Laven Crypto Roundtable 04/02/2020
Posted on 5 Feb 2020
On the 4th February 2020, Laven hosted its 3rd Crypto Roundtable. We would like to thank all who attended. Hopefully, you found it to be an interesting and useful discussion. We are planning to host another event in the same format later this year, so stay tuned!
The Crypto-Roundtable was an initiative set up by Laven Partners under the Chairmanship of George Wood (Managing Director) and Keith Tomlinson (Director). It comprised of a roundtable discussion of around 15 leaders and representatives across the digital asset industry including asset managers, service providers and investors.
In this, the first roundtable of 2020, the panel recognised 2019 as a year of great progress and looked ahead to 2020, focussing on: what are currently the largest challenges to investing in the crypto space at this time?
For the purposes of this note, we have split the discussion into key themes.
A recurring issue raised around the table was that it was hard-to-impossible for managers in the digital asset space to get Personal Indemnity (PI) insurance or Directors and Officers (D&O) cover. It was noted that there are a number of good directors willing to act for digital asset funds, but that the lack of available D&O cover was a fatal issue for many, hampering the ability for funds to secure good quality independent directors.
As for the reasons why insurers were unwilling to provide meaningful insurance at a reasonable price, the roundtable noted that insurers have provided several reasons for this. One explanation was that there was only a limited appetite for insuring this space and that most of this appetite had been taken up by a few large players, leaving insurers potentially with balance sheets quite exposed in the space. Another reason mentioned was that insurers had not had a great year, and were unwilling to expose themselves to a market they see as higher risk. It was also suggested that the general lack of education around the digital asset space might be a contributing factor, as the lack of understanding means that insurers see the area as riskier. The panel also discussed whether there is a lack of “business drivers” at the insurers who are making the case as to why they should provide insurance (at a reasonable price point).
Finally, several around the table noted that the introduction of the 5th Anti-Money Laundering Directive (5AMLD) into UK law last month, and the greater focus of those regulations on client due diligence could help make the risks in the space more palatable for insurers.
A number of points concerning valuation were discussed around the table. From an administrators perspective, it was noted that there are a number of different methods currently utilised and that there are no particular trends as to how valuation should be conducted. There are a number of issues around valuation including timing as most digital asset exchanges operate continuously. The issue of price transparency was raised in the context of valuation, how should a valuation be made when there are different prices on different exchanges and the prices are not all immediately available. It was mentioned that CME uses an average of exchanges to establish a reference price for Bitcoin futures using a list of approved exchanges. At this point, some queried whether outlier exchange prices should be removed from these averages to establish the most representative price. It was noted that FCA guidance on valuation of semi-liquid digital assets was rather unclear.
The discussion on this point shifted to whether auditors were really up to speed on the digital asset space. The consensus around the table was that auditors were behind the curve on digital assets, but now seem to be investing more time and effort. The feeling around the table was that of all the big auditors KPMG were the most up to speed on the digital asset space. Many around the table felt that with more time and education auditors would improve and standards would emerge in the space.
Transparency and the lack of clear standards
The issue of transparency from service providers was raised by several around the table. There was a lack of due diligence in the space, making it difficult for investors to have a clear picture of the risk and reward profile of potential investments. It is clear that many new entrants to the space are very unclear on what information needs to be disclosed to investors.
A number of participants noted that the lack of clear industry standards and transparency was hurting investor confidence in the space. There should be clear standards for exchanges and custodians in order to encourage confidence in service providers as a whole. It was noted that there was one case where an exchange was deliberately designed to have leakage.
In terms of transparency of exchanges, a number of people around the table highlighted how several exchanges had moved to Panama to avoid scrutiny and regulation. The consensus is that this is the opposite of what the industry needs and are fuelling the lack of transparency. It was noted by several members of the roundtable that investors and funds need to consider the reputational risk they create for the entire asset class by executing trades on exchanges that are less transparent.
