President Trump’s Truth Social recently made headlines with the announcement of a new bitcoin-based ETF that will potentially trade on the NYSE Arca. The recent S-1 filing does more than push crypto-based funds into the spotlight; it highlights some key legal and operational challenges that even private fund managers investing in crypto projects should consider. In the filing, Truth Social adopts a firm policy: it will permanently and irrevocably abandon any rights to digital assets that it obtained incidentally to owning Bitcoin through events like forks or airdrops.
Despite the Truth Social Bitcoin ETF being a publicly traded fund, the issues raised in the S-1 filing are pertinent to even private fund managers. As the mass adoption of the crypto market increases, the popularity of private funds investing in these assets continues to grow. Even private funds that do not intend to primarily invest in cryptocurrencies are increasingly utilizing opportunities to temporarily store value in this asset class that is showing signs of steady appreciation. A private fund manager should be aware of the need to implement a policy for blockchain forks and airdrops and the importance of proper disclosure of that strategy when preparing investor documents.
Forks and Airdrops:
A “fork” occurs when a blockchain protocol undergoes a split, often resulting in a new digital asset. A reader who has followed the crypto market for several years may remember when Bitcoin split into the Bitcoin we know today and another coin, Bitcoin Cash. When these “fork” instances occur, holders of the currency will often receive an equal number of new coins as they hold of the original coin. (Original Bitcoin holders retained their Bitcoin but also received Bitcoin Cash.) These events have the potential to create value as the new assets develop their own market demand.
Similarly, airdrops distribute free tokens to holders of an existing cryptocurrency. These events can have different motivating factors such as building community among holders, incentivizing early adoption of the crypto project, and rewarding holders for their participation. No matter the motivation, airdrops can sometimes generate unexpected assets of significant value.
For funds that hold crypto assets, the economic, tax, legal, and custody implications of these events could be significant. An airdropped token may not be supported by the fund’s investment strategy. For example, a fund primarily investing in other types of assets may suddenly find itself involved in a participation-rewarding airdrop for holding a crypto token. Airdropped tokens might also trigger tax consequences or require new compliance protocols, and may create difficulty calculating the NAV per share.
The Truth Social Bitcoin ETF Approach to Airdrops and Splits:
To avoid these complications, the Truth Social Bitcoin ETF has opted for a straightforward approach: it will abandon any rights to assets acquired through airdrops or forks. While this strategy simplifies operations and sidesteps potential regulatory complexities, it also comes with a cost. As the filing notes, “shareholders will not receive the benefits” of any airdrops or forks.
This approach seems simple and effective, but that does not mean that it should be the standard followed by managers of private funds—our typical client. This approach does not seem to be the norm, and there are other approaches used in the crypto fund market.
Consider the policy of Grayscale Bitcoin Trust, a leading Bitcoin ETF. In the case of an airdrop or split, the fund will distribute the new asset to an agent who will sell it and distribute the cash back to the shareholders. Or, in the case of Bitwise 10 Crypto Index Fund, the sponsor is authorized to try to take advantage of airdrops for the benefit of investors.
Because a complete abandonment of assets created through airdrops or splits may not be the market norm, any fund manager should try to dispel ambiguity around the treatment of these assets. Investors may later claim they were misled if these events occur and the fund takes action to abandon the rights to the new assets, especially if the value of the unclaimed assets is substantial.
Proper PPM Disclosure:
For private funds offered to sophisticated investors, a Private Placement Memorandum (PPM) must be provided for Regulation D Rule 506(b) offerings. While other private offerings may not have an explicit legal requirement for a PPM, issuing one is strongly recommended to demonstrate regulatory compliance and protect the fund and manager from liability. The PPM includes key disclosures regarding the fund’s investment strategy, risk factors, fees, and potential conflicts of interest. When drafting the investment strategy and risk factors sections, fund managers should carefully assess and disclose any legal risks associated with their approach.
Because the goal of a PPM is to disclose information and reduce ambiguity, all fund managers who plan to invest in crypto should include a section in the PPM detailing how forks and airdrops will be handled and the financial consequences of that policy. Whether a manager chooses to follow suit with the Truth Social approach or any other, it is key that this is communicated effectively. Ignoring this issue is no longer an option for serious digital asset fund managers.
While private offerings are exempt from the full SEC registration process, PPMs are still subject to anti-fraud rules. This includes the duty to disclose all material facts and risks that a reasonable investor would consider important, including the potential value lost or gained during an airdrop or split.
If you are interested in incorporating disclosures related to token splits and airdrops into your investor documentation, such as a Private Placement Memorandum (PPM), please don’t hesitate to reach out. We would be happy to assist.