Applying the SEC Custody Rule to Cryptocurrency Hedge Fund Managers
In the wake of the Bernard Madoff Ponzi scheme, the Securities and Exchange Commission (SEC) adjusted its rules to prevent future fraud.
For traditional investment funds, the SEC has protections in place to assure investors that their accounts contain the assets their advisers say they contain.
However, applying the custody rule to cryptocurrencies is difficult. New cryptocurrency-focused hedge funds
This Note will review why it is difficult to apply the current custody rule to cryptocurrency hedge funds, and how the rule can be modified to better fit the peculiarities of this new asset class. First, this Note looks at the present state of the rule and its general application to hedge funds. Second, it examines how cryptocurrency is “held” and the challenges this presents to hedge fund managers and their custodians. Third, it analyzes why the current rule does not meet these challenges. Finally, this Note presents an alternative mechanism that the SEC can adopt for applying the rule.
Table of Contents Show
I. The Custody Rule: Current Framework
The SEC first began to regulate custodial practices in 1962, when it adopted Rule 206(4)-2 under the Investment Advisers Act of 1940 (“IAA” or “the Act”).
Under the IAA, an “investment adviser” is any person who advises others on the purchase or sale of securities in exchange for compensation.
A. Basic Mechanics of the Custody Rule
Before jumping into the custody rule’s application to cryptocurrency, we must first understand the traditional mechanics of the rule. Once investment advisers are both registered and deemed to have custody of their clients’ assets, Rule 206(4)-2 provides four requirements: a qualified custodian, notice to clients, delivery of account statements, and surprise examinations.
1. Qualified Custodian
A registered investment adviser with custody of a client’s assets must hold those assets with a “qualified custodian” in either (a) separate accounts under each client’s name or (b) accounts in the adviser’s name that hold only the clients’ assets.
An adviser may hold client assets with more than one qualified custodian.
2. Notice to Clients
Once a registered investment adviser with custody opens an account on the client’s behalf or makes changes to the custodial arrangement, they must promptly notify the client in writing. This notice must provide the qualified custodian’s name, address, and information about how the funds are being held.
3. Delivery of Account Statements
The qualified custodian must deliver account statements directly to the client at least quarterly. These statements must list the balance of funds for each type of security in the account, as well as all transactions occurring during the period.
4. Surprise Examination
Each adviser must ensure that an independent public accountant performs at least one surprise examination per year to verify their clients’ assets.
B. Hedge Funds and the Custody Rule
Some hedge funds enjoy exceptions to both SEC registration and these custody rule requirements. The term “hedge fund” refers generally to a professionally managed pool of assets that employs a wide range of investment strategies.
As discussed above, some hedge fund managers are exempt from SEC registration altogether. The most important exemption is for private fund advisers.
In addition, even if the investment adviser is registered and has custody of client funds, the custody rule’s requirements are different for hedge funds. If the registered investment adviser advises a limited partnership and sends each of the fund’s clients audited annual financial statements within 120 days of each fiscal year, the adviser is not required to notify clients of the qualified custodian’s information, have the qualified custodian deliver quarterly account statements, or have their clients’ assets verified by a surprise examination.
Further complicating the application of the rule, there has been much debate as to whether cryptocurrency is a security at all. If a hedge fund does not engage in the “purchase or sale of securities,” its manager will be exempt from regulation under the IAA. In addition, there is an argument that certain coins are not “client funds.”
When hedge funds are not investing in traditional securities, like stocks or bonds, but rather in cryptocurrency operating on a digital ledger, how do they comply with these rules? To answer this question, we must first look at how cryptocurrency is held and stored and how that differs from traditional securities. We will then look at challenges in applying the rule to this novel financial instrument.
II. Cryptocurrency and Custody
Unlike traditional financial assets, cryptocurrencies are not based on institutional trust. This difference is important in the custody context. With traditional assets, we believe that a central party —whether a bank, Paypal, or a grain storage facility—is maintaining a ledger that is properly recording the assets they hold and marking which of those assets belong to us. We do not expect to see the ledger—we trust that the institution has protections in place to prevent internal fraud and attacks from outsiders. Blockchain, the technology that underpins cryptocurrencies like Bitcoin, is based on a fundamentally different premise. This Part will first describe how cryptocurrency functions in general, and then zero in on private keys, which relate directly to the application of the custody rule.
A. The Nature of Cryptocurrency
Bitcoin, the most popular cryptocurrency by market cap, operates off of a ledger database that is fully available to the public―anyone can view any part of the ledger and the software used to protect it (but perhaps not edit).
Although Bitcoin is the most popular cryptocurrency, with a first-to-market advantage, there are hundreds of other cryptocurrency coins known as “altcoins,”
To “hold” one Bitcoin, you need (1) access to a blockchain, (2) a Bitcoin address, (3) the private key, and (4) some type of storage device, such as a Bitcoin wallet.
The blockchain is essentially the ledger. It uses an algorithm to record all cryptocurrency transactions and appends them as cryptographic “blocks” onto the existing ledger.
Rather than posting the name of each owner on the ledger, the blockchain is made up of numbers, known as addresses. This is like the bank account number to which you can send funds.
1Jc3MuGF3ALn12anPN3Xzqq13PP1e
However, because this information is public, moving cryptocurrency from one account to another requires a private key.
E9873D79C6D87DC0FB6A5778633389F4453213303DA61F20BD67FC233AA33262
When a party wishes to transfer cryptocurrency from one address to another, the private key functions like a password and applies a digital signature to an address, “unlock[ing]” the cryptocurrency stored there.
B. How Private Keys are “Held”
The indispensable nature of a private key highlights an important distinction. With traditional securities, we think of “holding” something—whether a stock certificate, a bearer’s bond, or a right to withdraw fiat currency from a bank—as a representation of a physical asset existing somewhere. With cryptocurrency, control of the private key and ability to use it to perform transactions on the blockchain is the entirety of possession.
Most investors in cryptocurrency will store their collections of private keys and addresses in a “wallet.” The term refers to a variety of software tools that not only store private keys and addresses, but also perform tasks, such as generating addresses and making transactions.
As a result, individual investors in cryptocurrency will often take advantage of the ease and simplicity of an online wallet program provided by one of the major cryptocurrency exchanges.
Hot storage refers to any storage method where the private keys are stored on a device connected to the internet. In contrast, “cold storage” refers to when the private keys are inaccessible via the internet.
To increase the security of the private keys, holders of large amounts of cryptocurrency can take additional measures, such as offline transaction signing and the use of multiple keys. Offline transaction signing creates an “air gap,” a secure computer network physically isolated from any unsecure network.
The use of multiple keys adds security to crypto transactions by dividing the keys necessary to authorize transactions.
The use of private keys is illustrated by the Winklevoss Bitcoin Trust exchange-traded fund
Private Key Management. The Custodian generates, stores and manages the private keys that control the Trust’s bitcoin . . . . The Cold Storage System only uses HSMs . . . used by the Custodian to digitally sign (i.e., authenticate) any transfer of the Trust’s bitcoin. The Custodian’s Cold Storage System utilizes multiple-signature (“Multisig”) technology with a “2-of-3” signing design that requires a signature from at least two (2) of three (3) potential Signers in order to move the Trust’s bitcoin.
From this language, we can see that “holding” cryptocurrency safely requires some technical sophistication and that digital assets have fundamentally different properties than traditional asset classes.
III. Challenges in Applying the Custody Rule
The unique way that cryptocurrency is held and stored affects the ability of fund managers to comply with the rule. Several of these problems stem from the qualified custodian requirement. First, there is a lack of qualified custodians with experience in cryptocurrency. Second, even if the custodian has developed services in this area, different coins require different storage, and the custodian may not be able to hold every asset a manager wishes to invest in. Finally, a custodian who does accept a fund’s cryptocurrency faces additional challenges from forks, airdrops, and liquidity.
A. Challenges with Qualified Custodians
1. Lack of Qualified Custodians
One of the primary problems for fund managers is the lack of qualified custodians and best practices for this asset class. Although there is a developed and sophisticated network of banks, broker dealers, and other entities that offer qualified custodian services, as of yet, few of these traditional custodians accept cryptocurrency.
