How do you like the idea of taking someone else's money, using it in the crypto market, and returning it while shaving off a percentage of profits? By the way, you risk nothing, because the client is warned about the risks of the insane volatility inherent to the cryptocurrency market. Many people like this idea, and you would be surprised how many results search engines provide on the "how to set up a crypto fund" query.

It would be strange if the services of trust management of financial assets did not migrate to the crypto market. It would be even more surprising if the "businessmen" did not try to earn money on this trust, thanks to the creative scams which are approaching critical mass. When endowed with such inherent traits and with a reputation spoiled on the caste level, how can the investor’s confidence be gained?

The first and the most important step is the acquisition of a legal status. For legal analysis, let's take an ordinary business model, in which the fund takes from the investors a cryptocurrency in exchange for its own tokens, promising a profit for one or another investment model (trade, investment in ICOs, arbitration, and so on). The token in this case plays the role of a share, that is, a security token.

There is no legislative practice in this sector in Russia as of yet and so crypto funds run to other jurisdictions, taking with them all of the hypothetical crypto taxes.

Where to Register a Crypto Fund

"It should be noted that the attractiveness of a jurisdiction is determined not by the absence of any regulation but by the presence of an understandable position of the regulator and the practice of law enforcement. The regulators of many countries have outlined the potential possibility of extending the legal regime of securities to security tokens," as stated by the partner of the law firm Liniya Prava and member of the Legal Committee of the RACIB Vadim Konyushkevich.

Classics of the genre: Cayman Islands

Trending: Singapore, Switzerland

Prospective: Malta, Gibraltar, Estonia

Each of the jurisdictions has its own subtleties. Head of FinTech Practice of O2 Consulting Daria Nosova explains the example of the release of tokens in Singapore:

If the crypto fund issues a digital token that has the signs of a Collective Investment Scheme (CIS) in confirmation of the funds invested by the investor, then according to the position of the MAS (Monetary Authority of Singapore), the financial regulator of Singapore, expressed a year ago, the current legislation on collective investment schemes will be applied to such funds, and it will be subject to authorization requirements for local funds or recognition for foreign companies offering shares in a given jurisdiction. If the released token falls under the criteria of a capital market product under the Securities and Futures Act, then its release and turnover will be under the control of the regulator. In some cases, it may be necessary to register a prospectus, or an exception may apply, and then registration will not be required (for example, when placed in favor of up to 50 persons with an issue of up to five million Singapore dollars, or solely in favor of institutional or qualified investors with relevant restrictions on advertising of the project).

In any case, in order to determine which rules to apply, the token is checked based on the main features: share in the corporation, debt obligation (bond), and share in the CIS. This list is open.

If the issued token is qualified as being a security, or if it is registered in the CIS, then the rules for releasing the corresponding traditional instruments are applicable to the issuer.

Licensing will also depend on the specifics and scope of the fund. Basically, we can talk about the CMS (Capital Markets Services) license required for asset management activities without restrictions on the type of investors.

Daria’s colleague, consultant Vlad Burilov, adds:

If we take the example of the Cayman Islands, only so-called “open funds” are subject to regulation and closed ones are not. Accordingly, a closed fund is easiest to register, but again, in terms of regulatory consequences, everything will depend on the amount of work of the crypto fund and the established limitations. An open-ended fund may be licensed, administered, registered, or withdrawn (exempted). In the latter case, there will be a serious restriction on the number of investors (no more than 15).

Gibraltar is also suitable for crypto funds as a jurisdiction. First, the laws of Gibraltar provide flexibility in the choice of the legal form of the funds (as in the U.K. and Ireland) and implement the E.U. directives, which means that there is an opportunity (at least before the U.K.’s withdrawal from the E.U.) to publicly offer shares of crypto funds to E.U. residents without registering a prospectus in each individual E.U. member state. Secondly, like the Caymans, Gibraltar makes it possible to ensure tax neutrality and the fund's profit from investing or trading in crypto assets can be exempt from corporate taxation under certain circumstances.

Finally, Gibraltar is taking active steps to regulate the blockchain and the crypto industry. From January 1, 2018, entrepreneurial activities, including storage and turnover of assets using distributed ledger technology (DLT) are subject to licensing. In the process of adoption, there is a package of laws on regulation of activities with crypto assets, including the initial offering of crypto tokens (ICO) and their secondary circulation on crypto exchanges. Such novelties attract crypto funds, because in a regulated environment it is easier for them to open bank accounts, and on regulated crypto exchanges it is easier for them to predict the risks of their cryptocurrency transactions. At the same time, the new regulation does not increase the regulatory load of the crypto fund. Both the DLT license and future ICO requirements do not apply to crypto funds that received the traditional GFSC (Gibraltar Financial Services Commission) permission to issue collective investment shares.

