The Fast and the Curious: Tech in the Crypto Fund Asset Space - September 2021
In this interview, our head of EU fund services business development, Karine Seguin, discusses with Dan Smith, our head of US fund services, and Aaron Sammut, our director of fund services in Malta, the importance of technology in the administration of crypto funds and how human judgement and collaboration with reputable providers remain key in such a dynamic space. The article was originally published by WealthBriefingAsia, one of Asia's leading online publication for wealth managers and private bankers.
Five years ago, cryptocurrencies barely registered on most fund administrators’ radars. But like everything crypto, that’s changed at an extraordinary pace. In 2020, crypto hedge fund total assets under management (AuM) were estimated at US$3.8bn – an increase from US$2bn in 2019*. And that doesn’t count all the investment flowing into private equity and VC funds investing in crypto-related projects and technology. How can tech help fund admins and their clients in this new space?
“It’s an exciting time,” says Dan. “Figuring this stuff out feels more like a partnership, with service providers, auditors and cutting-edge tech providers working together to keep up with traders.”
After all, he points out, this is new for everybody. “Four years ago, big traditional prime brokers were very circumspect about crypto. Now, getting into crypto prime brokerage is a primary initiative for their business.”
Crypto has its own particular challenges when it comes to tech. When Trident first entered the space, back in 2017, Dan remembers that “initially, we had to manually book crypto trading activity into our traditional hedge fund accounting systems”.
But Trident quickly realised that there was very little support from other industry participants to help in accumulating and then tweaking the data to enable this. “We dove in and figured out how to pull trades from the exchanges. But we then had to do a lot of manual spreadsheet work so we could get it into a format which could be put into our fund accounting system.”
Access to data can be an issue. “We must be as independent as possible from the fund manager,” says Aaron. “But certain crypto exchanges, for example, do not give access to anyone except the fund manager, so we have to get that information from other sources.”
And crypto-to-crypto transactions are a particular pain point. A traditional asset is bought and sold in fiat currency – but not necessarily with crypto. While that’s fine from a trading and economic perspective, it doesn’t fit with tax returns and many reporting requirements.
“Here in the US, you invest funds and investors have to file tax returns in USD,” Dan points out. “With crypto, you have to break down all the transactions into fiat currency so we can do the reporting we need to do for the auditors, the tax people and the regulators.”
Those regulators are also running to keep up. But many are still in a dilemma as to how to classify cryptocurrencies and take the evolving AML factor into consideration: how to tell if Bitcoin is coming from a legitimate source?
Clients were initially willing to convert their Bitcoin to USD, but now, depending on the market performance, they want to hold on to it, Aaron points out – and subscribe in crypto. “We have invested in data providers and tools which will help us forensically analyse where the Bitcoin or the Ethereum is coming from. The regulations are there, but with respect to crypto they are still a little vague in terms of risk assessment. Without a doubt, there will be increased regulatory clarity and scrutiny in the near future, given the rapid growth of the asset class.”
So what’s the way forward? “Partnering with the right technology provider is crucial: Trident Trust was cutting-edge tech company Lukka’s first fund admin client back in 2018. The tech has evolved since then, but there is still room for it to grow”, says Aaron.
“We invested a lot of time in our partnership with Lukka to seek ways to develop. For example, in 2017/18 we started with simple spot transactions, like fiat to crypto and vice versa. Derivative transactions, such as futures, swaps, options came in later and the technology had to keep up to date with all these new investment strategies – and now, we have the DeFi protocols as well. Technology providers have had to spend a lot of time and money to keep up with developments.”
“The recent pile into DeFi trades demonstrates just how quickly fund admins need to adapt. 16 months ago, Dan never had a client mention DeFi – then, almost overnight, clients started to do DeFi trades,” explains Aaron. “He went straight to Lukka for assistance: they knew DeFi was out there but didn’t have a workable solution available at the time. There’s a constant race across the service providers and the technology to keep up with the evolving strategies that crypto managers are deploying.”
But great tech also needs great people. Human judgement is key in such a dynamic space. “Trident’s team has been working with crypto for five years, and there’s no substitute for experience,” says Dan. “Good people can identify when something doesn’t look quite right.”
Aaron agrees. “It’s not humans versus machines, it’s humans with machines. Anyone can download data, but you need someone to ask the right questions about the data available so that we can identify any issues.”
Crypto tends to be treated as something different and special. But it’s just another asset class – and all asset classes should be treated equally and with the same attention.
“We don’t just do crypto,” says Aaron. “We administer all asset classes. And when a client comes up with a new strategy, we’ll discuss it and work it out in partnership with auditors, clients and tech providers.”
In the future, Dan wants to see tech enable crypto fund administration to be normalized: no different from traditional equity, bonds or futures trading, with data in a format everyone can consume.
“We’re now in the early phases of that, and it’s been fun for us to be part of that growth and help providers understand better what we need,” he says. “We're going to get the data, work with reputable providers and look at technology to help us do it the right way. Clients, investors and auditors like that approach. In this very fast-moving space, we are a safe pair of hands.”
This is the first of a series of insights about crypto assets that we will be posting periodically from now on. Stay tuned for the next episode!
*PwC 3rd Annual Global Crypto Hedge Fund Report 2021