As more traditional financial institutions and even non-financial institutions begin to engage in private crypto fund businesses and allocate crypto-related assets, the compliant operation of private crypto funds has become increasingly important. This article will summarize the types and characteristics of crypto funds based on different strategy attributes, trading methods, and sources of funds. It will also provide an overview of the macro-level regulatory environment for private crypto funds and, with reference to case studies of compliant fund operations, introduce the operational processes of private crypto fund businesses and the key elements for compliant operation.
- Definition and Classification of Private Crypto Funds
1.1 What is a Private Crypto Fund
1.1.1 Definition and Characteristics of Private Crypto Funds
Broadly, a fund refers to a certain amount of money established for a specific purpose. It mainly includes trust investment funds, provident funds, insurance funds, pension funds, and various foundation funds. The common feature is that these funds are managed centrally by professional asset managers to generate higher investment returns. These funds can be invested in primary markets (venture capital, private equity) and secondary markets.
Private Crypto Funds are a type of investment fund issued privately, targeting institutions and individual investors with a certain level of wealth and risk tolerance. They focus on investing in crypto assets and related projects, and their portfolio may include crypto assets, crypto options and futures, stocks of crypto companies, RWA (real-world assets), and more. Private crypto funds combine the characteristics of private equity funds with the unique features of crypto assets. Their distinguishing characteristics compared to other private funds can be summarized as follows:
①Specific Investment Scope: Private crypto funds focus on the crypto asset market, including digital currencies, blockchain projects, and decentralized finance (DeFi) applications.
②High Value Volatility: The value of crypto assets fluctuates significantly more than traditional financial assets. The valuation of unsecured crypto assets (such as most digital currencies) is mainly driven by speculative demand, leading to extreme price volatility. This high volatility presents investors with potential high returns but also increases investment risk.
③Varying Regulatory Attitudes Across Countries: Different countries have significantly different regulatory stances toward crypto assets. For example, the U.S. has unclear and evolving regulatory policies on cryptocurrencies, while Japan legalized Bitcoin relatively early and brought it under regulatory oversight. Fund managers of private crypto funds need to closely monitor changes in regulations across countries to adjust investment strategies and mitigate compliance risks.
④Low Transparency: Private equity funds are generally less transparent, and the anonymity and decentralized nature of the crypto asset market further exacerbate this lack of transparency. Therefore, private crypto funds need to establish robust information disclosure systems and investor protection mechanisms.
1.1.2 Differences Between Private Crypto Funds and Traditional Private Equity Funds
Private crypto funds and traditional private equity funds share similarities in many aspects, but due to differences in their investment targets and market environments, they also exhibit some key distinctions.
(1) Investment Targets
Private Crypto Funds: Focus on cryptocurrencies, blockchain technology, and related digital assets. They may invest directly in cryptocurrencies (such as Bitcoin, Ethereum) or in blockchain startups, tokenized assets, and other projects related to the blockchain ecosystem.
Traditional Private Equity Funds: Typically invest in assets within the traditional financial markets, such as stocks, bonds, real estate, private equity in companies, or other conventional asset classes. While the investment scope is more diverse, it is grounded in the traditional economic system.
(2) Risk and Volatility
Private Crypto Funds: The cryptocurrency market is highly volatile, with significant risks, including market fluctuations, technical risks (such as hacking), regulatory risks (due to varying regulatory attitudes across different countries and potentially changing policies), and liquidity risks (as some tokens or crypto assets may be difficult to quickly liquidate).
Traditional Private Equity Funds: Although they also face market volatility, changes in the economic environment, and sector-specific risks, these risks are typically more controllable and supported by historical data. Traditional private equity funds usually invest in assets with a longer market history and clearer regulatory frameworks.
(3) Regulatory Environment
Private Crypto Funds: They are constrained by the regulatory environment of the cryptocurrency market, which may pose greater uncertainties. Different countries have varying regulatory policies regarding cryptocurrencies and related assets, potentially impacting fund operations and investment strategies.
Traditional Private Equity Funds: Generally subject to strict financial regulations and legal frameworks, with clear compliance requirements. The investment targets are typically within more mature and regulated markets.