The lengths these third-party companies are taking to securely store digital assets sound like promising avenues for fulfilling the “[s]afekeeping”
2. Different Coins Require Different Storage
In addition to the limited number of qualified custodians, the custodians that do exist often limit the types of coins they accept. At the time of writing, Xapo only handles Bitcoin.
[S]even-hour process of signing up on exchanges, purchasing bitcoin, registering your identity, registering bank accounts, actually getting your bitcoin, transferring your bitcoin, waiting for however long it takes for confirmation, then trading on a crypto-to-crypto order book, and then having to pull all those off the exchanges if you want to be secure.
After that, one might need to download “wallet software for 10 different cryptocurrencies and syncing with those blockchains.”
Monero, a privacy-focused coin, illustrates why handling multiple coins can be challenging. Like Bitcoin, Monero uses a ledger to record transactions.
Some custodians might simply charge more. Coinbase Custody, which intends to offer support for most major cryptocurrencies, plans to charge a startup fee of $100,000 along with a monthly fee based on assets.
3. Forks and Airdrops
Sometimes owners of cryptocurrency can gain rights to different coins for free, with or without any action on their part, which presents qualified custodians with additional, unforeseen challenges. The two ways this happens are through “hard forks” and “airdrops.” A hard fork occurs when incompatible sets of rules governing the ledger emerge.
For qualified custodians holding the fund manager’s digital assets, these giveaways present potential problems. To begin with, the newly awarded coins do not always show up in the wallet software. Instead, the recipient often must take extra steps before they can have access to the private keys. After a hard fork of Bitcoin created BitcoinCash on August 1, 2017, Coinbase did not support the newly minted currency until January 1, 2018.
This illustrates another uncertainty. In the event of a hard fork or airdrop, could a fund manager compel the independent custodian to update their system to support and distribute the newly created coin? Qualified custodians should have legitimate concerns in adopting new coins because they must consider the safeguards of the storage system.
This odd incentive would also implicate issues of valuation. Though valuation may be less problematic here than in the case of exchange-traded funds (ETFs), which must reach a net asset value on each business day,
Apart from the issue of whether or not to adopt a token arising from an airdrop or fork, the custodian and hedge fund manager may disagree on whether the new token is a fraudulent offering, which could violate securities laws. In 1999, the SEC acted against “free stock” offerings,
4. Liquidity―Security vs. Convenience
The need for security also creates problems with liquidity and timing. The time a custodian takes to move cryptocurrency in and out of storage has a direct bearing on a hedge fund’s liquidity. Unlike mutual funds and open-ended ETFs, hedge funds often restrict the limited partner’s ability to withdraw funds through notice periods, “lock-up” periods, and “gates,” which regulate the amount of liquidity needed at any one time.
Secondly, even though hedge funds have discretionary liquidity restrictions, such as side pockets and gates,
B. Applicability of The Custody Rule to Particular Assets
To further complicate the application of the custody rule to cryptocurrency hedge funds, there are valid arguments that the rule should not apply to certain types of digital assets. As mentioned previously, under the rule, custody means “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.”
1. Is the Token Asset a Security?
One of the central questions surrounding cryptocurrency regulation is whether the token asset is a security. The SEC has weighed in several times on whether a particular initial coin offering (ICO) is a security. In a July 2017 investigative report, the SEC reviewed the “DAO,” a “decentralized” group selling a token to the public in order to raise funds for projects.
But others have disagreed with this conclusion. In December 2016, the New York firm Debevoise & Plimpton wrote a memo explaining why a token was not an investment contract under the Howey test.
2. Are the Tokens “Client Funds?”
Even if a fund manager’s tokens are not securities, the manager will also have to argue that they are not “client funds” to avoid application of the rule.
There is good reason for including fiat currency in the custody rule. If a fund manager were to store bricks of client cash under their mattress, it would certainly raise all of the concerns that prompted the original adoption of the rule, such as loss, misuse, and misappropriation. Similarly, if a cryptocurrency fund manager were to keep their client’s Bitcoin private keys in a safe in their home, those same concerns would likely arise. The introduction of cryptocurrency debit cards,
Even if the SEC determines that cryptocurrencies constitute neither client funds nor securities, fund managers without a qualified custodian would still fall afoul of the rule. If an investor requests a redemption, the fund manager may have to convert the client’s funds from cryptocurrency to fiat on an exchange. As soon as that transaction occurs, the fund manager could be considered to have “access to client funds” for purposes of the rule. Funds could avoid this by having investors invest and take redemptions in only cryptocurrency. Such a policy would be impracticable for many investors and would require modification of Form D and many other registration documents that denominate minimum investment and offering amounts in US dollars.
3. Do the Tokens Fall Under the Private Placement Exemption?
If a token is a security, it can still be exempt from the qualified custodian requirement if it falls under the private placement exemption. This exemption applies to privately offered uncertificated securities.
To understand whether pre-ICOs should fit within the exemption, we can look to the Simple Agreement for Future Tokens (“SAFT”). The SAFT is a standard agreement promising to deliver future tokens, modeled after an agreement used by startups entering angel and seed-round investments.
IV. Introducing an Alternative Mechanism for Compliance with Rule 206(4)-2
In light of the complications of applying the current custody rule to cryptocurrencies, the SEC has three possible options. First, it could institute a period of no action while the market for specialized qualified custodians develops. Funds would continue operating without fear of immediate censure in the hope that a mature and sophisticated set of qualified custodians would develop. Second, a more aggressive SEC could take enforcement action immediately and fine fund managers that are not complying with the rule. But in the absence of fraud or tangible harm to investors, wide-reaching fines and cease-and-desist orders may be hard to justify. Solving the fundamental inconsistency between the rule and practice requires a more comprehensive regulatory response. The third option is to issue a no-action letter that specifically sets out new requirements for the custody rule for investment advisers managing cryptocurrency hedge funds. This is the best choice. The rule should be adjusted to allow fund managers to maintain their client’s digital assets on exchanges and in their own custody, provided certain policies and procedures are met. These requirements can follow the spirit of the custody rule by mitigating the sorts of abuses the rule originally set out to prevent: investor funds being “lost, misused, misappropriated or subject to the advisers’ financial reverses.”
A. Regulatory Basis and Rationale for Modifying the Rule
To argue for a change in the rule, we must first look at how cryptocurrency hedge funds fall into the SEC’s regulatory goals. Creating a special set of custody rules for digital assets would necessarily discriminate between funds with traditional assets and funds with digital assets. But doing so is in line with the SEC’s regulatory goals and prior actions.
The SEC’s long-running mission has three prongs: (1) protect investors; (2) maintain fair, orderly, and efficient markets; and (3) facilitate capital formation.
In terms of investor protection, hedge fund investors may not demand the same protections as main street investors. For one, investors in hedge funds are wealthier than the average individual. Most fund investors will be “accredited investors,”
As a counterpoint, although hedge funds were traditionally the target of wealthy individuals, institutional investors now make up more than 60 percent of hedge fund assets.
On the other hand, by not modifying the rule, the SEC would be inhibiting capital formation in a promising industry, contrary to its third goal of facilitating capital formation. In Chairman Clayton’s remarks at the Economic Club of New York in July 2017, he noted that in times of technological change, the SEC must “strive to ensure that our rules and operations reflect the realities of our capital markets.”
This has happened before. In the past, the SEC has allowed modifications to the custody rule when the circumstances were compelling and protections were adequate.
The SEC has also granted exceptions to custody requirements in other contexts—such as under the Investment Company Act (ICA)—when there were sufficient safeguards in place. Like the IAA custody rule, Section 17(f) of the ICA requires that funds hold securities only with qualified custodians
The SEC has also provided an exception to the 17(f) custody rule for funds holding cash or securities with the Chicago Mercantile Exchange or other clearing members while they cleared swaps.
