Cryptocurrencies promise to be one of the biggest developments in the history of funds, so how are the Channel Islands securing first-mover advantage?
The world of blockchain technology has once again moved to the forefront of investors’ minds, as the value of Bitcoin reaches new heights and a deluge of business ideas use crowdfunding to raise the millions they need to get going. Amid all of this activity, the Channel Islands have quietly been making their own way, mining the point at which blockchain technology and traditional finance meet.
In 2019, blockchain technology and Bitcoin will celebrate their 10th anniversary. For most people, however, awareness of blockchain is only just gaining momentum, despite the initial media furore surrounding the rise in value of Bitcoin back in 2013/14.
That the world’s first cryptocurrency briefly hit the $1,000 mark a few years ago, seems almost quaint today – holders of Bitcoin have become more used to valuations in excess of $3,000. Indeed, at the time of writing (17 October) it has soared to a staggering $5,762.
Such an increase in value has driven investors’ curiosity, but the world of cryptocurrencies, with its volatility and network of unusually titled exchanges, isn’t easy for the less-than-dedicated to penetrate. However, with the potential for enormous returns, many investors do want to be involved but direct investing may not be for them.
This point was proved in 2014, when the world’s first regulated cryptocurrency fund launched from Jersey. The Global Advisors Bitcoin Investment fund (GABI) was established to provide an alternative, indirect route to investment, taking in fiat currency and investing in Bitcoin.
“Funds are attractive to investors because of the opportunity to spread the investment risk and the ease of having someone else manage the assets,” says Mark Grenyer, Director at JTC Group. “With a new asset class like cryptocurrencies, it’s also about ease of access. For example, it isn’t straightforward opening a personal crypto trading account and having the confidence of knowing which providers to use.”
The fact is, GABI was ground-breaking. As a regulated route to an unregulated market, the fund gave ‘expert’ investors a way into Bitcoin. But this wasn’t the only benefit. To be a regulated fund, Global Advisors had to get Jersey’s regulatory authorities on board and, once accomplished, the island’s reputation soared in the crypto universe.
“After inception in November 2013, it took nine months to secure regulatory approval for the fund,” says Jean-Marie Mognetti, CEO at Global Advisors. “In order to gain that regulatory approval, the legal infrastructure of the vehicle was key, not only from a commercial perspective, but also to meet the rigorous standards applied by the JFSC.
“In particular, understanding the risks of the vehicle was of paramount importance to both parties, to ensure they were considered, managed and controlled (internally and externally) to withstand the scrutiny this product would inevitably receive. To date, the fund’s success speaks for itself and reflects positively on the innovative regulated environment Jersey has created.”
Since the launch of GABI, Global Advisors has floated it on The International Stock Exchange and has also launched two more crypto funds, including one that focuses on the new wave of Initial Coin Offerings (ICOs) – the latest crypto-based phenomenon that involves investors buying into blockchain-based business ideas using cryptocurrencies.
At JTC, Mark Grenyer has seen GABI have a long-lasting impact on Jersey’s place within the crypto universe. “GABI is a great story for Jersey and the Channel Islands. Together with the recent CoinShares Fund we worked on with Global Advisors and Carey Olsen, it shows that, as well as being able to accommodate private crypto funds, there’s a pathway through the islands that leads not only to a regulated fund but also to a listing.”
Impact in guernsey
While GABI has had a greater impact for Jersey, Guernsey hasn’t yet seen the crypto sector turn to its funds regime in quite the same way, despite the similarities between the laws of the two islands. But this hasn’t stopped the island looking to gain from blockchain technology too.
In August, Zurich’s Solidium Partners issued an insurance-linked security using a Guernsey Incorporated Cell Company, Solidium Re ICC. The $14.8 million catastrophe bond transaction is thought to be the first securitisation to be settled with blockchain.
Guernsey, which has a larger insurance industry than Jersey, was similarly engaging in a world first for blockchain technology in the finance sector, and this ability to innovate is as much down to the regulatory environment as anything else.
“The advantage we have is that Guernsey has a very flexible regulatory framework, which makes it possible to work with new asset classes and technologies that may not easily fit within existing regulatory regimes elsewhere,” says Stephen Ozanne, Senior Associate at law firm Walkers.
