Building A Legal Crypto Investment Fund: A Step-By-Step Guide

Cryptocurrency is a highly volatile market, and with the right investment strategy, it can be an opportunity to make a lot of money. However, it is important to understand the legal and regulatory requirements before starting a crypto investment fund.

In the US, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are the main regulatory bodies overseeing the cryptocurrency market. The SEC has indicated that digital tokens can be treated as securities, which means that investment funds dealing with cryptocurrencies may need to register with the SEC under the Investment Advisers Act of 1940. The CFTC, on the other hand, regulates commodities, futures, swaps and currencies, and has stated that Bitcoin and other cryptocurrencies are considered commodities under the Commodities Exchange Act of 1934. This means that crypto fund managers who invest in cryptocurrency futures contracts or use leverage or margin would need to register with the CFTC.

Other regulatory considerations for crypto investment funds include anti-money laundering (AML) and know-your-customer (KYC) regulations, as well as tax implications. It is important to consult with legal and tax professionals to ensure compliance with all applicable laws and regulations.

In terms of setting up a crypto investment fund, it is important to have a strong strategy, a reliable brand name, and a trusted trading platform. The fund should also be promoted through various channels to attract investors. Additionally, risk management is crucial, and it is recommended to spread investments across several platforms to mitigate the risk of hacks or other issues.

Understand the regulatory landscape: SEC, CFTC, KYC, AML, and more

When it comes to building a crypto investment fund, it is essential to have a solid understanding of the regulatory landscape to ensure compliance with the law and avoid potential fines and legal issues. Here is an overview of some key regulatory bodies and their roles in the crypto space:

SEC (Securities and Exchange Commission)

The SEC is a crucial regulatory body that plays a significant role in the crypto industry. They have stated that a cryptocurrency could be considered a security depending on how the digital token was created. This determination falls under the Howey Test, which defines a security as having:

• An investment of money
• In a common enterprise
• With an expectation of profits
• Solely from the efforts of others

The SEC has also imposed monetary penalties on digital asset market participants for fraud and unregistered securities offering violations. As such, it is important to understand their regulations and remain compliant.

CFTC (Commodity Futures Trading Commission)

The CFTC regulates commodities, futures, swaps, and currencies. They have stated that cryptocurrencies like Bitcoin are considered "commodities" under the Commodities Exchange Act of 1934. As a result, cryptocurrency fund managers who invest in cryptocurrency futures contracts or use leverage or margin are required to register with the CFTC and the National Futures Association (NFA).

KYC (Know Your Customer) and AML (Anti-Money Laundering)

KYC and AML compliance are critical aspects of the crypto industry, serving to prevent financial crimes, enhance reputation, and foster trust with users, regulators, and traditional financial institutions. KYC involves robust identity verification checks during customer onboarding and transactions, while AML involves implementing measures to prevent money laundering, terrorist financing, and other illicit activities.

Crypto businesses must adhere to these regulations and conduct thorough customer due diligence (CDD) to mitigate financial crime risks and ensure compliance with relevant laws. Failure to comply can result in significant reputational and financial damage, as seen in the case of BitMEX, which faced legal action and a significant outflow of funds due to non-compliance with KYC and AML regulations.

FinCEN (Financial Crimes Enforcement Network)

FinCEN is another important regulatory body that provides guidance and regulations for virtual currencies. They have stated that a person who creates units of convertible virtual currency and sells those units to another person for real currency is considered a money transmitter and must register as a Money Services Business (MSB). FinCEN also requires MSBs to comply with anti-money laundering programs and reporting and record-keeping regulations.

Other Regulatory Bodies

In addition to the above, there are other regulatory bodies that impact the crypto space, including the IRS, which has designated cryptocurrency as property, and the Bank Secrecy Act, which requires cryptocurrency exchanges to register with FinCEN and comply with AML and Combating the Financing of Terrorism (CFT) regulations.

As the crypto industry continues to evolve and gain mainstream acceptance, regulatory clarity and compliance will become increasingly important to ensure the stability and integrity of the market. It is crucial for businesses to stay informed about the latest regulatory developments and adapt their strategies accordingly to remain compliant and competitive.

Choose the right structure: Crypto hedge fund, VC fund, index fund, or ETF

When building a crypto investment fund, it is essential to choose the right structure that aligns with your investment goals and strategies. Here are the key differences between crypto hedge funds, venture capital (VC) funds, index funds, and exchange-traded funds (ETFs):

Crypto Hedge Fund

Crypto hedge funds are actively managed investment vehicles that aim to generate returns by trading cryptocurrencies. They pool capital from investors to purchase digital assets and employ sophisticated portfolio strategies to optimise returns while managing risk. Crypto hedge funds offer active management, aiming to generate returns despite market volatility. As of 2020, the total assets under management (AUM) in crypto hedge funds reached approximately $3.8 billion USD.

