pool the fund has allocated to.

There is now a more traditional approach to crypto fund governance, and managers increasingly want to be regulated. They ask for:

• a governance framework that avoids conflicts of interest;
• proper disclosure and transparency;
• independent service providers;
• an audited track record;
• independent compliance and regulatory services; and
• oversight by suitably qualified and experienced independent directors.

Our guide to setting up a Cayman crypto and blockchain fund covers the structures and service providers involved, and pricing questions are covered in our guide to hedge fund valuation policies.

Questions to ask when appointing independent directors to a crypto fund

Independence

Is the prospective director independent of the investment manager, the administrator and all other service providers to the fund?

Experience

Does the individual have relevant industry experience, including experience of the fund's strategy? Look for experience with other crypto funds and an understanding of the underlying markets and infrastructure: exchanges, derivatives, decentralised exchanges, yield farming, staking, OTC desks, custodians, technology and industry developments.

Qualifications

Does the individual hold relevant professional qualifications?

Residence

Is the individual resident in the Cayman Islands? There is no residency requirement for directors of Cayman funds, but it is often sensible to have directors on the board who understand the Cayman regulatory landscape, compliance obligations, reporting deadlines and audit timeframes.

Regulation

Is the individual a stand-alone director, or part of a regulated director services firm that requires compliance with the regulator's standards, including holding insurance?

Capacity

Does the individual have sufficient time to dedicate to the board?

These questions are developed further in our guide to appointing Cayman fund directors from regulated firms.

Bell Rock and crypto fund governance

Bell Rock, a CIMA-licensed company manager, provides independent director services to Cayman digital asset funds, blockchain foundations and other technology companies. Directors are named individuals who act in their personal capacity, with backgrounds spanning law, portfolio management, risk management, product structuring, compliance and fund governance.

Frequently asked questions

Does a Cayman crypto fund need independent directors?

A fund registered with CIMA as a mutual fund must have at least two CIMA-registered directors. Whether they are independent of the manager is a governance choice, and investors increasingly expect it.

Can a crypto fund with only a few investors avoid CIMA registration?

Not on the former limited investor basis. That exemption was removed with effect from 7 February 2020, and limited investor funds must now register with CIMA under section 4(4) of the Mutual Funds Act.

Do Cayman fund directors have to live in Cayman?

No. There is no residency requirement, but Cayman-resident directors bring familiarity with local regulation, reporting deadlines and audit timeframes.

Related reading

• Maximal extractable value: governance risks for funds
• Decentralised protocols: legal and governance questions
• Cayman foundation companies for DAOs
• Digital Asset Custody for Cayman Funds: What Boards and CIMA Expect

Bell Rock supports crypto fund boards through its independent director services.