Although most cryptocurrency hedge funds will be exempt from the Investment Company Act and not subject to rule 17(f),
B. Modifying the Rule
Unlike the funds in previous no-action letters, hedge funds do not have a viable qualified custodian option for their cryptocurrency assets. Therefore, there may be a low bar if we are merely looking for a modification that is “at least as secure and competent as the same services available” through the existing custodians.
1. Independent, Third-Party Administrators
First, many protections offered by a qualified custodian can be replicated by requiring the fund to hire an independent, third-party administrator to handle clients’ fiat currency, record keeping, and selection of auditors. Without holding the private keys, a third-party administrator could still add protections for investors by holding the fund’s fiat currency and by maintaining reporting and disclosure records. For example, clients could direct their investments in fiat currency directly to a bank account under the control of the administrator. The fund manager would have no ability to withdraw funds from this account. The administrator would then take responsibility for directing the fiat currency to third parties, such as exchanges or parties to private negotiations. Since fiat currency does not present the same problems as digital assets, there is no reason to extend an exemption to custody for it.
In addition, the fund administrator would keep records on the fund’s assets. These records would then be used to provide reports to investors and to calculate the fund’s net asset value. If the fund manager involves any brokers or third-party traders in their transactions, the administrator must take responsibility for reconciling the accounts.
2. Direct Pricing from the Exchange
Second, the custody rule requires the fund to deliver account statements to customers to deter general partners from reaching into the cookie jar and taking improper payments.
3. Quarterly Audit
Third, like the surprise examination, a quarterly audit would help make sure that the assets that the adviser is telling its clients are there are actually there. Increasing the frequency of audits from annually to quarterly would extend protections to investors by decreasing an ill-intentioned fund manager’s window of opportunity for fleecing their clients. Rather than extending a fraudulent scheme for years, as in the case of Bernard Madoff, a quarterly audit would detect misallocation or misappropriation of cryptocurrency and flag the issue for gatekeepers and regulators. While the procedures for storing cryptocurrencies are plagued with technological difficulties and malicious actors, accounting firms are fully capable of auditing digital assets. The only barrier to competency is whether accounting firms are willing to commit resources to learning the field. Many firms have already heeded the SEC’s Chief Accountant’s 2017 call for “lighting a lamp” to see how cryptocurrency affects financial reporting and have performed audits for cryptocurrency hedge fund clients.
4. Custody and Security Policies
Fourth, the fund must have a policy in place to address custody and security, including cybersecurity. This differs from anything found in the current custody rule. However, having a custody and security policy in place would help identify failures and warn investors of risks. In the case of a malicious actor, it would provide the SEC and non-malicious fund managers a roadmap for understanding where the failure occurred and how it could be remedied. In addition, policies would provide additional materials for investors to do due diligence. Especially in the context of cybersecurity, investors would have the opportunity to read the policy and determine whether it provided enough assurances to make them comfortable enough to invest. This is perhaps an idealistic notion―had Madoff provided potential investors with an accurate custodial policy, it is unclear how many would have been deterred. The exercise of drafting a policy would have benefits regardless. For example, a market for compliance consultants may evolve and create industry standards.
5. Disclosure of Risks
Fifth, the fund must provide investors with a special disclosure stating risks stemming from the custody arrangement and trading on exchanges. Hedge funds file disclosures on Form ADV and/or Form PF.
6. Best Interest Determination
Sixth, the general partner of the fund or fund manager must determine that holding client funds or securities on an exchange is in the best interest of the limited partners (investors). In the September 12, 2016, no-action letter to the Delaware Depository discussed in Part IV.A supra, the SEC’s decision to allow the company to have custody of the fund’s gold or silver was contingent on a majority of the fund’s board members determining that “maintaining custody . . . with the Company is in the best interest of the Fund and its shareholders.”
In the context of cryptocurrency funds, this is an attractive provision for investors. It puts the onus on the fund manager to ensure that it is meeting standards of safety when handling clients’ digital assets. As time goes on and familiarity with this asset class increases, “reasonable care” may come to have a clearer definition. In the meantime, “reasonable care” provides needed flexibility to a field lacking technological standards.
7. Insurance
These requirements alone might still be insufficient. Do these rules provide a custodial framework that is “at least equal in nature and quality to the services that could be provided by bank custodians . . . after consideration of all of the relevant factors?”
Some of the risk inherent to keeping custody of cryptocurrencies can be mitigated through insurance. And insurance might make the SEC more willing to tolerate a set of rules that allows significantly more risk of misappropriation and loss from theft, depending on what type of assets a given hedge fund manager chooses to invest in. Although there is not yet a mature market for insuring cryptocurrency, it is foreseeable that one will evolve. For example, despite a lack of data and adverse results, Waymo’s autonomous ride sharing program was able to partner with an insurer.
In addition, new technologies and innovations may dramatically reduce the risk of fund managers and exchanges maintaining custody of digital assets. The private company Chainalysis offers investigative tools that can track Bitcoin transactions to wallets.
Conclusion
As hedge funds continue to invest in cryptocurrency, the market for custodial services will adapt to the changing landscape. In the meantime, the SEC will have to manage the challenge of applying the custody rule to a technologically complex asset class that was not contemplated during the rules’ inception. My proposed alterations of the custody rule will allow hedge funds to continue to invest in cryptocurrency while providing investors a higher degree of security. These requirements might still fall short of achieving protections that are “at least equal in nature and quality to the services that could be provided by bank custodians”
DOI: https://doi.org/10.15779/Z38M03XX77.
Copyright © 2019 California Law Review, Inc. California Law Review, Inc. (CLR) is a California nonprofit corporation. CLR and the authors are solely responsible for the content of their publications.
Drew Schaefer: J.D. 2019, University of California, Berkeley, School of Law. My deepest gratitude to Robert Bartlett, Karl Cole-Frieman, Anthony Wise, and the editorial staff of the California Law Review for their helpful comments and suggestions.
