EU regulation could help cryptocurrency funds grow

Regulation spurring growth of crypto as asset class

Cryptocurrency (also referred to as digital assets) is a growing asset class. According to Crypto Fund Research, there are currently 804 cryptocurrency funds in total, 355 of which are hedge funds and 425 are venture capital funds – and these numbers are on the rise, supported by the validation of new regulation.

With the growth of cryptocurrencies and crypto funds, more and more institutional investors are looking to get into this space. A 2019 survey released by Fidelity Investments revealed that 47% of US institutional investors think digital assets have a place within their portfolios. The survey — which was conducted by Greenwich Associates and included more than 400 pensions, family offices, hedge funds, financial advisors, endowments and foundations — found that while about 22% of respondents currently have some exposure to digital assets, 40% said they were open to making crypto investments over the next five years.

However, cryptocurrency exchanges and custody solutions have often been perceived as risky due to their unregulated nature. For instance, within the EU framework, up until last month, providers engaged in exchange services between cryptocurrencies and fiat currencies, as well as custodian wallet providers, were under no obligation to identify suspicious activity.

However, following the EU’s decision to extend the scope of its Fifth Anti-Money Laundering Directive (5AMLD) to include cryptocurrency exchanges and custodian wallet providers, this is now changing. For the purposes of anti-money laundering and countering the financing of terrorism (AML/CFT), authorities in Europe will soon be able to monitor the use of cryptocurrencies.

The implications of 5AMLD

The 5AMLD, which came into force in the EU on 10 January 2020, extends the scope of AML duties to any “digital representation of value that is not issued or guaranteed by a central bank or a public authority and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.”

The new legislation covers two types of cryptocurrency business:

  1. “providers engaged in exchange services between virtual currencies and fiat currencies”, i.e. cryptocurrency exchanges
  2. “custodian wallet providers”, i.e. cryptocurrency wallet services (where the service holds its users’ private keys).

Cryptocurrency exchanges are persons or entities who offer exchange services to cryptocurrency users, usually against payment of a certain fee. They allow cryptocurrency users to sell their coins for fiat currency or buy new coins with fiat currency. They usually function both as a market and as a form of exchange office. Examples of well-known cryptocurrency exchanges are Kraken and Coinbase.

Wallet providers, meanwhile, are those entities that provide cryptocurrency users digital wallets or e-wallets, which are used for holding, storing and transferring crypto coins.

Under 5AMLD, all of these cryptocurrency businesses are now considered “obliged entities” and face the same AML/CFT regulations applied to financial institutions under the directive’s predecessor, 4AMLD. This means they are now obliged to perform customer due diligence (CDD) and submit suspicious activity reports (SARs).

What does all of this mean for fund managers?

Institutional investors are getting increasingly comfortable with cryptocurrencies as an asset class and specific international regulation (such as the 5AMLD) is expected to further enhance their confidence. Both cryptocurrency exchanges and custodians are an important part of the cryptocurrency ecosystem and regulating them is expected to result in more investments into crypto funds. This means that digital assets will likely become a much greater part of fund managers’ lives in the years to come.

Given that crypto is still a very young asset class, however, these funds do still face many challenges, including in the opening of bank accounts where they do not fit the established business categories.

How IQ-EQ can help

IQ-EQ’s expert Digital Assets team has considerable experience servicing funds that include crypto assets, tokens and venture capital (blockchain). Our specialist team has experience of the innovative financial channels, instruments and systems that are transforming the sector. The team also works directly with financial centres and their regulators to support the development of this emerging asset class – a particularly important aspect as the sector is gaining more recognition and support from investors, industry, governments and central banks while the related regulatory landscape is constantly evolving.

IQ-EQ helps fund managers by providing assistance with investor KYC, compliance, NAV calculations, investor portal solutions, fund accounting and transfer agency activities. So if you are looking to launch and manage a fund in this innovative sector, our experts provide the support and services you need.

To find out more about IQ-EQ’s cryptocurrency fund services, please don’t hesitate to get in touch:

T: +31 20 522 2525