Ripple Not Included: New Morgan Creek Fund Excludes Pre-Mined Cryptocurrencies
Some cryptocurrencies took a big step towards institutional adoption today, with the launch of the Morgan Creek Digital Asset Index Fund.
Backed by the Morgan Creek institutional investment house that currently manages $1.5 billion in assets, the fund gives pensions, wealthy families, endowments and accredited investors a way to gain exposure to bitcoin,
ethereum and eight of the largest cryptocurrencies by market value.
But notably missing from the list will be some of the largest cryptocurrencies in the world. The rules-based index fund, managed by San Francisco-based Bitwise Asset Management, excludes cryptocurrencies such as Ripple’s XRP and Stellar’s lumen, that were created through a controversial process called a pre-mine.
Whereas most cryptocurrencies are mined through a process that rewards computing power processed on the
blockchain with newly minted coins, pre-mined currencies were largely or exclusively created when the blockchain first began, introducing a number of potential risks the fund seeks to avoid.
“If there’s a central party that owns 30% or more of supply then we withhold those from the index,” said Morgan Creek Digital partner Anthony Pompliano. “Because we think that introduces a lot of additional risk that may not be there if it was a more decentralized network.”
The index fund holds a market-cap-weighted basket of the other 10 largest digital assets, recalculated monthly. Further requirements to be in the fund include custody qualifications, trade concentration limits and the technical ability to be secured off-line in what is called cold storage.
In spite of the restriction, XRP is currently the third largest cryptocurrency market at $13.4 billion. Lumens are currently the sixth largest cryptocurrency at $4.2 billion. Other coins that could someday also be excluded based on the pre-mine criteria are NEO, which is current the 16th largest cryptocurrency at $1.3 billion and NEM, at $983 million.
Among the potential regulatory risks associated with the centralization of some
crypto-assets is the increased possibility of market manipulation by token holders and the possibility that a regulatory body could deem the tokens securities.
“We’re fully prepared and feel we’ve built something that institutional investors will find attractive regardless of how the assets are categorized,” said Pompliano. “Whether they’re securities or not.”
To help build the index and a number of other unannounced cryptocurrency project Pompliano came to Morgan Creek earlier this year. In January his previous firm Full Tilt Capital announced its second fund would be exclusively focused on cryptocurrency. Then, in March, Morgan Creek acquired his firm for an undisclosed amount and he was made partner of the combined entity.
The final piece for the index fund fell into place earlier this year when Morgan Creek partnered with cryptocurrency fund-sponsor Bitwise Investment Advisors, LLC, a subsidiary of Bitwise Asset Management to handle
trading, taxes and provide cryptocurrency custody through their own partner, Kingdom Trust.
According to Bitwise co-founder Hunter Horsley, the biggest distinction between the Morgan Creek Digital Asset Index Fund and its HOLD 10 Fund announced last year is the committee of vetters. In addition to Morgan Creek CEO Mark Yusko, Pompliano and Bitwise global head of research Matt Hougan sit on the committee.
Horsley says the two main considerations that “justify the decision" of the committee to limit the pre-mined coins are concerns over potential fraud committed by large-percentage token holders and regulatory concerns about the securities status of tokens that are largely owned by a single group.
“With decentralization being a cornerstone of most blockchain designs, having a large portion of assets held centrally runs counter to that and could create complexities that differ from what we would expect from public blockchains,” said Horsley. “That’s not for sure, it’s just a potential risk.”
Further to that point, a U.S. Securities and
Exchange Commission director earlier this year said that while it was unlikely that ether was a security, other crypto-assets were still less certain. Though the director didn't name specific cryptocurrencies a number class action lawsuits have been filed alleging that XRP is a security. To help off-set some of the concerns around centralization, Ripple last year locked up 55 billion XRP into a series of smart contracts designed to restrict its own access to the funds.
The Morgan Creek Digital Asset Index Fund is available today to approved institutional investors and accredited investors. To help ensure participants of the underlying assets in the fund Horsley says it will be audited by Bitwise auditor Cohen & Company beginning in the fall with results published on an annual basis starting in early 2019.
“We set up the product with Bitwise and created a structure that we endeavor will become the industry standard the way the S&P became the industry standard for indexing equities,” said Yusko, who is also Morgan Creek’s chief investment officer.
“That’s our long-term vision, our long-term goal,” he added.