- See Press Release, U.S. Sec. & Exch. Comm’n, The Securities and Exchange Commission Post-Madoff Reforms (Apr. 2, 2012), https://www.sec.gov/spotlight/secpostmadoffreforms.htm [https://perma.cc/ZDT3-5U7Y] [hereinafter Post-Madoff Reforms]. ↑
- See Diana B. Henriques & Alex Berenson, The 17th Floor, Where Wealth Went to Vanish, N.Y. Times (Dec. 14, 2008), https://www.nytimes.com/2008/12/15/business/15madoff.html [https://perma.cc/5USX-KGUD]. ↑
- See K.V. Nagarajan, The Code of Hammurabi: An Economic Interpretation, 2 Int’l J. of Bus. & Soc. Sci. 108. (2011). ↑
- Id. at 111. ↑
- See Post-Madoff Reforms, supra note 1 (“The rules provide greater assurance to investors that their accounts contain the funds that their investment adviser and account statements say they contain.”). ↑
- See Advisers Act Rule 206(4)-2, 17 C.F.R. § 275.206(4)-2 (2019)). ↑
- Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act Release No. IA-2876, 68 Fed. Reg. 56,692 (Oct. 1, 2003). ↑
- Id. ↑
- See Post-Madoff Reforms, supra note 1 (“Among other things, the new rules encourage registered investment advisers to place their clients’ assets in the custody of an independent firm, unlike Bernard Madoff did.”). ↑
- See Complaint at 5, SEC v. Madoff, No. 08 Civ. 10791 (S.D.N.Y. 2008) (“Madoff kept the financial statements for the firm under lock and key, and was ‘cryptic’ about the firm’s investment advisory business when discussing the business with other employees of BMIS”). ↑
- See Wolfie Zhao, Morgan Stanley: Hedge Funds Poured $2 Billion into Cryptos in 2017, CoinDesk (Dec. 20, 2017), https://www.coindesk.com/morgan-stanley-hedge-funds-poured-2-billion-into-cryptos-in-2017 [https://perma.cc/3JMR-4XKN] (“The investment bank further detailed that more than 100 crypto-related hedge funds have sprung up over the past six years, [but] 84 of the funds launched in 2017.”). ↑
- See Alex Hern, ‘$300m in Cryptocurrency’ Accidentally Lost Forever Due to Bug, Guardian (Nov. 8, 2017), https://www.theguardian.com/technology/2017/nov/08/cryptocurrency-300m-dollars-stolen-bug-ether [https://perma.cc/4BV3-76ZE]; Stan Higgins, Ethereum Client Update Issue Costs Cryptocurrency Exchange $14 Million, CoinDesk (June 2, 2017), https://www.coindesk.com/ethereum-client-exchange-14-million [https://perma.cc/8CWS-JCN9]. ↑
- Cameron Keng, Bitcoin’s Mt. Gox Goes Offline, Loses $409M – Recovery Steps and Taking Your Tax Losses, Forbes (Feb. 25, 2014), https://www.forbes.com/sites/cameronkeng/2014/02/25/bitcoins-mt-gox-shuts-down-loses-409200000-dollars-recovery-steps-and-taking-your-tax-losses/#53fc792d5c16 [https://perma.cc/QPX5-FGYW]. ↑
- See Get Free Crypto Coins if You Own Bitcoins (BTC), Crypto Mining Blog (July 24, 2017), http://cryptomining-blog.com/tag/airdrop/ [https://perma.cc/RA26-PD9Q]; Jamie Redman, Bitcoin Cash Network Completes a Successful Hard Fork, Bitcoin.com (Nov. 13, 2017), https://news.bitcoin.com/bitcoin-cash-network-completes-a-successful-hard-fork [https://perma.cc/L6BN-YQSD]. ↑
- See, e.g., Information about “Coinbase Custody” available via their website, https://custody.coinbase.com [https://perma.cc/M67Y-CWS5]. ↑
- Robert E. Plaze, Regulation of Custodial Practices Under the Investment Advisers Act of 1940 Rule 206(4)-2, Investment Adviser Association Investment Adviser Compliance Conference, Crystal City, VA at 1 (March 6–7, 2014), https://docplayer.net/17221319-Regulation-of-custodial-practices-under-the-investment-advisers-act-of-1940-rule-206-4-2.html [https://perma.cc/WH5D-8356]. ↑
- See id. ↑
- See id. at 2. ↑
- See Staff Responses to Questions About the Custody Rule, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/divisions/investment/custody_faq_030510.htm [https://perma.cc/PJ5L-UEQN]; see also Douglas L. Hammer et al., U.S. Regulation of Hedge Funds 325 (2013). ↑
- Hammer, supra note 19, at 9. ↑
- See Advisers Act Rule 206(4)-2(a), 17 C.F.R. § 275.206(4)-2(a) (2018); Hammer, supra note 19, at 325; Plaze, supra note 16, at 5. ↑
- 17 C.F.R. § 275.206(4)-2. ↑
- Id. ↑
- See Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act Release No. 2176, 68 Fed. Reg. 56,692 n.17 (Oct. 1, 2003). ↑
- See 17 C.F.R. § 275.206(4)-2(a)(3). ↑
- See Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act Release No. 2176, 68 Fed. Reg. 56,692 n.18; Plaze, supra note 16, at 12. ↑
- 17 C.F.R. § 275.206(4)-2(a)(2). ↑
- Id. § 275.206(4)-2(a)(7); Hammer, supra note 19, at 327. ↑
- 17 C.F.R. § 275.206(4)-2(a)(3). ↑
- See Hammer, supra note 19, at 328. ↑
- 17 C.F.R. § 275.206(4)-2(a)(3). ↑
- See id. § 275.206(4)-2(a)(4). ↑
- See 17 C.F.R. § 275.206(4)-2(a)(4); In re Kaufman, Bernstein, Oberman, Tivoli & Miller, LLC, S.E.C. Admin. Proc., File No. 3-11341 (Nov. 20, 2003), Plaze, supra note 16, at 17. ↑
- 17 C.F.R. § 275.206(4)-2(a)(4)(i)–(iii). ↑
- Hammer, supra note 19, at 1. ↑
- Id. at 14. ↑
- Private Fund Adviser Exemption, 17 C.F.R. § 275.203(m)-1. However, even when exempt from SEC regulation, they may nonetheless be subject to an analogue under state law. For an example of state-level regulation of cryptocurrency custody, see the New York “Bitlicense,” Virtual Currencies, N.Y. Comp. Codes R. & Regs.. tit. 23, § 200.9 (2015), https://www.dfs.ny.gov/legal/regulations/adoptions/dfsp200t.pdf [https://perma.cc/KU46-WQ36__]__ (“Each Licensee shall maintain a surety bond or trust account in United States dollars for the benefit of its customers in such form and amount as is acceptable to the superintendent for the protection of the Licensee’s customers. To the extent a Licensee maintains a trust account in accordance with this section, such trust account must be maintained with a Qualified Custodian.”). See also Hammer, supra note 19, at 332. ↑
- See Cryptocurrency Investment Fund Industry Graphs and Charts, Crypto Fund Res., https://cryptofundresearch.com/cryptocurrency-funds-overview-infographic [https://perma.cc/Q8VX-NY9Q] (“The vast majority of crypto investment funds are small. Half have less than $10 million in assets under management (AUM).”). ↑
- See, e.g., Cryptocurrency Fund L.P., Notice of Exempt Offering of Securities (Form D) (July 7, 2017), http://pdf.secdatabase.com/2809/0001711332-17-000001.pdf [https://perma.cc/G2D5-V8YQ] (seeking a total offering of 200mm). ↑
- Form ADV is used by investment advisers to register with the SEC and state securities authorities. See Fast Answers: Form ADV, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/fast-answers/answersformadvhtm.html [https://perma.cc/Q28G-XRGP]. ↑
- 17 C.F.R. § 275.206(4)-2(a)(4) (2019). ↑
- Id. ↑
- See Hammer, supra note 19, at 330. ↑
- The Public Company Accounting Oversight Board is a non-profit corporation established by Sarbanes-Oxley Act of 2002 to supervise the audits of public companies and broker-dealers. The SEC approves the PCAOB’s rules, standards, and budget. See About the PCAOB, Pub. Company Acct. Oversight Board, https://pcaobus.org/About/Pages/default.aspx [https://pcaobus.org/About/Pages/default.aspx]. ↑
- The rule states “If you are an investment adviser . . . it is a fraudulent, deceptive, or manipulative act, practice or course of business . . . for you to have custody of client funds or securities unless . . .”17 C.F.R. § 275.206(4)-2(a) (emphasis added). ↑
- See Pedro Franco, Understanding Bitcoin 9–10 (2015). ↑
- Id. at 9. ↑