Crypto Venture Capital (VC) Fund

Crypto VC funds invest directly in cryptocurrency or blockchain-related companies, often focusing on early-stage startups. They review various projects to determine their viability, growth potential, and return on investment. By investing in multiple projects, VC funds aim to mitigate their risk. Crypto VC funds play a crucial role in supporting innovative blockchain projects and driving the growth of the crypto industry.

Crypto Index Fund

Crypto index funds passively track cryptocurrency indices, providing diversified exposure to the market. Instead of investing in individual cryptocurrencies, index funds mirror the performance of a specific crypto index, offering investors a simpler way to gain exposure to a basket of digital assets. Crypto index funds are similar to traditional index funds that track established market indices like the S&P 500 or Nasdaq Composite.

Crypto Exchange-Traded Fund (ETF)

Crypto ETFs are traded on stock exchanges and hold crypto assets. They offer investors a regulated way to gain exposure to the crypto market without directly purchasing or trading cryptocurrencies. Crypto ETFs provide built-in diversification, lower fees, and the expertise of fund managers. Similar to traditional ETFs, crypto ETFs can track a specific market index or a basket of crypto assets. As of May 2024, the SEC has approved the listing of spot ether ETFs on major US exchanges.

When choosing the right structure for your crypto investment fund, consider factors such as your investment strategy, level of active management, diversification needs, and the stage of the projects you want to invest in. Each type of fund has its own advantages and is suitable for different investment objectives.

Build a strong brand and strategy: Reflect credibility and trustworthiness

Building a strong brand and strategy is essential for the success of your crypto investment fund. Here are some key considerations to reflect credibility and trustworthiness:

• Consistency: It is vital to maintain consistency in your messaging, actions, and delivery. Ensure that your brand identity, voice, and tone are aligned across all channels and touchpoints, including your website, social media presence, emails, and sales pitches. Consistency demonstrates your professionalism, reliability, and credibility.
• Transparency: Be transparent and communicate openly with your stakeholders, especially your customers. Share your goals, processes, results, values, vision, and culture. Admit your mistakes and show a willingness to learn from them. Transparency builds trust, loyalty, and respect.
• Value Proposition: Offer high-quality products or services that address the pain points of your target audience. Add value to their business and exceed their expectations. Provide useful and relevant content that educates, informs, and entertains, showcasing your thought leadership and expertise. By creating value, you foster satisfaction, advocacy, and referrals.
• Responsiveness: Listen to your customers, prospects, and partners. Be responsive to their feedback, questions, and concerns. Engage with them on social media, forums, and reviews. Acknowledge their feedback and show that you care about their experiences. Your responsiveness demonstrates your commitment to your audience.
• Innovation: Stay ahead of the curve by constantly researching your market, customers, and competitors. Identify new opportunities, trends, and challenges. Experiment with new ideas, technologies, and methods, and optimise your results. Innovation showcases your creativity, agility, and ability to adapt.

By incorporating these elements into your brand and strategy, you will reflect credibility and trustworthiness, which are essential for attracting and retaining customers, partners, and employees in the competitive world of crypto investment.

Select the right platforms: Coinbase, Binance, Bittrex, etc

When it comes to selecting the right platform for your crypto investment fund, there are several factors to consider. Some of the most popular platforms include Coinbase, Binance, and Bittrex. Here's an overview of each platform to help you make an informed decision:

Coinbase

Coinbase is one of the oldest and most well-established crypto exchange platforms in the industry, with over 30 million customers. It offers a user-friendly interface that makes buying coins a straightforward process. Coinbase supports the purchase of Bitcoin, Ethereum, and Litecoin with USD, which is ideal for beginners. However, their fees are relatively high compared to other exchanges, with a 1.49% fee for US bank account standard buy/sell transactions and a 3.99% fee for credit/debit card purchases. Coinbase is trusted and secure, with USD wallets treated like bank accounts that are FDIC-insured up to $250,000.

Binance

Binance is another popular crypto exchange that was founded in 2017. It offers instant buy and sell services and a wide range of alternative cryptocurrencies or 'altcoins' for trading. Binance has a tiered fee structure, with a 0.1% fee for spot trading and a 0.5% fee for instant buy/sell for accounts trading less than $50,000 in a 30-day period. Binance also has a large user base, with close to 14 million active users. The platform is secure and trusted, employing two-factor authentication for added security.

