Galaxy Investment Partners, the family office of ex-hedge fund manager Mike Novogratz, has recently made a name for itself for adopting cryptocurrency as an asset class. Is this a blip for family offices, or the start of a trend? James Brockhurst, senior associate at Forsters LLP, takes a look
In 2017 there was a surge of investment into cryptocurrencies and initial coin offerings (ICOs). In the latter half of 2017, ICOs eclipsed angel/venture capital seed capital as a method of fundraising. Initial Coin Offerings, or 'ICOs', are the blockchain equivalent of initial public offerings or funding rounds. Rather than issuing shares in exchange for equity, a business launching an ICO issues tradable cryptographic tokens to which are attached certain economic rights.
An investor can typically only buy ICO tokens with established cryptocurrencies (usually Bitcoin or Ethereum).
There has been a hesitant take-up by family offices of cryptocurrencies and ICOs. The essence of cryptocurrencies—which derive their value solely from what the market will pay for them—flies in the face of investment logic and risk strategy. Cryptocurrency and ICOs have also faced reputational issues. Only a courageous chief investment officer would stand before a committee meeting to advocate a crypto or ICO investment. But perceptions are changing.
Bitcoin (BTC), and to a slightly lesser extent Ethereum (ETH) have appreciated exponentially this year increasing almost 1000% since the start of 2017 to more than $10,000. Cryptocurrencies remain overall an unsophisticated investment with a nominal entry-level, frequently bought in small quantities. But now the cavalry have arrived - the City of London and New York City have introduced securitisation, options, and derivatives into the cryptocurrency market.
There have been crypto funds for some years in jurisdictions like Jersey, but this year has seen the entry of big players such as Chicago Board Options Exchange (CBOE) and Chicago Mercantile Exchange (CME). Offshore private banks also want to get in on the act—how, they ask, can we custodise crypto? Meanwhile, investors continue to see value (possibly as a hedge) in a currency which is independent of banks, governments, inflation, quantitative easing, and geopolitical conflict. Others see value and utility in the underlying technology (blockchain), particularly those investing in ETH which is built on a more sophisticated blockchain than Bitcoin.
As to ICOs, the first question is: What exactly are you buying into? You are not purchasing a share, but a cryptographic token. What rights attach to the token? If the business issuing the tokens is a company, how do the rights of token-holders interact with the rights of shareholders? Is there any prohibition in the company articles from declaring dividends? Is there a facility for the tokens to be re-purchased by the company? Is there a market for the tokens themselves (i.e. are they listed on a reputable exchange)? These are the relevant questions.
Many innovative companies are choosing the ICO fundraising route, so investment opportunities do exist. Separating the wheat from the chaff is one thing, but identifying fraudulent ICOs is another as, unfortunately, fraud is all too rife.
Much of this is due to the uncertain regulatory status of ICOs in many countries. Family offices considering seed investment in an ICO will not touch anything where there is any regulatory uncertainty, which will vary from country to country. China's disdain for cryptocurrencies is well documented. Then there is the United States, Singapore, and the UK where regulators have made ambivalent noises on ICOs. If, disregarding the ICO, the underlying asset would otherwise qualify as a security, then more than likely the issuance will be a regulated activity. Some start-ups have used ICOs to circumvent securities legislation, which is obviously illegal.
Family offices may only feel comfortable dipping their toes into ICOs which are underpinned by traditional (non-blockchain) assets. Take real estate for example. An ICO was launched recently by a UK company which for decades has specialised in student accommodation. ICOs underpinned by blockchain-based assets, whether it be a new cyptocurrency (Electroneum being a well-publicised example) or crypto-based financial applications (such as crypto-based lending solutions) may be too high risk.
A further challenge for family offices is in the trust context. Are trustees permitted to hold cryptographic tokens under the trust deed? Is the high risk level acceptable? Are the trustees willing to hold such assets? This is less likely an issue where the trustee is a private trust company, but institutional trustees are likely to reject crypto assets in the absence of clear authorisation in the trust deed and, possibly, indemnities.
Whatever one's view, blockchain is here to stay in some form or other, and the support (or rejection) of family offices will determine how far the blockchain revolution travels.