- See Winklevoss Bitcoin Trust, Amendment No. 8 to Form S-1 Registration Statement 14 (Dec. 7, 2016), https://www.sec.gov/Archives/edgar/data/1579346/000119312516786685/d302498ds1a.htm [https://perma.cc/T8NS-YL5T]. ↑
- “Cryptocurrencies” are often referred to as coins, tokens, or altcoins. Bitcoin and other cryptocurrencies used as a transfer of value are referred to as “coins.” Cryptocurrencies that are built on top of platforms, like Ethereum, do not themselves facilitate the transfer of value and are referred to as “tokens.” “Altcoins” refers generally to cryptocurrencies that are modifications of Bitcoin’s code, such as Litecoin. For the purposes of this paper, we will refer to all three as cryptocurrencies, unless the topic requires further specificity. See Altcoin, Investopedia, https://www.investopedia.com/terms/a/altcoin.asp [https://perma.cc/7PAB-G8WQ]. ↑
- Sarah J. Hughes & Stephen T. Middlebrook, Advancing a Framework for Regulating Cryptocurrency Payments Intermediaries, 32 Yale J. on Reg. 495, 505 (2015). ↑
- See Conrad Barski & Chris Wilmer, Bitcoin for the Befuddled 7–14 (2015). ↑
- Id. at 19. ↑
- See Daniel Drescher, Blockchain Basics 63–69 (2017). ↑
- See id. at 77. ↑
- In fact, there is an additional database called the “Unspent Transactions Outputs cache” that records available funds for each address. Imran Bashir, Mastering Blockchain 125 (2017); Franco, supra note 46, at 15. However, like much of the overview here, a more simplistic overview is sufficient for purposes of applying the custody rule. ↑
- See Drescher, supra note 53, at 29–32, 79. ↑
- Barski & Wilmer, supra note 51, at 10. ↑
- Id. at 11. ↑
- Private Key, Bitcoin Wiki, https://en.bitcoin.it/wiki/Private_key [https://perma.cc/ADU6-26XZ]. ↑
- Barski & Wilmer, supra note 51, at 11. ↑
- Richard Caetano, Learning Bitcoin 16 (2015) (“It is not possible to recover lost private keys.”). ↑
- Bitcoin Hedge Fund FAQs, Hedge Fund Law Blog (May 19, 2017), http://hedgefundlawblog.com/bitcoin-hedge-fund-faqs.html [https://perma.cc/EKV8-76LK] (“[T]he investment management industry is used to a certain definition of custody (holding something) that may not fit within the digital asset space, where control and the ability to utilize an asset is really more of the applicable context.”). ↑
- Barski & Wilmer, supra note 51, at 12. ↑
- Id. at 33. ↑
- For examples of wallet services, see Wallet Services, Coinbase, https://support.coinbase.com/customer/en/portal/topics/601112-wallet-services/articles [https://perma.cc/T2GP-N95G]. ↑
- Id. ↑
- See Barski & Wilmer, supra note 51, at 36. ↑
- Id. at 33. ↑
- Id. at 33. ↑
- See Jared Polites, Op-Ed: How Air Gap Technology Has and Will Secure Our Cryptocurrency Assets, CCN (Sept. 29, 2018), https://www.ccn.com/op-ed-how-air-gap-technology-has-and-will-secure-our-cryptocurrency-assets/ [https://perma.cc/RVV5-VABL]; Kim Zetter, Hacker Lexicon: What Is An Air Gap?, Wired (Dec. 8, 2014), https://www.wired.com/2014/12/hacker-lexicon-air-gap [https://perma.cc/6EK4-KLPF]. ↑
- Barski & Wilmer, supra note 51, at 141. ↑
- See Franco, supra note 46, at 136. ↑
- See Id. ↑
- Caetano, supra note 61, at 17. ↑
- An exchange traded fund, or ETF, would allow individuals to invest in cryptocurrency without owning the coin directly. Instead, they would own shares in the entity that hold the coins. ↑
- In 2017 the SEC rejected a proposed rule change that would have allowed for the Winklevoss Bitcoin Trust ETF to be listed on an exchange. See Joseph Adinolfi & Ryan Vlastelica, Here’s What’s Next for Bitcoin After the SEC Killed the Winklevoss Bitcoin Trust, MarketWatch (Mar. 13, 2017) https://www.marketwatch.com/story/heres-whats-next-for-bitcoin-after-the-sec-killed-the-winklevoss-bitcoin-trust-2017-03-10 [https://perma.cc/GG9K-ZH49]. ↑
- See Winklevoss Bitcoin Trust, supra note 48. ↑
- Order Disapproving a Proposed Rule Change, as Modified, Release No. 34-80206, File No. SR-BatsBZA-2016-30 (Mar. 10, 2017), https://www.sec.gov/rules/sro/batsbzx/2017/34-80206.pdf [https://perma.cc/3CD6-8AYN]. ↑
- Winklevoss Bitcoin Trust, supra note 48 (emphasis added). ↑
- Although there are frequent news stories about large custodians developing cryptocurrency products, as of writing, none of the largest hedge fund custodians act as qualified custodians for cryptocurrency assets. Neer Varshney, Coinbase’s Cryptocurrency Custodial Service is Open for Business, Hard Fork (July 2, 2018), https://thenextweb.com/hardfork/2018/07/02/coinbases-cryptocurrency-custody [https://perma.cc/T7RL-QRHC] (“There has been a lack of reliable custodian services for cryptocurrencies all across the globe due to uncertainty in the regulations.”). ↑
- Qualified Custodian Kingdom Trust Now Accepting Investments in cash and Stellar Lumens, Kingdom Trust (July 5, 2018), https://www.kingdomtrust.com/news/news-qualified-custodian-kingdom-trust-now-accepting-investments-in-zcash-and-stellar-lumens [https://perma.cc/F5WW-K4ZB]. ↑
- See Vault: We’ve Built a Fortress for You, Xapo, https://www.xapo.com/en/security#vault [https://perma.cc/3TVH-QYZK]. ↑
- Joon Ian Wong, Photos: The Secret Swiss Mountain Bunker Where Millionaires Stash Their Bitcoins, Quartz (Oct. 17, 2017), https://qz.com/1103310/photos-the-secret-swiss-mountain-bunker-where-millionaires-stash-their-bitcoins/ [https://perma.cc/R8XW-JBFJ]. ↑
- Sam McIngvale, Coinbase Custody is Officially Open for Business, The Coinbase Blog (July 2, 2018), https://blog.coinbase.com/coinbase-custody-is-officially-open-for-business-182c297d65d9 [https://perma.cc/UB4T-E5DT]. ↑
- Alex Morris, Coinbase Custody Now Holds More Than $500 Mln in Digital Assets, U Today (Feb. 21, 2019), https://u.today/coinbase-custody-now-holds-more-than-500-mln-in-digital-assets [https://perma.cc/5QC8-V5VP]. ↑
- 17 C.F.R. § 275.206(4)-2(a) (2019). ↑
- See David Hundeyin, BitGo Receives Approval to Operate as Regulated Cryptocurrency Custodian, CCN (Sept. 16, 2018), https://www.ccn.com/bitgo-receives-approval-to-operate-as-regulated-cryptocurrency-custodian [https://perma.cc/NZA9-R2HY]; Yogita Khatri, TokenSoft to Offer Coincase Custody as STO Client Option, Coindesk (Dec. 20, 2018), https://www.coindesk.com/tokensoft-to-offer-coinbase-custody-as-sto-client-option [https://perma.cc/52QD-VEDV]. ↑
- See Learning About Xapo – General: Does Xapo Support Other Cryptocurrencies Besides BitCoin?, Xapo, https://support.xapo.com/learning/about-xapo/general/does-xapo-support-other-cryptocurrencies-besides-bitcoin [https://perma.cc/K6SE-4GS5] (“While you have access to any currency across the entire world with your Xapo account, the only cryptocurrency you can use and store is bitcoin (BTC)”). ↑
- Laura Shin, Can’t Invest in a Crypto Hedge Fund? DIY With Shapeshift’s Prism, Forbes (Aug. 7, 2017), https://www.forbes.com/sites/laurashin/2017/08/07/cant-invest-in-a-crypto-hedge-fund-diy-with-shapeshifts-prism/ [https://perma.cc/78W4-HDF7]. ↑
- Id. ↑
- Id. ↑
- See Private Digital Currency, Monero, https://getmonero.org [https://perma.cc/R3UY-7L2W] (“Monero is a decentralized cryptocurrency, meaning it is secure digital cash operated by a network of users. Transactions are confirmed by distributed consensus and then immutably recorded on the blockchain.”). ↑