(4) Types of Investors
Private Crypto Funds: Often attract investors who have a deep interest in cryptocurrencies and blockchain technology. These investors may be more willing to accept the high volatility and opportunities that come with innovative technology.
Traditional Private Equity Funds: The investor base is broader and usually includes high-net-worth individuals, institutional investors, pension funds, and endowments seeking relatively stable returns.
(5) Dependence on Technology
Private Crypto Funds: They have a stronger dependence on technology, requiring the management team to possess knowledge and skills in blockchain technology, smart contracts, decentralized finance (DeFi), and other cutting-edge technologies.
Traditional Private Equity Funds: They rely more on traditional financial analysis, market research, and portfolio management techniques, with relatively lower dependence on technology.
(6) Liquidity
Private Crypto Funds: While liquidity in the cryptocurrency market can be high, it can also pose liquidity risks due to shallow market depth or the nature of specific assets. Liquidity risk becomes more pronounced during periods of extreme market volatility.
Traditional Private Equity Funds: The liquidity arrangements for investment targets are generally more predictable, though they may still face liquidity constraints, particularly when investing in long-term assets like private companies or real estate.
These distinctions highlight that although both types of funds have similar structures, they differ significantly in terms of investment targets, risk tolerance, regulatory environment, and technological requirements.
1.2 Classification of Private Crypto Funds
As private crypto funds focus on the crypto asset market, they can be categorized using various criteria. Below are some common methods for classifying private crypto funds based on investment targets, operation methods, and other factors:
(1) Classification by Investment Targets
①Direct Investment Funds: These funds primarily invest directly in cryptocurrencies, blockchain projects, or NFTs (non-fungible tokens). They purchase and hold these assets with the aim of earning returns from the appreciation in their value.
②Indirect Investment Funds: These funds participate indirectly in the crypto asset market by investing in the equity of companies related to crypto assets, fund shares, or derivatives. For example, they might invest in the equity of cryptocurrency exchanges, blockchain technology companies, or crypto mining companies.
(2) Classification by Operation Methods
①Closed-End Funds: Closed-end funds set a fixed size upon establishment and do not accept new investments during a specific period. These funds typically have a fixed duration and are liquidated or transitioned at the end of the term. In the context of private crypto funds, closed-end funds provide fund managers with stable capital for long-term investment planning.
②Open-End Funds: Open-end funds allow investors to subscribe to or redeem fund shares at any time during the fund’s duration. These funds offer greater flexibility and can be adjusted based on market demand and investor preferences. However, in a highly volatile crypto asset market, open-end funds may face significant liquidity pressures.
(3) Classification by Investment Strategy
Private crypto funds can also be classified based on investment strategies, including passive, neutral, active, and fixed income strategies:
①Passive Strategy: The returns come from the appreciation of cryptocurrency prices. In the crypto asset space, this typically involves tracking the performance of highly liquid cryptocurrencies (such as Bitcoin, Ethereum) and passively profiting from price increases.
②Neutral Strategy: This strategy uses long-short hedging and tools like derivatives to hedge market volatility (Delta), aiming to control the overall risk exposure at near-zero levels and achieve absolute returns unrelated to cryptocurrency price fluctuations. Common strategies like arbitrage and market-making fall under this category.
③Active Strategy: Fund managers use an analytical model or prediction to set a target price and trade based on it. If the current price is lower than the target price, they go long; if it is higher, they go short. Position sizes are adjusted based on the price difference between the current and target prices. Returns are generated from both market performance (Beta) and excess returns (Alpha) based on subjective judgment.
④Fixed Income Funds: These funds generate returns through “bonds,” although the crypto asset space does not yet have standard bonds. There are many over-the-counter loans, or non-standard bonds. These funds can earn interest by lending or through interest rate spreads, similar to traditional fixed-income funds. Although relatively stable, strong risk management (such as collateral management) is required in practice. DeFi, which involves financial activities based on blockchain smart contracts, also has some fixed-income attributes.
(4) Other Classification Methods
In addition, private crypto funds can be classified based on other factors such as the source of fundraising or the investment stage. For instance, based on the source of funds, they can be divided into private equity funds and private securities funds. Based on the investment stage, they can be classified as angel funds, venture capital funds, and others.
