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Motivation
The goal of this project is to utilize distributed ledger technology to reduce the need for middlemen involved in fund administration such as custodians, accountants, auditors for traditional asset management. The resulting efficiency gains can then be passed to investors as lower fees and faster processing. In addition, the project uses the Ethereum blockchain and standardized token infrastructure to promote transparency and liquidity for investors.
A fund manager first needs to incorporate a new company or partnership. To sell to non-U.S. investors, the manager then creates one or more entities domiciled in an off-shore jurisdiction like the Cayman Islands or Bermuda, allow with a master-feeder structure. For each fund entity, lawyers draft large, mostly-boilerplate legal documents to define the rules of the fund. A custodian bank holds the fund assets, while an administrator processes investor subscriptions, investor redemptions, and net asset value calculations. Accountants and auditors verify that the transactions processed accurately.
This complexity produces many harmful externalities, both obvious and non-obvious.
Clearly, all the parties need to be compensated, which is why a hedge funds requires $50k-100k in setup costs and $25-50k in ongoing annual administration costs. This makes it prohibitively expensive for new fund managers, even if they just want to build an audit-able track record using their own capital. For established funds, administration costs are ultimately paid by investors in the form of the 2% annual management fee.
Yet potentially more harmful is that the presence of many different entities and third parties decreases transparency and increases fraud risk. The history of hedge funds are littered with infamous Ponzi schemers like Bernie Madoff, who was able to con sophisticated investors and auditors for many years because hedge funds are not transparent.
All fund-related transactions such as subscriptions, redemptions, net asset value calculations, and fee payments are recorded on the Ethereum blockchain and utilize its distributed ledger technology to ensure transaction accuracy. Investor balances are also recorded and stored in the smart contract.
All transactions that transfer funds or alter state emit events which are recorded on the blockchain, generating a replayable audit trail.
Assuming that investors comply with their regulatory requirements, they can transfer the tokens that represent their share ownership to other investors via standard infrastructure that supports ERC20 tokens.
Please see the repository for instructions on how to create a fund using this protocol and to run tests.