We are thrilled to have Scott Feingold on the team, a Senior Fund Controller with over a decade of experience in the fund administration industry. In this Q&A session, Scott shares his experiences in the digital asset space over the last five years, highlights the primary challenges that ongoing fund administration faces, and provides insights into the future of digital asset funds.
Q: What is your background in fund administration and how have you seen the digital asset space evolve over the last several years?
I have been in the fund administration space since 2007. In the past 16 years, I have worked with all types of asset classes and by far, crypto has been the most interesting and most challenging of them all.
In 2018, I was working for Morgan Stanley at the time, and I received a call from my old boss and friend who started a fund administration company called Triple Leo Consulting. At this time, administrators that could handle digital assets were very rare. No one had the technology or knowledge to do proper accounting for these types of funds. Digital asset hedge funds were hot at the time. Everyone saw how much money people were making from investing in Bitcoin or Ethereum and wanted a piece of it. Of course, there were a ton of “shitcoins” out there as well, but hedge funds did not have to hedge anything, since a simple investment in Bitcoin would grow their AUM by the millions.
Eventually, a “crypto winter” took out a sizable number of funds. Numerous coins became worthless, and Bitcoin went down again. As things got worse, funds were starting to liquidate and the easy, bullish days of digital asset hedge funds were over. Funds had to figure out other ways to make money in such a volatile asset class.
Funds then started to invest in digital asset arbitrage, futures, swaps, forward contracts, etc. Defi also started to make an impact. Funds could earn tremendous interest rates by lending their crypto assets. This became the next trend and funds were making millions investing in early blockchain products and receiving tokens. Even if many of the illiquid investments did not work out, all you needed was to hit on 1 or 2 of them to make significant returns. Not to mention, platforms were giving 12-15% yields, so even just staking your crypto on those platforms would guarantee great returns for managers and investors.
Then, as it happens so frequently in crypto, the bubble burst. In the last year or two we have seen many of the major players going bankrupt due to over-leveraging and over-lending. Another thinning out process is occurring, and the trend will shift elsewhere once again. My belief, as we are seeing now, private investments and diversifying in other asset classes will now be the norm.
Q: What have been the primary challenges from an ongoing fund administration perspective with the emergence and evolution of digital asset funds?
Through the years, we have seen many challenges within the crypto industry. The digital asset space is still young, so these growing pains and challenges are to be expected. One of the bigger challenges has been and continues to be the lack overall of knowledge. This lack of knowledge impacts administration firms, audit and tax firms, legal firms, etc. The space is not only immensely complex, but it is also constantly evolving and changing. There are new platforms, protocols, and new ways to make profit. As a service professional, it is a constant battle to remain informed and up to date on current trends. Take defi for example – how do tax preparers and auditors get comfortable with it when they don’t have 100% transparency of the transactions (which is also the whole point of defi)? It’s a catch-22.
Another major issue is the lack of regulation. Overall, there is just not enough regulation to broadly make institutions and investors comfortable enough to invest. But on the other hand, crypto was meant to be more of peer-to-peer monetary system without the interference of banks and the government. To take it one step further, there is an ongoing battle of what cryptocurrency should be classified as? A commodity, security, neither, or both?
The last challenge I will mention, although there are several, is technology. Most fund admins cannot account for crypto simply because they do not have technology to do so. Crypto is 24-7-365, so you need a strong platform that can pull in trades, holdings, transfers, prices, timely and accurately (if it is an open-ended fund). And if you do have the platform, APIs are just not that good yet for centralized exchanges. There are constant breaks that need to be managed. For decentralized exchanges, the lack of available APIS creates tremendous burden on the fund administrators. Tracking all the defi transactions becomes significantly more manual and time consuming.
Q: What do you foresee in the growth of digital asset funds broadly?
The volatility of being a digital asset hedge fund is extreme. I believe the tide has turned and investors are more reluctant when investing. Closed ended funds are trending – investing in early web3 and blockchain gives the fund managers and investors a little more confidence. The most important thing is to diversify. We have seen over many years, it is hard to not just become successful as a fund investing in crypto, but to have consistent returns and to raise capital.
The digital asset world is so young, and I cannot wait to see where it goes in the next 5 years. It is constantly evolving, and investment managers must evolve with it. Here is to a bullish 2023!
Q: For managers that are investing in digital assets, whether in open- or closed-ended vehicles, what are some of the pitfalls or challenges to be aware from a fund administration and accounting perspective?
Knowledge – One of the biggest challenges across the industry is knowledge. Time and time again, I have seen fund managers sign with fund administrators that do not know how to account for digital assets. It is one thing to account for Bitcoin, Ethereum trades on a centralized exchange, but it is entirely different to account for defi (staking, lending, borrowing, yield farming, etc.). It is so important to find an administrator from the launch of the fund to track and account for all these activities properly as it becomes exceedingly difficult to sort through this data after the fact.
CFO internally or outsourced – When it comes to funds that are more active in the defi space, it is essential to have someone internally or outsourced, that can track all the private investments (SAFTs, SAFEs, Pre-ICOs) and defi activity. Having an experienced fund admin is important, but it is also important to have someone who can organize and track (if it is an active fund) the activity internally so the fund admin receives the correct and accurate information. Defi is constantly changing, so if the fund manager does not have the time to keep up with it, the fund admin is at a severe disadvantage and will receive incomplete records.
Finding the right fit – This should be a partnership. The fund managers should be able to trust the fund admin with handling the back and middle officer work so they can focus on the front office raising capital and investments. Smaller admins can offer more personalized service and help less experienced fund managers grow.
We are absolutely thrilled to welcome Scott aboard the Vector AIS team, bringing his over 15 years of fund administration expertise to both our clients and team. With Scott’s in-depth knowledge of digital assets, we’re excited to push forward and further support the growth of digital asset managers. Keep your eyes peeled in 2023 for our blog series centered around closed-end digital asset funds. From navigating the accounting challenges of DeFi investments to understanding the regulatory implications of cryptocurrency investing, to uncovering the impacts of NFTs and other digital assets, we’ve got you covered. Plus, we’ll be diving into accounting for tokenization of assets and much more! Stay tuned for insights from our team of experts in the digital asset space.
Vector is a different kind of fund administrator. Vector is committed to building the next generation of fund administration. We provide closed-end alternative investment firms with industry-leading technology, top-tier talent, innovative workflows, and a comprehensive suite of integrated fund services.
Our offerings include: fund accounting and reporting; capital calls and distributions; fund operational support; investor reporting and access to an LP portal; fund launch support; tax and audit process management; general partner support and anti-money laundering screening.