Bittrex

Bittrex is a well-known crypto exchange that supports the trading of over 200 different cryptocurrencies. It offers a simple 0.25% commission trading fee, making it a cost-effective option for those looking to save on trading fees. Bittrex prioritizes security and uses an elastic multi-stage wallet strategy that keeps 80%-90% of all funds offline. Like Binance, it also requires two-factor authentication for all withdrawals and API usage. Bittrex has over 500,000 active users and is considered a trusted platform, founded by a group of cryptocurrency enthusiasts with experience from companies like Microsoft and Amazon.

In summary, each platform has its own advantages and unique features. Coinbase is ideal for beginners, Binance offers a wide range of altcoins, and Bittrex provides a large selection of cryptocurrencies with competitive fees. When selecting a platform, consider your investment goals, the level of security, the range of supported coins, and the associated fees to make an informed decision that aligns with your crypto investment fund strategy.

Manage risk and volatility: Diversify, use quantitative strategies, and more

Diversification is a fundamental principle of investing that helps to reduce a portfolio's risk. When it comes to building a cryptocurrency portfolio, managing risk in this volatile market is essential to protecting your bottom line. Allocating to a variety of digital assets will help you profit from the overall crypto market's growth.

• Buy cryptocurrencies with different use cases: Cryptocurrencies are used as a medium of exchange, but they can also be used as a store of value or a means to preserve and grow wealth. For example, Ethereum, the second-largest crypto network, has smart-contract functionality that allows the creation of digital programs. Crypto investors can also allocate some of their portfolio to stablecoins, which have a value pegged to an underlying asset, such as fiat currency.
• Invest in different cryptocurrency blockchains: Blockchain is the technology that allows cryptocurrencies to function, but its capabilities go beyond that. The most popular blockchain is Ethereum, which facilitates the execution of agreements without a third party. A competing blockchain is Cardano (ADA), which focuses on security, scalability, and efficiency.
• Diversify by market capitalization: Bitcoin is the cryptocurrency with the largest market capitalization. However, there are many other altcoins with varying market caps worth considering. A crypto with a larger market cap may be more stable and have stronger fundamentals, but a crypto with a smaller market cap might have strong growth potential.
• Diversify crypto projects by location: Choosing cryptocurrency projects from different locations can expose you to a wider variety of innovations. It's best to steer clear of crypto projects in areas where crypto is banned or restricted and focus on areas where innovation is growing. For example, Portugal is considered a crypto hub, and El Salvador was the first country to adopt Bitcoin as legal tender.
• Invest in different industries: Cryptocurrency opportunities can be found in various industries. DeFi, or Decentralized finance, allows people to easily conduct digital transactions through a peer-to-peer blockchain network without a third party. Crypto's use in the world of video games has also taken off, with a growing number of users trading virtual assets in a global virtual marketplace.
• Branch out to different asset classes: Digital investments are part of different asset classes, giving investors another way to diversify. The most common asset class, encompassing Bitcoin and Ether, includes cryptos that are a store of value or medium of exchange. Another asset class is utility tokens, which give users the right to use a product on a certain platform. Non-fungible tokens, or NFTs, are yet another class of digital investments that have penetrated the mainstream via digital art.

In addition to diversification, there are other ways to manage risk and volatility in your crypto investment fund:

• Prioritize liquidity: Liquidity looks at how readily an asset can be converted into cash while still preserving its value. Traders must be able to enter and exit positions quickly to keep up with the volatile crypto market. Bitcoin, for example, has the greatest liquidity of any cryptocurrency in the marketplace.
• Embrace dollar-cost averaging: This involves making small regular investments instead of diving into a lump-sum investing strategy. This approach allows you to buy more digital currencies when prices are low and fewer when prices are high. By consistently embracing dollar-cost averaging over the long term, you can potentially reduce the impact of short-term market volatility.
• Regularly assess gains: According to experts, investors should take profits from their crypto investment on a regular basis. Consider selling a portion of an asset when the price is high, placing the funds in a stablecoin, and then repurchasing it when the price drops again.
• Use quantitative strategies: Quantitative investment strategies use mathematical models and algorithms to identify investment opportunities. These strategies should be systematic and remove much of the emotional element from investing. Some common approaches include statistical arbitrage, factor investing, risk parity, machine learning, and artificial intelligence (AI).

Frequently asked questions