- See Moneropedia, Monero, https://getmonero.org/resources/moneropedia/ringsignatures.html [https://perma.cc/Y5BT-ULMR] (“One of the security properties of a ring signature is that it should be computationally infeasible to determine which of the group members’ keys was used to produce the signature . . . . So, ring signatures ensure that transaction outputs are untraceable.”). ↑
- GenericShill, Monero Wallets in 2018: Finally Some Progress in Light Wallets, Altcoin Trading (Jan. 3, 2017), https://www.altcointrading.net/monero-wallet [https://perma.cc/C896-SMKV]. ↑
- The Next Monero Client Release Will Have Full Multisig Support, NewsBTC (Dec. 18, 2017), http://www.newsbtc.com/2017/12/18/next-monero-client-release-will-full-multisig-support [https://perma.cc/6UJT-USA9] (“Monero, the coin known for its privacy and anonymity, will receive multisig support soon.”). ↑
- GenericShill, supra note 94. ↑
- It will be interesting to see how Coinbase Custody handles technological challenges and how many different coins it ultimately supports. See Frank Chaparro, Coinbase is Going After Big Hedge Fund Money with its New Cryptocurrency Security Platform, Bus. Insider (Nov. 16, 2017), http://www.businessinsider.com/coinbase-going-after-hedge-fund-money-with-new-cryptocurrency-security-platform-2017-11 [https://perma.cc/5H7S-G2KS]. ↑
- William F. Jarvis, Understanding the Cost of Investment Management: A Guide for Fiduciaries, Commonfund Instit. 6 (Oct. 2015), https://www.caia.org/sites/default/files/understanding_the_cost_of_investment_management.pdf [https://perma.cc/MW7X-75WC] (“As an example, these costs, which are generally 5 to 10 basis points for U.S. funds, rise to 10 to 25 basis points for large international funds and can easily exceed 25 basis points for small international funds.”). ↑
- Kent Oz, Independent Fund Administrators as a Solution for Hedge Fund Fraud, 15 Fordham J. Corp. & Fin. L. 329, 355 (2009). ↑
- See Narayan Prusty, Building Blockchain Projects 32 (2017). ↑
- Franco, supra note 46, at 108–09. ↑
- IG Analyst, What are Bitcoin Forks and How Do They Work?, IG (Nov. 20, 2018), https://www.ig.com/au/trading-opportunities/what-are-bitcoin-forks-and-how-do-they-work--181120, [https://perma.cc/QJZ8-XFMA]. ↑
- See, e.g., Ermos Kyriakides, All You Need to Know About Airdrops, Hackernoon (July 31, 2018), https://hackernoon.com/all-you-need-to-know-about-airdrops-98b1b5af7941 [https://perma.cc/C5RN-PG2K]. ↑
- See Bitcoin Cash – Frequently Asked Questions, Coinbase, https://support.coinbase.com/customer/portal/articles/2853600-bitcoin-cash---frequently-asked-questions [https://perma.cc/LW4E-4TDH]. ↑
- Cryptocurrency Market Capitalizations for Bitcoin Cash, CoinMarketCap, https://coinmarketcap.com/currencies/bitcoin-cash [https://perma.cc/5K8K-VEWQ]. ↑
- Coinbase, Updated: What to Expect During the Bitcoin Cash Hard Fork, Coinbase Blog (Nov. 13, 2018), https://blog.coinbase.com/what-to-expect-during-the-bitcoin-cash-hard-fork-f15fd03687db. [https://perma.cc/L2TF-8XVP]. ↑
- See id. ↑
- See Notice About Bitcoin Gold, Poloniex (Oct. 24, 2017), https://poloniex.com/press-releases/2017.10.24-Notice-About-Bitcoin-Gold/ [https://perma.cc/7L66-P7AH]; see also Update as of Tuesday, November 20, 2018, The Coinbase Blog (Nov. 20, 2018), https://blog.coinbase.com/what-to-expect-during-the-bitcoin-cash-hard-fork-f15fd03687db [https://perma.cc/L2TF-8XVP] (“We will continue to evaluate the safety of the BCH SV chain . . . We anticipate this development work will take at least a few weeks, but may take longer . . . If network conditions significantly change or become unsafe at any point, Coinbase may revise these plans.”). ↑
- In a staff letter, the SEC cited valuation as one of the concerns in not allowing an ETF to be listed on an exchange. Staff Letter, Dalia Blass, Director, Div. of Inv. Mgmt., U.S. Sec. & Exch. Comm’n, Engaging on Fund Innovation and Cryptocurrency-related Holdings (Jan. 18, 2018), https://www.sec.gov/divisions/investment/noaction/2018/cryptocurrency-011818.htm [https://perma.cc/9ZUF-ZGT7] [hereinafter Staff Letter] (“Would funds have the information necessary to adequately value cryptocurrencies or cryptocurrency-related products, given their volatility, the fragmentation and general lack of regulation of underlying cryptocurrency markets, and the nascent state and current trading volume in the cryptocurrency futures markets?”). ↑
- Julia Kagan, Incentive Fee, Investopedia (Jan. 9 2018), https://www.investopedia.com/terms/i/incentive-fee.asp [https://perma.cc/3Z8D-ERD6]. (“In hedge funds, where incentive fees are more common, the fee is generally calculated based on growth of the fund’s or account’s net asset value (NAV).”). ↑
- Donald R. Chambers et al., Alternative Investments: CAIA Level 1 399 (3d ed. 2015); Vikas Agarwal, Naveen D. Daniel & Narayan Y. Naik, Role of Managerial Incentives and Discretion in Hedge Fund Performance, 64 J. of Fin. 2221 (2009). ↑
- Press Release, U.S. Sec. & Exch. Comm’n, SEC Brings First Actions to Halt Unregistered Online Offerings of So-Called “Free Stock” (July 22, 1999), https://www.sec.gov/news/headlines/webstock.htm [https://perma.cc/KHN4-T8S3]. ↑
- See id. (“In each of the four cases, the investors were required to sign up with the issuers’ web sites and disclose valuable personal information in order to obtain shares. . . . Through these techniques, issuers received value by spawning a fledgling public market for their shares, increasing their business, creating publicity, increasing traffic to their websites, and, in two cases, generating possible interest in projected public offerings.”). ↑
- Houman B. Shadab, The Law and Economics of Hedge Funds: Financial Innovation and Investor Protection, 6 Berkeley Bus. L.J. 240, 252 (2009). ↑
- See Staff Letter, supra note 109. ↑
- Vault: We’ve Built a Fortress for You, supra note 82. ↑
- A gate limits the amount of a hedge fund’s assets that can be withdrawn by investors. A side pocket is a type of account used by hedge funds to separate liquid and illiquid assets. See James Chen, Gate Provision, Investopedia (Mar. 26, 2018), https://www.investopedia.com/terms/g/gateprovision.asp [https://perma.cc/Q3ZA-YNXP]; James Chen, Side Pocket, Investopedia (Jan. 22, 2018), https://www.investopedia.com/terms/s/sidepocket.asp [https://perma.cc/2PS2-CSHD]. ↑
- See George O. Aragon et al., U.S. Sec. & Exch. Comm’n, Staff Paper: Hedge Fund Liquidity Management (2017), https://www.sec.gov/files/dera_hf-liquidity-management.pdf [https://perma.cc/Y72P-DQKT] (“Interestingly, the committed period of financing from a fund’s creditors is unrelated to portfolio illiquidity. A possible interpretation for this ‘non-result’ is that, while funds pursuing illiquid strategies have a greater demand for longer-term financing, its creditors are less willing to extend long-term loans due to the illiquid nature of the fund’s assets.”). ↑
- 17 C.F.R. § 275.206(4)-2 (2019). ↑
- Sec. & Exch. Comm’n, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: the DAO, Release No. 81207 (July 25, 2017), https://www.sec.gov/litigation/investreport/34-81207.pdf [https://perma.cc/4MXK-C4YL] [hereinafter the DAO Report]. ↑
- SEC v. W.J. Howey Co., 328 U.S. 293 (1946). ↑
- The Dao Report, supra note 120, at 11. ↑
- SEC v. Shavers, No. 4:13-CV-416, 2013 WL 4028182, at 2 (E.D. Tex. Aug. 6, 2013), adhered to on reconsideration, No. 4:13-CV-416, 2014 WL 12622292 (E.D. Tex. Aug. 26, 2014); Alexander B. Lindgren, Blockchain Regulation: Growing Pains of A Financial Revolution*, 59 Orange County Law. 38, 40 (October 2017). ↑