A number of participants around the table discussed the lack of a clear regulatory regime as a key challenge for investors. Regulators are beginning to get involved, but there is still no clear standards for the industry to follow. This helps build the negative perception that there is a lack of transparency in the space.
There was a consensus that the introduction of good regulation to the space would improve investor confidence and help the space to grow. It was noted that the speed of development and technology can make regulation difficult, but it was mostly agreed that the financial service regulators in the US, Europe and Asia have market abuse, code of conduct, personal trading regulations that are remarkably similar. It was generally agreed that consistent and clear regulations would help to put providers on a level playing field and improve transparency. It was noted that there was nothing stopping funds and service providers from implementing controls which are aligned with regulations related to code of conduct and market abuse in the US, Europe and Asia.
The roundtable also discussed that an issue for regulators is the lack of education, which is holding back the development of a clear and consistent regulatory regime. There was a consensus that better education about digital assets would allow for more intelligent regulation and regulators that will be both more willing and more able to intervene in the space to bring about meaningful change.
Around the table, there was a feeling that the operational risk within the space was high. At many funds, the operations lack the proper procedures and safeguards that are standard with other alternative funds. The lack of operational controls is compounded by the lack of transparency which can create a feeling of angst and discomfort for investors. It was noted by administrators and funds of funds that a lot of handholding is required to improve the operations for new entrants into fund management. In some cases, it was clear that managers had not even read their own legal documents or policies and procedures, and so were essentially flying blind. This was the case for at least one exchange who ignored their own policies procedures and internal controls which ultimately lead to its collapse.
A number of participants mentioned that they have noticed regulators holding digital asset managers to a higher standard operationally than they would for more traditional managers. This was particularly true on the risk management side. It is not entirely clear what the risk management standards are for those in the digital asset space, but it was agreed that implementing strong controls will help build investor confidence.
Technology and organised crime
There were several important issues raised around the technology used in the space and possible links to organised crime. The growth in custodian services available for digital assets continues to mature and is going a long way to improving security as custodians are specialised in the security element which significantly reduce the threats related to the theft of assets. It was noted that the entrance of Fidelity into this custodian space was seen as a major boost due to the brand recognition that they have.
From a technology perspective, several noted that it was difficult to recruit individuals skilled enough to find the flaws on the exchanges. This is an important issue, but it was noted that from a career longevity perspective there are far greater incentives to be a good actor as opposed to a bad actor.
A final key topic discussed was the emergence of off-exchange settlement, which could represent a major breakthrough for the industry in terms of security. This new system would allow for the trading of digital assets on an exchange whilst allowing for the actual settlement to be conducted off-exchange settling and for only the amounts that have been transacted. The off-exchange settlement solution creates a lower risk of theft of assets than those transactions, holding collateral and sitting on the exchange. This could be a major boost to investor confidence and would go a long way to helping grow the space in the future.
Crypto and Laven
Laven has been working with managers in the digital asset and crypto space having been at the forefront of the industry since its beginnings. We have recently appeared in the FCA’s ‘Guidance on Crypto Assets’ published earlier this year as a key correspondent showing out prominence in the space. Laven offers the following services in the crypto sector:
Laven has over a decade of experience carrying out due diligence reviews of managers who work with a variety of different asset classes. Laven has adapted this process to enable an efficient review of a Fund holding digital asset classes including Operational Due Diligence, Investment Due Diligence and Operational Assessment.
Laven’s hybrid approach to compliance fusing technology and subject matter expertise ensured that our compliance package was easily tailored to a firm managing digital assets. Leveraging the knowledge we have accumulated in the digital asset space through the due diligence reviews and our advanced knowledge of regulatory compliance, we have created a world-class infrastructure to ensure compliance when dealing with Digital Assets.
Laven’s AML and Market Abuse training modules will make sure our clients are fully trained for the 5AMLD’s implementation date in January 2020. With nearly 1000 users of our online training we are confident we can bring the right amount of knowledge and testing to help our clients.
If you are interested in any of our Crypto services or attending our next roundtable please contact our Marketing Team at firstname.lastname@example.org.