Having launched many crypto investment funds over the last few years and continue to provide governance services such as independent director services to both funds and blockchain foundations and token issuance companies, it has become apparent that the need for experienced independent directors is, in most cases, more important for crypto funds than more traditional alternative investment asset classes. The reason for this is simple: investor confidence.
Initially, many funds launched here in the Cayman Islands as emerging manager funds under an exemption from registration with the regulator in the Cayman Islands, the Cayman Islands Monetary Authority (CIMA). Given that they were exempt from registration, services were not required such as the appointment of a minimum of two CIMA registered directors, the appointment of an independent fund administrator or the appointment of an auditor. Provided that the fund had 15 or fewer investors whom were capable of removing the operators of the fund i.e. the directors, then it was treated as exempt, managers would incorporate a company and that was it. However, it was noticeable that two factors resulted: (i) these funds struggled to raise capital; and (ii) the law changed on August 7, 2020 following the passage of the Mutual Funds (Amendment) Law, 2020 of the Cayman Islands (the “Amendment Law“) so that even limited investor funds required registration forcing many smaller funds to close as a result of the additional running costs.
It might be conjecture, but it is likely that many crypto funds struggled to raise capital due to investor confidence. Despite pitch deck's and marketing materials making claims of returns of thousands of percent from various unaudited strategies, it was evident that investors were concerned that the lack of checks and balances over their investment presented significant risk on top of the volatility risk of the underlying cryptocurrencies. This was compounded by the risk of fraud by the fund manager, the risk of improper oversight or, in many cases, no oversight whatsoever and conflicts of interest. It also meant that we generally saw a lack of institutional investor interest as no traditional due diligence could be done or comfort provided as is normally the case for institutional hedge funds.
Fundamentally, this has changed and in many respects this has been from the demands of investors and the expectations of counterparts in the crypto funds space. For example, we now see investors look properly at due diligence and not simply at the returns generated based on a metric that only the manager can provide or in some cases not provided based on which defi pool the fund has allocated to. We now see a more traditional approach to crypto fund governance and a desire for regulation by managers, a request for structuring a crypto fund with the best governance framework, avoiding 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.
What Questions should you ask when appointing independent directors to your crypto fund?
Independence - is the prospective director independent of the investment manager, administrator, legal counsel and all other service providers?
Experience - does the individual have relevant industry experience and experience with the fund’s strategy? Experience with other crypto funds and understanding of the underlying asset (exchanges, derivatives, dew, yield-farming, staking, OTC desk), custodians, technology and industry developments.
Qualifications - does the individual have relevant professional qualifications?
Residence - is the individual resident in the Cayman Islands? Although there are no residency requirements for Cayman funds, it is often sensible to have directors on the board who understand the regulatory landscape in the Cayman Islands and affecting other Cayman funds, compliance, reporting deadlines, audit timeframes etc. It is also often the case that the residence of the board of directors will meet requirements for the fund to be treated as offshore.
Regulated - is the individual a stand-alone director or part of a regulated director services firm that mandates compliance and standards set by the regulator including holding insurance.
Capacity - does the individual have sufficient capacity i.e. time, to dedicate to the board.
Bell Rock - Crypto Fund Governance
We routinely act on the board of a crypto investment funds as well as blockchain foundations and other disruptive tech companies. Each member of a director services team has over 20 years of senior level industry experience in fields such as law, portfolio management, risk management, product structuring, compliance and fund governance, having worked for well known names in the financial services industry such as Citi, BNP Paribas, Credit Suisse, Bank of America to name a few.
