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23 Stan. J.L. Bus. & Fin. 112 (2018)
Rise of the Crypto Hedge Fund: Operational Issues and Best Practices for an Emergent Investment Industry

handle is hein.journals/stabf23 and id is 120 raw text is: 










          Rise of the Crypto Hedge Fund:

 Operational Issues and Best Practices for

        an Emergent Investment Industry

                Edmund Mokhtarian* and Alexander Lindgren**

Abstract

In the last several years, a discreet $800+ billion financial system has emerged in the form of
cryptocurrency markets. The extraordinary returns generated by cryptocurrencies such as
Bitcoin have led to a frenzy of investment activity and interest from traditional investors. This
interest has, in turn, spawned dozens of cryptocurrency-focused hedge funds to service this
growing demand. Moreover, although this trading activity is highly speculative, it is subject to
almost no regulatory oversight. Regulators at the IRS, CFTC, and most notably the SEC have
only recently established a regulatory framework to govern cryptocurrency activity. Notably,
that framework is a functional one, classifying each cryptocurrency either as a security or
commodity based on its particular uses. However, most of the established and highly-traded
cryptocurrencies, such as Bitcoin and Ether, gualify as commodities rather than securities, and
thus they are not subject to securities laws. Hedge funds that trade in these cryptocurrency
commodities, or crypto funds, fall almost entirely outside the extensive securities regulations
that would apply to traditional hedge funds.

This article argues that these crypto funds constitute a new type of financial institution that is
not, and cannot be, governed by traditional hedge fund regulation because doing so would
disregard the unique operational and technological features of cryptocurrencies. Existing rules
and best practices for hedge funds in key areas-such as investor asset custodianship, capital
formation, and distribution of returns-are frequently nonsensical or even counterproductive
in the context of crypto funds. Without regulatory guidance, crypto funds will need -and have
the opportunity-to develop a set of best practices tailored to cryptocurrency trading. In doing
so, crypto funds also present a significant opportunity for much-needed financial innovation
and problem-solving in the cryptocurrency markets. However, crypto funds also present a far
greater risk of fraud or investor losses than a traditional hedge fund, as cryptocurrency markets
lack the liquidity, stability, and regulatory certainty of traditional securities markets.

This article concludes with concrete recommendations regarding several of the most salient,
cryptocurrency-specific concerns currently facing crypto funds, including (i) the types of
cryptocurrencies that should be traded, (ii) the types of potential investors who can provide


* Technology Advisor; J.D., Harvard Law School.
** Partner at Lindgren, Lindgren, Oehm, & You LLP; J.D., University of Minnesota Law School.

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