- Global Development Status of Private Crypto Funds
2.1 Scale of Crypto Funds
In recent years, the total market value of cryptocurrencies has shown fluctuating growth. As of the time of writing, the market capitalization has exceeded $2.3 trillion. According to data from Crypto Fund Research, although crypto funds account for a relatively small percentage of the total fund market, by the end of 2023, nearly 900 crypto funds had been established globally. These funds span across various categories, including hedge funds, venture capital funds, and index funds. Additionally, according to a report by Galaxy, the performance of crypto asset funds was strong in 2023, with assets under management (AUM) reaching $33 billion. Bitcoin holds a dominant position in the market, becoming the most favored investment target among funds.
2.2 Primary Registration Locations for Crypto Funds
Although specific data on the registration locations of private crypto funds is not fully available, data from Crypto Fund Research provides an overview of the geographic distribution of crypto fund registrations.
On a country-by-country basis, the United States is the preferred location for nearly half of the world’s crypto funds, making it the most significant registration hub. It is worth noting that while the Chinese government, particularly in mainland China, has taken a conservative stance toward crypto assets, the substantial size of China’s economy and investment demand have still supported a considerable number of crypto funds registered in the country.
This geographical distribution highlights the global spread of crypto fund activities, with the U.S. leading the way and other regions, including China, maintaining a presence despite regulatory challenges.
2.3 Overview of Well-Known Private Crypto Funds
2.3.1 Pantera Capital
Founded in 2003 and headquartered in California, USA, Pantera Capital is a private fund known as the world’s first investment fund focused on blockchain technology and digital currencies. Pantera Capital manages a wide range of assets, including multiple funds and portfolios centered on Bitcoin, ICOs (Initial Coin Offerings), and decentralized finance (DeFi). According to its official website, Pantera Capital currently manages $4.8 billion in blockchain-related assets.
2.3.2 a16z Crypto
a16z Crypto is a venture capital fund focused on crypto and Web3 startups, operating under Andreessen Horowitz, a renowned venture capital firm headquartered in California, USA. The investment portfolio of a16z Crypto is extensive, covering blockchain infrastructure, decentralized applications (dApps), and payment systems. As reported on its official website, a16z Crypto manages over $7.6 billion across four funds, and it holds significant influence in the industry.
2.3.3 Galaxy Digital
Founded in 2018 and based in New York, USA, Galaxy Digital is an investment management company specializing in digital assets and blockchain technology. It was established by former hedge fund manager Mike Novogratz. Galaxy Digital offers a variety of cryptocurrency-related investment products, including hedge funds, venture capital funds, and asset management services. According to its website, Galaxy Digital currently manages approximately $2.1 billion in assets and has a prominent position in the cryptocurrency industry, frequently making headlines.
2.3.4 AnB Investment
AnB Investment is an independent segregated portfolio company (SPC) registered in the Cayman Islands. It operates two funds: a multi-strategy quantitative fund and a neutral strategy fund. The primary investment targets are crypto assets and DeFi, with the goal of earning alpha returns from market volatility. The total AUM (Assets Under Management) is $50 million, with a minimum individual investment of $100,000. Both funds allow for monthly subscription and redemption. The revenue sources for operating the funds include management fees and performance-based incentives. According to AnB Investment’s promotional materials, the management fee is 2.4%, and the performance fee, following the high-water mark principle, is 20%. The primary expenses for operating the funds include costs associated with strategy, trading, auditing, operations, risk control, and legal systems and personnel.
2.3.5 HashKey Digital Investment Fund
The HashKey Digital Investment Fund will begin accepting investor subscriptions on September 1, 2023. The fund is licensed by the Hong Kong Securities and Futures Commission (SFC) and managed by HashKey Capital Limited. The portfolio is composed entirely of virtual assets. HashKey Capital is launching this compliant secondary market liquidity fund, which will allocate less than 50% of its investments in Bitcoin and Ethereum, the two largest cryptocurrencies, while also diversifying into other cryptocurrencies.
