articles | 05 October 2021

CASPs, investment funds and liquidity

In the last decade or so, a new asset class has been created; the crypto-assets class.

It all started in 2009 with Bitcoin, the first project, a cryptocurrency, on the now widely understood and adopted technology of blockchain. Nowadays, the term cryptocurrency has become mainstream. Since that first Bitcoin was mined, many more cryptocurrencies, providing different offerings with unique characteristics have been developed. As with everything new that is this disruptive and scalable, there have been many instances of fraud, cyber theft, and pure mis-selling of these cryptocurrencies as investment products. Consequently, regulators are catching up to reduce these instances.

In 2018, the European Commission published a proposal on the Regulation of Markets in Crypto-Assets (MiCA). Since MiCA introduced and defined the term crypto-assets, it has become a widely used and the most appropriate term for an asset class category that encompasses all such digital projects including cryptocurrencies and beyond. Fast-forward to 2021, crypto-assets are still on a rollercoaster ride with regulation. The need for and the benefits from regulation in crypto-assets are by now obvious. As more and more regulators are accepting to register crypto-businesses, CySEC has become one of the latest to do so.

The need for Crypto-assets regulation

Blockchain, the technology used to develop crypto-assets projects, allows for several exciting capabilities and one that is the most controversial, anonymity.

The fact that the initial digital projects were all built around earlier concepts of new types of money, resulted in the first crypto-assets being cryptocurrencies. Cryptocurrencies mimic physical, government-regulated currencies which are also known as fiat currencies. Thus, the majority of the newly formed crypto-assets became an alternative medium of transacting, anonymously.

This anonymity capability of crypto-assets has attracted all sorts of crowds, pioneers, enthusiasts, and a segment interest in bypassing anti-money laundering (AML) laws, especially the well-known travel rule. Effectively, the travel rule mandates for the transactional parties to provide, obtain, store and report information on the recipient, the receiver, and the source of funds. In other words, it is a way of knowing who sends what assets and where such assets came from. Understandably, conformity with the AML travel rule is an indispensable requirement and will be part of any regulation in crypto-assets.

CySEC, the AML and counter-terrorist financing (AML/CFT) supervisor for crypto-asset operations undertaken in or from Cyprus, will now accept applications for the registration of crypto-businesses. This will enable crypto-assets services providers (CASP) to apply for registration, and as part of their application, the crypto-business will be subject to specific organisational and operational requirements with the said travel rule, along other AML policies and procedures, being a particular area of scrutiny.

CySEC and crypto-investment funds

CySEC is also the regulator for investment funds in Cyprus. Although the jurisdiction has been steadily growing, it still seems to be disregarded by the - even more rapidly - growing sector of investment funds investing in crypto-assets. We expect the CASP registration development to change the landscape positively in the following path forward:

  • By obtaining a CASP-status registration, the regulator and in turn the banks, will give credibility to the crypto-businesses that comply with the regulatory framework and AML laws. Complications in establishing such crypto-ventures shall be minimised.

    • It follows, that a regulated investment fund will be in a position to establish arrangements with such crypto-assets services providers registered in Cyprus, or in EEA, without any negative implication in their relationship with the regulator or the banks.

      • One such CASP arrangement concerns liquidity provision of crypto-assets for investment funds with a crypto-focused investment strategy

In short, crypto-investment funds should now, not find any obstacles in establishing themselves in Cyprus under CySEC, and in deploying their crypto-investment strategy in alignment with AML laws and the regulatory framework.

CASPs as liquidity providers

Liquidity providers (LP) are key participants in financial markets and, unlike the more traditional markets of shares and bonds, the crypto space is still developing a reliable ecosystem of such providers. A liquidity provider acts at both ends, buying and selling particular assets at certain prices. It means that an LP is making the market, providing the all-important liquidity investment firms and investment funds require to hedge their risks and to deploy their investment strategies. 

The crypto assets services providers (CASP) registration specifies three (3) classes of crypto-asset activities under CySEC, and two of them cover for this LP business model. Specifically, a combination of the crypto-asset activities 

  • Within CASP Class #2, allow for the registration of LPs as institutional brokers business models and

  • Within CASP Class #3, allow for the registration of LPs as crypto-exchanges business models.

It is for this reason, in our opinion, a tremendous by-product of the latest CASP registration development, that liquidity provision in crypto-assets for investment funds in Cyprus will flourish and in turn help crypto-investment funds gain legitimacy. This will do so by both, CASPs registered in Cyprus and CASPs registered in EEA that have proceeded to notify CySEC they will be undertaking crypto-asset operations in Cyprus.

We therefore expect the recent CASP initiative by CySEC to further strengthen the overall investment funds jurisdiction and be part of the reason the assets under management in Cyprus continue to grow. Let there be (crypto) liquidity.

Author: Nikolas Xenofontos, Managing Director, Salvus 

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