- See A Securities Law Framework for Blockchain Tokens, Coinbase (Dec. 7, 2016), https://www.coinbase.com/legal/securities-law-framework.pdf [https://perma.cc/AEL9-ZBG3]. ↑
- Id. ↑
- Public Statement, Jay Clayton, Chairman, Sec. & Exch. Comm’n, Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017), https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11#_ftn5 [https://perma.cc/VMJ2-VMNR]. ↑
- Id. ↑
- As mentioned previously, custody is defined as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.” Advisers Act Rule, 17 C.F.R. § 275.206(4)-2(d)(2) (2019) (emphasis added). ↑
- Form ADV: Uniform Application for Investment Advisor Registration and Report by Exempt Reporting Advisers, Item 9(F), https://www.sec.gov/about/forms/formadv-part1a.pdf [https://perma.cc/2BVM-CKP7__] __(added in 2011); see Rules Implementing Amendments to the Investment Advisers Act of 1940, Investment Advisers Act Release No. 3221, 76 Fed. Reg. 42,950, 42,972 (July 19, 2011). ↑
- See Gina Clarke, Why Debit Cards and Visa Could Save Cryptocurrencies, Forbes (Oct. 22, 2018), https://www.forbes.com/sites/ginaclarke/2018/10/22/why-debit-cards-and-visa-could-save-cryptocurrencies/ [https://perma.cc/7AAT-EESN]. ↑
- See Kurt Wagner, World’s First Bitcoin ATM Opens In Vancouver, Canada, Mashable (Oct. 30, 2013), https://mashable.com/2013/10/30/bitcoin-atm-2/#uLHkI4tLRsqC [https://perma.cc/WUX8-Y96N]. ↑
- See Paying With Bitcoin, Expedia.com, https://www.expedia.com/Checkout/BitcoinTermsAndConditions [https://perma.cc/72PZ-B3K6] (“Our acceptance of Bitcoin is powered by our partner, Coinbase. We do not guarantee and are not responsible for the availability of Coinbase’s services.”). ↑
- See, e.g., Cryptocurrency Fund L.P., Notice of Exempt Offering of Securities, Form D (July 7, 2017), https://www.sec.gov/Archives/edgar/data/1711332/000171133217000001/xslFormDX01/primary_doc.xml [https://perma.cc/83H5-MCRH]. ↑
- See Advisers Act Rule 206(4)-2(b)(2), 17 C.F.R. § 275.206(4)-2(b)(2) (2019); Hammer, supra note 19, at 326. ↑
- 17 C.F.R. § 275.206(4)-2(b)(2). ↑
- See Juan Batiz-Benet, Jesse Clayburgh & Marco Santori, The SAFT Project: Toward a Compliant Token Sale Framework 15 (Oct. 2, 2017), https://saftproject.com/static/SAFT-Project-Whitepaper.pdf [https://perma.cc/SD6P-AZP7] (“In short, the SAFT provides investors with the right to fully-functional utility tokens, delivered once the network is created and the tokens are functional. The SAFT is very likely a security, namely an investment contract.”); see also Carolynn Levy, Safe Financing Documents, Y Combinator (Sept. 2018), https://www.ycombinator.com/documents [https://perma.cc/RM2E-97MQ]. ↑
- See SAFT for Filecoin Token Presale (Series S-2), Protocol Labs, https://coinlist.co/assets/index/filecoin_index/Protocol%20Labs%20-%20SAFT%20for%20Filecoin%20Token%20Presale-0f43e05c4ad1c0bd8993b60c4d6bf3cbd4f3d278dd7a62dde1972c9d82c65184.pdf [https://perma.cc/A3W6-UBFD] (“The offer and sale of this security instrument has not been registered under the U.S. Securities Act of 1933, As Amended (The “Securities Act”), or under the securities laws of certain states. This security may not be offered, sold or otherwise transferred, pledged or hypothecated except as permitted under the act and applicable state securities laws pursuant to an effective registration statement or an exemption therefrom.”) (alteration in original). The original SAFT template can be downloaded at https://saftproject.com/static/Form-of-SAFT-for-token-pre-sale.docx [https://perma.cc/U7SQ-WEJL]. ↑
- See SAFT for Filecoin, supra note 137, at 2. ↑
- Rule 144 is an SEC regulation that provides an exemption from registration for the sale of a security if certain conditions are met. One of those conditions set under 144(b)(1)(ii) and (d)(1)(ii) is a one-year holding period for securities issued by a non-reporting company, which includes the majority of ICOs. See 17 C.F.R. § 230.144 (“Persons deemed not to be engaged in a distribution and therefore not underwriters”); Rule 144: Selling Restricted and Control Securities, U.S. Sec. & Exch. Comm’n, (Jan. 16, 2013), https://www.sec.gov/reportspubs/investor-publications/investorpubsrule144htm.html [https://perma.cc/TB63-PYXP]. ↑
- Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act Release No. IA-2876,68 Fed. Reg. 56,692 (Oct. 1, 2003). ↑
- What We Do, U.S. Sec. & Exch. Comm’n, (June 10, 2013), https://www.sec.gov/Article/whatwedo.html [https://perma.cc/F6SZ-LYQL]. ↑
- Division of Enforcement, U.S. Sec. & Exch. Comm’n,: Annual Report: A Look Back at Fiscal Year 2017 (2017), https://www.sec.gov/files/enforcement-annual-report-2017.pdf [https://perma.cc/E3XL-CMDW]. ↑
- Jay Clayton, Chairman, U.S. Sec. & Exch. Comm’n, Remarks at the Economic Club of New York (July 12, 2017), https://www.sec.gov/news/speech/remarks-economic-club-new-york [https://perma.cc/CW8V-RFJJ]. ↑
- See Testimony on “Virtual Currencies: The Oversight Role of the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission”: Hearing Before the S. Comm. on Banking, Hous., & Urban Affairs, 115th Cong. (Feb. 6, 2018) (statement Jay Clayton, Chairman, U.S. Sec. & Exch. Comm’n) (“Cryptocurrencies, ICOs and related products and technologies have captured the popular imagination – and billions of hard-earned dollars – of American investors from all walks of life. In dealing with these issues, my key consideration – as it is for all issues that come before the Commission – is to serve the long-term interests of our Main Street investors.”). ↑
- See Staff Letter, supra note 109 (“As you know, the U.S. investment fund market is one of the most robust, varied and successful markets for investment products in the world. Its success can be attributed, in significant part, to the commitment of fund sponsors to responsible innovation and continuous improvement of the products they offer. This commitment is especially important because many of America’s Main Street investors rely on registered funds to help them build toward education, retirement and other important goals.”). ↑
- See Hammer, supra note 19, at 104. ↑
- 17 C.F.R. § 230.501(a)(5)–(6) (2019). ↑
- Polina Marinova, DFJ’s Tim Draper on Bitcoin’s Rise, Steve Jurvetson’s Exit, and His Biggest Investing Regret, Fortune (Jan. 31, 2018), http://fortune.com/2018/01/31/dfj-tim-draper-bitcoin [https://perma.cc/KJM3-WQD5]; Robert McMillan, Someone Just Bought $19M in Silk Road Bitcoins From the Feds, Wired (July 1, 2014), https://www.wired.com/2014/07/silkroadauction/ [https://perma.cc/4HHQ-6Q2U]. ↑
- See U.S. Sec. & Exch. Comm’n, Staff Report, Implications of the Growth of Hedge Funds (2003), https://www.sec.gov/news/studies/hedgefunds0903.pdf [https://perma.cc/5UE7-JQDS] (“The growth in hedge funds has been fueled primarily by the increased interest of institutional investors such as pension plans, endowments and foundations seeking to diversify their portfolios with investments in vehicles that feature absolute return strategies”). ↑
- See id. ↑
- See Press Release, U.S. Sec. & Exch. Comm’n, SEC Adopts Dodd-Frank Act Amendments to Investment Advisers Act (June 22, 2011), https://www.sec.gov/news/press/2011/2011-133.htm [https://perma.cc/7MR6-MHTA]. ↑