- Overview of Major International Regulatory Rules for Private Crypto Funds
Currently, various international organizations and countries have established regulatory guidelines for private crypto funds. Below are some key examples:
3.1 U.S. Securities and Exchange Commission (SEC) and the Application of Securities Laws
In 2017, the U.S. Securities and Exchange Commission (SEC) released the well-known “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO.” The report stated that certain cryptocurrencies and Initial Coin Offerings (ICOs) could fall under the definition of “securities” as outlined in the Securities Act of 1933 and the Securities Exchange Act of 1934. As a result, these crypto assets must comply with corresponding securities regulations, including registration, information disclosure, and anti-fraud protections. This primarily applies to crypto projects and token offerings that raise funds and promise future profits or returns. For example, if a token is issued through an ICO to raise funds and grants holders rights such as dividends or other economic benefits, it may be classified as a security. Issuers of such assets must register with the SEC or apply for exemptions, and they are required to regularly disclose financial and other key information to ensure investor protection.
Since then, the SEC has intensified its regulation of crypto funds, requiring them to comply with existing securities laws. For instance, crypto funds involved in tokenized securities or similar products must register or obtain exemption status. Additionally, fund managers must ensure compliance with “qualified investor” regulations and adhere to anti-money laundering (AML), anti-fraud, and other regulatory requirements.
The SEC’s regulatory efforts have been increasing annually, reflecting its focus on investor protection and market stability. In 2020, the SEC issued the “Framework for Investment Contract Analysis of Digital Assets,” further clarifying the criteria for determining whether a crypto asset qualifies as a security. This framework focuses on factors such as whether the token’s purchasers expect to profit from others’ efforts, the involvement of the project team in the asset’s development and marketing, and whether the project has decentralization characteristics. If the “21st Century Financial Innovation and Technology Act” (FIT21 Act) is passed, the SEC’s standards may undergo further adjustments.
3.2 EU Market Abuse Directive (MAD) and Market Abuse Regulation (MAR)
The EU’s Market Abuse Directive (MAD) and Market Abuse Regulation (MAR) have been in force since 2018. These regulations are part of a comprehensive framework designed to prevent market manipulation, insider trading, and unlawful disclosure of inside information. MAR, since 2018, explicitly applies to financial instruments in the cryptocurrency market. For instance, if crypto assets are considered “financial instruments” (such as tokenized securities), they must comply with MAR, including rules that prevent insider trading, market manipulation, and improper disclosure of information. Traders involved in crypto assets, especially those transacting on regulated markets or those whose actions might influence market prices, are also subject to the market abuse rules. This ensures that investors receive fair and transparent information while preventing market distortions caused by unlawful activities.
3.3 Financial Action Task Force (FATF) Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) Requirements
The Financial Action Task Force (FATF) is an international organization that sets global standards for anti-money laundering and counter-terrorist financing. In 2019, FATF issued guidance on virtual assets and virtual asset service providers (VASPs), outlining AML/CFT requirements for the crypto asset space for the first time. The guidance imposes stringent AML/CFT standards on VASPs, including requirements for customer due diligence (CDD), which involves collecting and verifying customers’ identity information. VASPs must report suspicious transactions that exceed specific thresholds to the relevant authorities, and they are also required to monitor cross-border transactions. Institutions that are directly involved in the custody, management, transfer, or trading of virtual assets are classified as VASPs and must comply with FATF’s AML/CFT requirements. Countries worldwide are gradually incorporating FATF guidelines into national laws, mandating that crypto funds adhere to these standards.
3.4 European Alternative Investment Fund Managers Directive (AIFMD)
Initially passed in 2011, the AIFMD was introduced to strengthen regulation over European alternative investment funds. With the rise of crypto funds, the scope of AIFMD was expanded in 2020 to include crypto asset funds. Fund managers must ensure adequate information disclosure and risk management to protect investors’ interests. Specific rules under AIFMD include requirements for regular disclosure of the fund’s investment strategies, asset allocation, and associated risks to investors. Managers must also have sufficient compliance measures in place to avoid conflicts of interest, and investors must provide informed consent. Consequently, crypto funds in Europe are subject to stringent regulations, ensuring investor protection.