Cryptocurrencies don’t tick existing regulatory boxes, because nobody has been sure exactly how best to classify them. The recent rush to ICOs has provided the perfect example of the problems being faced by regulators.
“The difference between a fund that invests in ICOs and an ICO itself can be put quite simply – are you buying shares in Disney or are you buying tokens to use in Disney World?” asks Chris Griffin, Counsel at law firm Carey Olsen.
“Are these online tokens securities? And if they’re not, then what are they? Are they commodities or currencies? The answer will drive the regulatory analysis, and you’re unlikely to get a pan-regulatory view, particularly in the crypto space, which moves so quickly that it’s inevitable regulators are playing catch-up.”
Regulation and reputation
Whilst the islands’ regulatory authorities are showing the flexibility needed to deal with new, difficult-to-define asset classes, perhaps the aspect of the funds regimes that makes them most amenable to innovation is the reliance on the local fund administrator as the regulated entity.
As the administrator has the expertise, knowledge and controls needed to meet regulatory requirements (think AML, KYC and so on), the fund’s founders can move quickly to establish their new fund, precisely because the administrator already has everything in place.
This means Jersey now has a head start on other jurisdictions. “As a business, we’ve had to invest heavily in developing bespoke processes and controls in the administration and oversight of these funds,” explains Grenyer.
Early on in Bitcoin’s development, it gained a reputation for being used for criminal purposes. Naturally, the regulator wants to make sure locally held coins don’t taint the islands’ reputations.
“The regulator focuses on key areas such as the provenance of the Bitcoin, which must be sourced from a traceable line of ownership, and the custodian arrangements surrounding Bitcoin,” says Chris Griffin.
Matters like this and the issue of there being no Channel Island-based banks being willing to work with crypto businesses will eventually be resolved. In the meantime, in the blockchain sector at least, the islands are proving themselves to be as flexible and innovative as they so often claim to be. Given the medium to long-term outlook for cryptocurrencies and blockchain technologies, this could prove to be vital.
“It’s interesting to note that traditional heavyweight institutional investors remain cautious and are yet to enter the market,” says Jean-Marie Mognetti. “The biggest actors are still family offices and sophisticated private investors. Interest from hedge funds is gaining momentum, but is still a minority. There are no ETF products yet, but when they arrive it will have a huge effect – creating almost overnight a large change in the fragile equilibrium between offer and demand.”
The crypto sector is still young, but the Channel Islands have taken important first steps that have really made an impression. The key for the islands is to stay on top.
“It will be interesting if in three to five years, crypto will be seen as an established asset class alongside real estate and private equity,” says Grenyer. “It will be equally interesting to see the extent to which the disruptive effect of crypto and the blockchain technology that underpins it has altered the financial landscape generally.
“For present purposes, the great thing is that both the government and the regulator are supportive and knowledgeable, and this gives us a real opportunity to establish and develop this niche.”
Building blocks
Bitcoin is the most famous of blockchain applications. While the valuation of cryptocurrencies grabs the headlines, many people believe blockchain’s biggest benefits will come from far more prosaic uses, and the funds industry could be a beneficiary.
“As with the dotcom boom, blockchain may currently be in a bit of a bubble that could burst, but the technology itself will have been proven,” says Stephen Ozanne, Senior Associate at Walkers. “I expect institutional technology and investment companies to adopt blockchain technology to run their existing platforms. For instance, I can see the advantages of using blockchain to administer a fund, and I’ve seen tokens used to register investors’ interests.
“However, one of the key issues facing public blockchains, such as the Bitcoin blockchain or Ethereum, is that they enable anonymous transactions, making it difficult to complete customer due diligence. I expect this problem to be solved with the use of private or permissioned blockchain platforms such as IBM’s blockchain.”
Private blockchains allow administrators to know the users and so can comply with regulatory obligations. Asset manager Northern Trust has already gone down this route by working with IBM and using the IT giant’s private blockchain, which is based on Hyperledger Fabric.
The solution is used to manage a Guernsey-domiciled private equity fund, providing secure and transparent access to managers and investors alike. According to Northern Trust, the new platform ‘delivers a significantly enhanced and efficient approach to private equity administration’.
For investors interested in the returns that blockchain can deliver, funds are a natural way to reduce risk. But rather than looking to Bitcoin or the cohort of ICOs that are making waves today, it may be more prudent to back those firms that are looking to exploit this new technology in far more mundane ways.