Expert of the Belarusian law firm Revera Guy Mayevsky believes in Malta's prospects: "We were guided by four points:

 The country has a clear regulation on cryptocurrencies;

 Amendments were made to the legislation on collective investment schemes, which also apply to crypto funds;

 Malta has a well-developed IT infrastructure;

 The country is a member of the E.U.

Current Maltese legislation has introduced crypto funds into the regulatory framework of professional investment funds (PIF). Norms allow people to manage funds with a high degree of flexibility in selecting assets and keep up to 100 million euros in their control.

Other popular jurisdictions for cryptos are Switzerland and Liechtenstein. These countries, however, also have their own nuances. For example, Switzerland has more stringent legislation for classical investment funds. In Liechtenstein, laws require banks to be involved as responsible custodians. And they traditionally behave carefully, which can limit the choice of crypto assets for investment."

Crypto lawyer Oleg Kondratiev unequivocally considers the U.S. as an unfavorable jurisdiction: "That territory is not quite favorable for us, where everything has to be answered for. Only members of the list of qualified investors can accept cryptocurrency in trust management. Crypto laws are different from state to state. In some places, you can already pay for public services, and elsewhere there is categorical rejection."

Do Tokens Have to Be Registered?

"The issue of digital tokens can be subject to registration in any jurisdiction where it can be qualified as a security and where there are requirements for registration of the securities prospectus, as well as requirements for concluding contracts, the subject of which are derivative financial instruments," Daria Nosova emphasizes. This, roughly speaking, is the vast majority of countries in the world.

Another thing is that not all of them have regulatory clarifications or instructions from the regulator on the order of qualifying the tokens. At the moment, countries can only be divided into those in which the issues of such tokens are already structured, such as issues of securities or derivative financial instruments (U.S., Canada), and those where it is expected in the foreseeable future. Of course, in this case, we are not talking about countries where crypto assets are directly withdrawn from the legal turnover at the legislative level (a recent example is India)."

"Operations with tokens that have signs of securities in these jurisdictions will be subject to securities or financial instruments legislation, which often means having a special license to conduct securities transactions (for example, a broker’s license) or a permit and comply with all relevant requirements, including those that carry out such activities (for example, the availability of staff who meet the qualification requirements)," said Vadim Konyushkevich. "In some jurisdictions, for example, in Estonia, under certain circumstances, raising funds by selling tokens can be qualified as investment services or lending activities."

The Must-Haves for Crypto Investment Funds

The absence of detailed legal regulation of crypto funds in most jurisdictions forces honest funds to resort to the so-called best practices. Of fundamental importance is the legal formulation of the conditions for raising funds from the investors, including the characteristics of the tokens, the rights and obligations of investors, and the fund, securities, and guarantees, the purposes and procedure for spending the raised funds, and so on. This can be either separate agreements with investors, or general conditions that are in the public domain.

Must-have number one is the investment agreement. In it, you prescribe, for example, that both U.S. citizens and individuals who are not on the U.S. territory can invest through the fund. This is a fairly common limitation in practice. Daria Nosova comments: "It all depends on which exception you are targeting from the requirement to register the securities prospectus: Reg D, Reg S, or both. If it is Reg D, then it is necessary that investments are offered only to accredited investors. It does not matter whether it's citizens or residents or not. If it is Reg S, then investments can be offered only outside the U.S., that is, individuals who are not U.S. citizens, and such persons should not be in the United States at the time of offering investments."

Must-have number two is KYC. Before getting and investing in tokens, the fund must identify who it takes these funds from. At the same time, the question remains: should the KYC procedures developed for cash transactions be applied in the same way to crypto assets that are formally not money? While there are discussions on this issue, lawyers recommend conducting the most detailed KYC procedure in order to minimize the corresponding legal risks. This will primarily testify to the fund’s compliance with the basic requirements of anti-money laundering legislation, and also provide an additional guarantee of project reliability for investors.

As for must-have three, it is AML, or Anti-Money Laundering, and lawyers have varying opinions. Kondratiev believes that KYC is sufficient for a fund, and proving the legality of the origin of funds is the concern of their owner. Konyushkevich believes that "the legality of monetary funds must be confirmed by the citizen who deposits them. You just need to know from whom you got them. You cannot check them, you can just refuse the client without justifying the reasons, and the same can be specified in the contract." Daria Nosova warns: "If you fall under AML law at the place of your institution . . . As practice shows, you do not formally fall under such requirements, but the condition for passing such an inspection will be set by the bank, in which the fund will have open accounts."

In conclusion, I would like to summarize that the regulators of many countries are moving very rapidly towards detailed legal regulation of the activities of the crypto industry and crypto funds in particular. Therefore, in the near future, we will see a qualitative improvement of the market. The question of taxation remains open. But this topic requires a separate article with the same detailed immersion in the subject.