Are you a crypto proprietary trader thinking of taking things to the next level by setting up a fund? Here is what you need to know.
For a lot of us, the big appeal of proprietary trading is in the high ceiling. You can leverage your nous, experience, and analytical skills to create a competitive edge that offers much greater potential returns than many other kinds of investment. However, this shot at increased returns doesn’t come without its own drawbacks and risks.
Big rewards can mean big risks. Prop trading puts your own capital on the line, exposing you to losses when your trades don’t go well. Setting up a fund means you will invest with other people's capital - less risk for the individual trader, but less freedom. There are more protections, but also more effort and costs There are additional costs to factor in as well as the challenge of attracting capital from other investors, but the goals remain the same. You’ll still aim to create profit, offset potential risks, and all while deploying similar strategies for investments.
The aim here is to help you get to grips with the fund structure and gauge if you should use it for your prop trading.
Differences between prop trading and fund trading
The capital at risk: Prop trading differs from fund trading through the capital that you have in play. As a prop trader, you’re purely trading with your own funds. You get to maximise profits in prop trading by keeping every penny of the investment earnings - after all, it’s all earned through your own capital. The flipside, however, is risk. Many traders lose a lot of capital, and if they are only trading their own capital then they risk impoverishing themselves. A few well-caffeinated clicks of a button may well get you in early with the new DOGE, PEPE, or hot DeFi token; it may also wipe out your house deposit.
As a fund manager, you may still invest your own capital into the fund, but you’ve also got the funds of other people bundled into the pool. In fund trading, there tends to be a lot more money on the table, and you will need to manage your relationship with your investors. Naturally, these investors also share in the profits you make for the fund.
The people involved: As a prop trader you can be something of a lone wolf - a one man trading machine, prowling Twitter, Discord, Reddit and a whole series of more mainstream media in order to find signals upon which to base your trade. A fund requires a little more infrastructure. Depending on the jurisdiction you set it up in, your fund will need a professional administrator for the fund entity itself, a custodian to hold the capital, one or more mandatory directors for the fund company, and compliance staff
The entities in play: A prop trader can trade how he likes. You may have funds sitting on a DEX or CEX, or even just in your bank account; you may, or may not, have incorporated a company to hold the funds. A fund structure, by contrast, requires a company to act as the fund vehicle and to own the assets. There may be a fund feeder vehicle - another corporate entity - to attract and pool capital from other jurisdictions that you can then place into your main fund entity.
Knowing when to transition to a fund
Risk mitigation: Many prop traders make the transition into managing their own investment fund. For some, it is all about risk - trade with other people’s money, and you lose less of your own.
You want to make bigger trades; Some see it as the next step in their trading career. Having proved themselves trading on their own account, they want to trade bigger sums. Having a fund structure means you can more easily attract capital, and those begin building the capital base you need for the bigger trades
The clamour of family and friends: Others find the investors to come to them - family and friends, perhaps, who have heard of their success and want a piece of the action.
VC and PE investments: Making money on the daily or weekly rhythms of the crypto markets is one thing, but some traders and investors are looking to back longer term projects. If you want to invest for the longer term, and to help Web3 projects transform the digital economy and wider internet, then a fund structure is what you need. Here, close-ended funds give investors and projects the longer-term certainty they need about their capital
You want to attract money from overseas: Maybe you know a few potential investors, but they are in another country to you. If so, this may be a reason to move away from prop trading into a fund. Byt having fund structures you can more easily pool theur capital and invest it. If they send it directly to you in your jurisdiction, this could have all sorts of tax implications bot for you and for them. Putting it in a fund, especially one within a fund-friendly jurisdiction, will mitigate this problem
Benefits of a fund structure
As the above should make clear, setting up a fund offers many advantages. It gives you the ability to pool cypto capital and make bigger trades. By setting up a fund you make potential investors feel more secure about putting their money with you, thus widening the number of people you can raise capital from. In many jurisdictions, using offshore fund vehicles means you can attract, pool, and trade funds overseas, something that could otherwise be blocked to you. Finally, if you want to make long term investments - investments where the money can be locked in for long term gains - then you need a closed-end fund structure in order to stop your investors from suddenly pulling out the money they have placed with you.
Be Warned: Funds are useful, but your costs and admin will increase
Perhaps the main downside to you turning to a fund structure rather than sticking with pure proprietary trading is the additional administration and costs that come with it. I This is one reason why we prefer to help start-up fund managers set up in the British Virgin Islands. In the BVI, the requirements are tiered depending on the size of your fund, allowing your need for additional compliance to scale as your fund grows in size.. For many people looking to begin their career as a fund manager, setting up entities in these jurisdictions is a relatively low-cost way to prove their ability to generate strong returns without committing to the big administrative outlay needed elsehwere.
Either way, it’s a big shift in the role. After all, we know that a lot of prop traders like the freedom of the job and being able to focus on their favourite markets to find great opportunities. Turning into a fund adds many more tasks to your day and takes away some of these perks.
There’s also the element of additional hires to suit different jurisdictions. For some fund types, countries will require you to have local directors and pay regular audit costs on top of the custodians and professional fund administrators. There just isn’t a way around this. You can see the differences in a comparison like the British Virgin Islands against Luxembourg. For BVI Incubator Hedge Funds, you don’t need an auditor, custodian, offering memorandum, administrator, or even a licensed investment manager. Over in Luxembourg, Alternative Investment Funds are subject to what we’d say are high examination costs on top of annual fees of between €15,000 and €25,000.
You’ve got your additional hires and you’ve got to juggle the rules of different jurisdictions, and then there’s the very nature of running a fund structure. To run a fund, you’ll likely end up doing more work to try to enhance your appeal. You’ll need to operate in a way that attracts more money from new people. You’ll try to forge new relationships in pursuit of investors. Then, you’ll also need to spend more time managing the money from different investors once it comes into play. As Biggie Smalls said: mo money, mo problems.
There is a lot of upside, though. It’s a very scalable business model, and the costs don’t tend to change that much as your assets grow. There’s a flat rate for many of the costs of doing business, and major outgoings are usually a percentage of your revenue. Plus, you can charge a set percentage on fees to lead to further profits as you scale.
How much money do you need to set up a fund?
Where you want to incorporate a legal entity can drastically change how much money you need to set up a fund. With us, a limited company in the British Virgin Islands operating as a fund will cost ~$24,000 including legal set up costs, but we could also set you up with an investment fund in Delaware for US$5495. You have plenty of options and we can help you get settled with whichever one you choose. You’ll also need to keep in mind the minimum capital requirements of different countries. To make it easier, here’s a quick look at the minimum capital needed by some very business-friendly nations:
- Delaware Minimum Capital: US$0
- British Virgin Islands Minimum Capital: US$20,000 (Incubator Fund), US$100,000 (Professional Fund)
- Cayman Islands Minimum Capital: US$100,000 (Registered Mutual Fund)
- Ireland Minimum Capital: €125,000 or ~US$135,000 (Alternative Investment Fund Manager)
- Luxembourg Minimum Capital: At least €25,000 or ~US$27,000 (Less-Regulated Funds)
The switch from proprietary trading to a fund, or even carrying on your prop trading but under the structure of a fund, can offer greater opportunities for investments and returns. That said, it’s important to consider your options worldwide and the additional costs and admin you’ll face.