3.5 European Union’s Markets in Crypto-Assets Regulation (MiCA)
In an effort to create a unified regulatory framework for the crypto asset market, the EU introduced Regulation 2023/1114, the Markets in Crypto-Assets Regulation (MiCA), which was officially approved by the European Parliament in April 2023 and took effect on June 30, 2023. The transition period will end on June 30, 2026. As part of the EU’s broader digital finance strategy, MiCA covers the registration, operation, and investor protection requirements for crypto funds. It clearly defines the scope of its application, the classification of crypto assets, the regulatory authorities, and relevant reporting and business conduct rules. MiCA represents the most comprehensive regulatory framework for digital assets to date and applies across all 27 EU member states, as well as the three European Economic Area (EEA) countries (Norway, Iceland, and Liechtenstein). It will provide legal clarity for crypto assets and ensure regulatory consistency across the EU.
- Overview of Global Tax Policies for Private Crypto Funds
Many countries are actively developing or refining tax policies to ensure that the income and transactions of crypto funds are accurately reported and taxed, covering taxes such as capital gains tax, goods and services tax (GST), and value-added tax (VAT).
4.1 U.S.
Income Tax: In the U.S., private crypto funds can be structured as a Limited Partnership (LP), Limited Liability Company (LLC), or Corporation (C Corporation or S Corporation), each with different tax implications. In an LP (Limited Partnership), partners directly bear losses, share profits, and pay income taxes. An LLC (Limited Liability Company) has flexibility in choosing its tax structure. LLCs can elect to be taxed as a sole proprietorship, a partnership, an S Corporation, or a C Corporation. Corporations, on the other hand, face the issue of double taxation: corporations pay corporate income taxes on their profits, and if those profits are distributed as dividends to shareholders, the shareholders must also pay personal income taxes. Given the high return potential of crypto assets, using the corporation structure may not be favorable for reducing the overall tax burden on private crypto funds and their investors.
Capital Gains Tax: The U.S. differentiates between short-term and long-term capital gains taxes. Short-term capital gains apply to assets held for one year or less and are taxed at the individual’s ordinary income tax rate.Long-term capital gains apply to assets held for more than one year and are taxed at preferential rates of 0%, 15%, or 20%, depending on the individual’s annual income and tax status.
The U.S. Internal Revenue Service (IRS) issued Notice 2014-21, which clarified that virtual currencies are treated as property for federal income tax purposes. As a result, most crypto transactions are subject to capital gains tax. Investors must calculate their capital gains or losses by subtracting the asset’s cost basis from the sale price and pay the corresponding tax. The holding period (whether more or less than one year) determines the applicable tax rate.
4.2 European Union
Value-Added Tax (VAT): The EU’s approach to taxing crypto transactions varies by country. Some countries, like Ireland and Germany, do not impose VAT on Bitcoin transactions, while others, like Italy and Spain, may apply VAT to such transactions.
MiCA (Markets in Crypto-Assets Regulation): MiCA was introduced to create a legal framework for crypto assets not covered by existing EU financial services laws. It aims to support innovation, foster the growth of crypto assets and distributed ledger technology (DLT), and ensure appropriate consumer and investor protection. MiCA also enhances market integrity and, considering the potential for certain crypto assets to become widely adopted, it aims to promote financial stability within the EU.
4.3 United Kingdom
In line with its common law tradition and the flexibility of crypto assets, the UK government has opted not to create a specific tax law for crypto assets. Instead, crypto assets are taxed under existing frameworks based on their nature and usage. The main taxes applied are income tax and capital gains tax. These taxes are calculated similarly to other types of income and assets. Taxpayers must report their income and profits from crypto assets annually. The UK also offers certain tax exemptions or reliefs, such as personal allowances, Individual Savings Accounts (ISA) exemptions, and the Annual Exempt Amount for capital gains.
4.4 Singapore
（1）Income Tax: Singapore does not impose a capital gains tax, making it a favorable jurisdiction for private crypto funds. However, if crypto trading is considered business income, it is subject to income tax.
（2）Goods and Services Tax (GST): Singapore initially planned to impose GST on crypto transactions, but since January 1, 2020, it no longer applies GST to digital payment token (DPT) transactions. This exemption makes Singapore an attractive location for crypto-related businesses and funds.
- OECD Regulatory and Tax Compliance Framework
The Organisation for Economic Co-operation and Development (OECD) is one of the most influential international organizations, and its member countries have focused on the regulation and taxation of crypto assets. In recent years, the OECD has developed several key policies and frameworks to expand the application of existing rules and create new regulations for crypto assets and related funds. These frameworks aim to standardize the operations of private crypto funds and ensure global tax transparency and compliance. Therefore, it is essential to examine and summarize the OECD’s regulatory and tax compliance framework.