- Jay Clayton, Chairman, U.S. Sec. & Exch. Comm’n, Remarks at the Economic Club of New York (July 12, 2017), https://www.sec.gov/news/speech/remarks-economic-club-new-york [https://perma.cc/CW8V-RFJJ]. ↑
- See Depository Trust Company of Delaware, LCC dba Delaware Depository, SEC No-Action Letter, (Sept. 12, 2016) https://www.sec.gov/divisions/investment/noaction/2016/depository-trust-company-of-delaware-091216.html [https://perma.cc/7SX5-3X8]; Investment Adviser Association, SEC No-Action Letter, File No. 132-3, at 1 (Sept. 20, 2007), https://www.sec.gov/divisions/investment/noaction/2007/iaa092007.pdf [https://perma.cc/9YGB-U3ET]. ↑
- Investment Adviser Association, supra note 151. ↑
- See id. ↑
- Id. at 3. ↑
- Id. at 4. ↑
- Id. ↑
- Id. ↑
- Id. ↑
- See id. ↑
- Rule 17f-4 allows registered investment companies to deposit securities it owns into a securities depository. See Final Rule: Custody of Investment Company Assets with a Securities Depository, Release No. IC-25934 (Feb. 13, 2003), https://www.sec.gov/rules/final/ic-25934.htm [https://perma.cc/47L2-2ZVT]. ↑
- Depository Trust Co. of Delaware, supra note 151. (“These qualified custodians include, for example, banks satisfying the qualifications specified within Section 26(a)(1) of the 1940 Act, a member of a national securities exchange, or other entities that the Commission has prescribed by rule, regulation, or order for the protection of investors.”). ↑
- Id. ↑
- Id. ↑
- Id. ↑
- Id. ↑
- Id. ↑
- See Chi. Mercantile Exch., SEC No-Action Letter (Dec. 19, 2017), https://www.sec.gov/divisions/investment/noaction/2017/chicago-mercantile-exchange-121917.htm [https://perma.cc/4YE5-TY26] [hereinafter Chi. Mercantile Exch., No-Action Letter (Dec. 19, 2017)]. ↑
- See Chi. Mercantile Exch., SEC Staff No-Action Letter (July 29, 2011), https://www.sec.gov/divisions/investment/noaction/2011/cme072911-17f.htm [https://perma.cc/G4RF-YGW6] [hereinafter Chi. Mercantile Exch., No-Action Letter (July 29, 2011)]; Chi. Mercantile Exch., SEC Staff No-Action Letter (Mar. 24, 2011), https://www.sec.gov/divisions/investment/noaction/2011/cme032411-17f.htm [https://perma.cc/FPA4-LUXA]. [hereinafter Chi. Mercantile Exch, No-Action Letter (Mar. 24, 2011)]. Swaps are over-the-counter (not traded on an exchange) contracts through which two parties exchange cash flows or liabilities from two different financial instruments. For an assessment of the post-Dodd-Frank CFTC rules on swaps, see J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank (Jan. 29, 2015), https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf [https://perma.cc/LM4L-7KFG]. ↑
- See Chi. Mercantile Exch., SEC No-Action Letter (Dec. 19, 2017), supra note 169. ↑
- See Chi. Mercantile Exch,. SEC No-Action Letter (July 29, 2011), supra note 170; Chi. Mercantile Exch., SEC No-Action Letter (Mar. 24, 2011), supra note 170. ↑
- These included following regulation for swap collateral, promptly furnishing copies of asset records, and preserving the ability of the fund to withdraw assets if the custodial arrangement ever falls out of line with 17(f). See Chi. Mercantile Exch,. SEC No-Action Letter (July 29, 2011), supra note 170; Chi. Mercantile Exch., SEC No-Action Letter (Mar. 24, 2011), supra note 170. ↑
- “Company Act section 3(c)(1) excludes any pooled investment vehicle from the definition of ‘investment company’ if it does not have more than 100 beneficial owners of its outstanding securities (‘the 100-Owner Limit’) and does not make or propose to make a public offering of its securities.” Hammer, supra note 19, at 70.; see also 15 U.S.C. § 80a-3(c)(1). ↑
- See Depository Trust Co. of Delaware, supra note 151; see also Chi. Mercantile Exch., SEC No-Action Letter (July 29, 2011), supra note 170; Chi. Mercantile Exch., SEC No-Action Letter (Mar. 24, 2011), supra note 170. ↑
- See Investment Adviser Association, supra note 151; see also U.S. Sec. & Exch. Comm’n, Staff Report, Implications of the Growth of Hedge Funds vii (2003), https://www.sec.gov/news/studies/hedgefunds0903.pdf [https://perma.cc/5UE7-JQDS]. ↑
- See Chi. Mercantile Exch., SEC No-Action Letter (Dec. 19, 2017), supra note 169. For a list of security breaches on cryptocurrency exchanges, see Alex Munkachy, 30+ Cryptocurrency Exchange Hacks — A Comprehensive List, CoinIQ (June 21, 2018), https://coiniq.com/cryptocurrency-exchange-hacks [https://perma.cc/SK3U-BQTE]. ↑
- See Hammer, supra note 19, at 328.; see also Custody of Funds or Securities of Clients by Investment Advisers, Adviser Act Release No. 2176, 68 Fed. Reg. 56,692, 56,694 (Oct. 1, 2003). ↑
- For a simple explanation, see Bob Pisani, Here’s Why Bitcoin Prices are Different on Each Exchange, Yahoo Finance (Dec. 12, 2017), https://uk.finance.yahoo.com/news/apos-why-bitcoin-prices-different-221200635.html [https://perma.cc/B6U4-SNVD]. ↑
- APIs, or application programming interfaces, are sets of protocols and standards that applications use to communicate with other applications. Several exchanges provide free APIs that can be used to gather real-time and historical market data with time stamps. See, e.g., Bittrex, https://bittrex.com/home/api [https://perma.cc/B3A8-PAZA]; Coinbase, https://developers.coinbase.com [https://perma.cc/2AY3-Z4CT]; GDAX, https://docs.gdax.com/#pagination [https://perma.cc/DEL9-BKK2]. ↑
- See, e.g., Google Data APIs, G Suite Developer, https://developers.google.com/sites/faq_gdata [https://perma.cc/6H7Q-S28Y]. ↑
- Wesley R. Bricker, Chief Accountant, U.S. Sec. & Exch. Comm’n, Remarks before the Financial Executives International 36th Annual Current Financial Reporting Issues Conference: Effective Financial Reporting in a Period of Change (Nov. 14, 2017), https://www.sec.gov/news/speech/speech-bricker-2017-11-14 [https://perma.cc/2YTP-KPN2]; Brady Dale, Top SEC Accountant Wants Auditor Eyes on Crypto, Coindesk (Nov. 14, 2017), https://www.coindesk.com/sec-top-accountant-cryptocurrency-study [https://perma.cc/V5SW-4F29]. ↑
- See Hammer, supra note 19, at 189–97. Form PF is used by hedge funds to report assets under management to the Dodd-Frank-established Financial Stability Oversight Council. For an example, see Reporting Form for Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors, FORM PF (Paper Version), https://www.sec.gov/rules/final/2011/ia-3308-formpf.pdf [https://perma.cc/8LWE-TJGQ]. ↑
- Depository Trust Co. of Delaware., supra note 151. ↑
- Id. ↑
- Id. ↑
- See Investment Adviser Association, supra note 151. ↑
- See Munkachy, supra note 177. ↑
- Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act Release No. IA-2876, 68 Fed. Reg. 56,692 (Oct. 1, 2003). ↑
- Peter Rudegeair & Nicole Friedman, Riders in Alphabet’s Driverless Car Will Be Insured by Startup Trov, Wall Street J. (Dec. 19, 2017), https://www.wsj.com/articles/riders-in-alphabets-new-driverless-car-will-be-insured-by-a-startup-1513688581?tesla=y&mod=e2tw [https://perma.cc/92WP-TBP8]. ↑
- 2015 Power Broker, Risk & Insurance, http://riskandinsurance.com/2015pb-financial-service [https://perma.cc/L72A-6DGH]. ↑
- Depository Trust Co. of Delaware., supra note 151. ↑
- See Chainalysis, https://www.chainalysis.com [https://perma.cc/7B8F-CLYG]. ↑
- See Will Warren, What is a Decentralized Exchange?, Coin Center (Oct. 10, 2018), https://coincenter.org/entry/what-is-a-decentralized-exchange [https://perma.cc/J3M9-SSJK]. ↑
- Id. ↑
- See Depository Trust Co. of Delaware., supra note 151. ↑