Custody rule dilemmas in DeFi investing: Regulations struggle to address the role of smart contracts

As a new member of the U.S. investment funds team and Linklaters' global fintech initiative, I am thrilled to have authored an article for Hedge Fund Law Report analyzing a topic about which I am passionate: decentralized finance (DeFi).

The article, entitled “Custody Rule Dilemmas in DeFi Investing,” provides much needed guidance for private fund managers who are subject to Rule 206(4)-2 (the Custody Rule) under the Investment Advisers Act of 1940 and also seek to engage in DeFi-related investment activity (for example, investing DAI in a permissioned DeFi lending protocol). 

For these managers, it may be impractical, if not impossible, to comply with the Custody Rule. To the   initiated, this comes as no surprise. The Custody Rule—by all accounts—was never intended to deal with investments in digital assets and/or involving smart contracts deployed to various blockchains. Managers looking to abide by the Custody Rule must find guidance by embracing the spirit of the rule, which is to (among other things) protect client funds and securities from loss, misuse, or the deterioration of the manager's financial position. 

In order to achieve compliance with the U.S. securities laws, managers must also retain competent legal counsel that understand smart contracts and their role within the blockchains that support them.