5.1 Crypto-Asset Reporting Framework (CARF)
With the increasing popularity of crypto assets, the OECD recognized that existing tax information exchange standards, such as the Common Reporting Standard (CRS), do not fully address the specific needs of crypto assets. In response, the OECD introduced the Crypto-Asset Reporting Framework (CARF) in 2022 to enhance the tax information exchange and transparency related to crypto assets.
CARF requires crypto-asset service providers, including private crypto funds, to report their clients’ crypto asset transactions to the tax authorities of their home countries. The reports include details such as client identity information, transaction amounts, and the types of assets traded. This framework establishes a globally unified standard, enabling tax authorities to effectively exchange information about crypto assets, thereby preventing tax evasion.
5.2 Common Reporting Standard (CRS)
The Common Reporting Standard (CRS) is a global standard launched by the OECD in 2014 to combat cross-border tax evasion through the automatic exchange of information. Although CRS initially applied mainly to traditional financial assets, many countries have progressively expanded its scope to include crypto assets.
CRS requires financial institutions, including crypto funds, to collect and report their clients’ tax information, including details such as account holder identity, account balances, and interest income. This information is automatically exchanged between tax authorities of participating countries.
At the 2024 G20 Summit in Brazil, the participating countries agreed to extend the automatic exchange of information (AEOI) mechanism under CRS to cover crypto assets. This requires Reporting Crypto-Asset Service Providers (RCASPs) to report the crypto asset holdings of non-resident clients and automatically exchange this information with the clients’ home countries, thereby increasing tax transparency and preventing tax evasion in the crypto asset space.
5.3 Base Erosion and Profit Shifting (BEPS) Action Plan
The Base Erosion and Profit Shifting (BEPS) action plan is a global initiative jointly launched by the OECD and the G20 to address the risks of tax base erosion and profit shifting. As crypto assets gain prominence, certain BEPS action items, such as Action 1 and Action 13, have begun to apply to crypto assets and private crypto funds.
Key elements include:
（1）Tax Challenges of the Digital Economy: BEPS Action 1 examines how to address the tax challenges arising from the digital economy, including crypto assets. This action plan encourages countries to implement measures to ensure fair taxation of crypto assets.
（2）Country-by-Country Reporting (CbCR): BEPS Action 13 requires multinational enterprise groups, including private crypto funds, to submit country-by-country reports to tax authorities. These reports disclose information such as revenue, pre-tax profits, and taxes paid in each country. This helps tax authorities detect and address profit shifting practices.
Special thanks to Lava Capital SPC for their contribution to this article.
Reference：
[1]Rock’n’Bock. (2024b, May 7). 50 Blockchain & Crypto VC Funds List in 2024. Rocknblock.io; Rock’n’Block. 50 Blockchain & Crypto VC Funds List in 2024
[2]Home. (n.d.-b). Galaxy. https://www.galaxy.com/
[3]Home. (n.d.-c). Pantera. https://panteracapital.com/
[4]Enriques, L., & Zetzsche, D. A. (2019). Corporate Technologies and the Tech Nirvana Fallacy. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3392321
[5]Rubinstein, F., & Vettori, G. G. (2018). Taxation of Investments in Bitcoins and Other Virtual Currencies: International Trends and the Brazilian Approach. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3135580
[6]Bossu, W., Itatani, M., Margulis, C., Rossi, A. D. P., Weenink, H., & Yoshinaga, A. (2020). Legal Aspects of Central Bank Digital Currency. IMF Working Papers, 20(254). https://doi.org/10.5089/9781513561622.001
[7]Crypto Fund Research. (2024) 2023 Q4 Crypto Fund Report, Crypto Fund Research. Available at: 2023 Q4 Crypto Fund Report - Crypto Fund Research (Accessed: 22 September 2024).
[8] Crypto Fund Research. (2024) Cryptocurrency Investment Fund Industry Graphs and Charts. Available at: https://cryptofundresearch.com/cryptocurrency-funds-overview-infographic/ (Accessed: 22 September 2024).