How to Launch a Crypto Lending Fund: Structure, Collateral Control, Counterparties and Valuation

A crypto lending fund is first a liquidity decision. Under the Cayman Mutual Funds Act an open-ended fund issues equity interests redeemable at the investor's option. Section 2 of the Private Funds Act (2025 Revision) defines a private fund's investment interests as not redeemable at the investor's option. A lending book whose loans cannot be called before maturity usually fits one regime better than the other. Around that choice the manager builds loan documentation, collateral custody and control, and loan-to-value and liquidation mechanics that run around the clock. Borrower concentration limits and a valuation policy that measures credit risk as well as collateral value complete the build. The regulatory analysis then tests the fund's actual activities against the Virtual Asset (Service Providers) Act and the Securities Investment Business Act.

Managers who have lent to trading firms or miners usually know their borrowers well. What they have often not built is the machinery around the loan: who holds the collateral, who can move it, who calls margin on a Sunday night, and who tells the administrator that a loan is impaired. Allocators who lived through 2022 test that machinery before they test the yield. We ask managers to design the default case first, because the documents, the custody chain and the redemption terms all follow from it.

David Lloyd, Chief Executive Officer at CV5 Capital

Executive Summary

A crypto lending or credit fund earns interest by extending loans in fiat, stablecoins or digital assets to trading firms, market makers, miners or on-chain borrowers. Its risk is concentrated in three places: the borrower, the collateral and the gap between loan tenor and investor liquidity.

• Match the vehicle to the book. Term loans with no early call usually sit more naturally in a closed-ended private fund; short, callable, overcollateralised loans can support an open-ended fund with notice periods and gates.
• Collateral control is the core control. The fund should know at every moment where collateral sits, in whose name, who can move it and whether it can be reused.
• Margin calls and liquidations must run 24 hours a day, seven days a week, with written triggers, cure periods and named people with authority to act.
• Loan valuation is a credit exercise. Collateral value caps recovery but does not by itself establish the fair value of a loan to a weakening borrower.
• The Virtual Asset (Service Providers) Act definition of virtual asset service does not list lending as a category, so the analysis turns on whether the fund's operations involve any listed service in or from within the Islands.

Define the Book Before Choosing the Vehicle

Crypto credit covers several distinct businesses. A fund may make overcollateralised loans to trading firms and market makers, lend stablecoins against bitcoin or ether, finance miners against equipment or future production, or deploy capital into on-chain lending markets. Each has a different default profile, collateral type and exit speed.

Before drafting, the manager should record five features of the book: borrower types, loan and collateral currencies, tenor and call rights, target collateral coverage, and the share deployed on-chain. Those answers decide the vehicle, the dealing terms and most of the valuation policy.

The borrower and counterparty layer is where most crypto credit losses have originated, and the general framework is set out in our analysis of credit and counterparty risk in digital asset funds. This article concentrates on what changes when lending is the strategy rather than one exposure among many.

Open-Ended or Closed-Ended: Mutual Fund or Private Fund

The Cayman statutes draw the line by redeemability. The Mutual Funds Act defines an equity interest as one that is redeemable or repurchasable at the option of the investor, and a mutual fund as a vehicle issuing equity interests to pool investor funds. The Private Funds Act defines an investment interest as one that is not redeemable or repurchasable at the investor's option, and a private fund as a vehicle issuing such interests. Debt is excluded from the private fund definition of investment interest.

The practical test is simple. If the fund cannot recover cash from its borrowers within the redemption notice period under stress, it should not promise that liquidity. The detailed comparison of the two regimes is in our guide to whether the Mutual Funds Act or the Private Funds Act applies.

Loan Documentation and Collateral Types

Each loan needs a written agreement that the administrator and auditor can read. It should state principal, currency, interest basis, tenor, call rights, the collateral type and haircut, the loan-to-value trigger points, the cure period, events of default and the fund's enforcement rights. Where a master lending agreement is used, each drawdown should be confirmed in writing with its own terms.

The further down this table a loan sits, the slower its collateral is to liquidate and the more its value depends on legal enforcement.

Collateral Custody, Control and Rehypothecation

The 2022 lender failures taught allocators to ask one question first: whose asset is it? In one such case, the United States Bankruptcy Court for the Southern District of New York held in January 2023 that assets customers placed in a lender's yield programme were property of its bankruptcy estate. The decision rested on terms of use that transferred title to the lender. Depositors became unsecured creditors.

A lending fund sits on both sides of that lesson. As lender, it needs collateral held so that the borrower cannot move it and the fund can enforce against it. As an entity holding its own assets, it needs those assets held so that a custodian or venue failure does not turn them into an unsecured claim.

• Collateral held by a custodian in a segregated account, with control rights in favour of the fund on default.
• A tri-party arrangement in which a custodian holds collateral and releases it only on agreed instructions from both parties or on a documented default notice.
• An express prohibition on rehypothecation of posted collateral, or a precise statement of any permitted reuse and how it is reported.
• Daily reconciliation of collateral balances by the administrator against custodian statements, not manager reports.
• Wallet authority for the fund's own assets that separates trading, transfer approval and recovery roles.

Where the fund is a segregated portfolio, the same controls must also respect the portfolio boundary. Custody accounts, collateral agreements and venue relationships should be opened for the portfolio, as discussed in our review of whether segregated portfolio ringfencing survives crypto custody.

Loan-to-Value, Margin Calls and Liquidation

Loan-to-value is loan balance divided by current collateral value. As a hypothetical illustration, a loan of 6 million against collateral worth 10 million has a loan-to-value of 60 percent. If the collateral falls to 7.5 million, the ratio rises to 80 percent. Crypto prices move at weekends and overnight, so these thresholds are breached outside office hours.

The lending policy should set three levels for each collateral type. An initial level applies at drawdown. A margin call level requires the borrower to post more collateral or repay within a stated cure period. A liquidation level allows the fund to sell collateral without further notice. The gaps between levels should reflect how far the collateral can fall during the cure period and the time needed to liquidate.

Liquidation also needs a venue. Selling large collateral blocks on one exchange in a falling market can realise well below the screen price. The policy should name the categories of venue or desk used for liquidation, the approval required and how proceeds are applied. Every call and liquidation should be logged and reported to the board.

Borrower concentration is the other limit that matters. Overcollateralisation protects against price moves, not against a single large borrower failing with collateral that cannot be reached. Limits should cap exposure per borrower, per borrower group and per collateral asset, and the offering document should disclose them.

On-Chain Lending: Smart Contract and Oracle Risk

Lending through decentralised protocols replaces a known borrower with code. The fund supplies assets to a pool, and the protocol lends them to borrowers who post collateral. Liquidations are executed by the protocol when its price feed shows collateral below the required level.

That changes the risk rather than removing it. The fund depends on the smart contract performing as written, on the oracle reporting accurate prices, on governance not changing parameters adversely, and on pool liquidity being available when it wants to withdraw. A pool can be fully utilised, leaving lenders unable to exit until borrowers repay or are liquidated. The diligence points are set out in our analysis of smart contract risk for fund allocators.

The offering document should state whether on-chain lending is permitted, cap exposure in total and per protocol, and describe how positions are valued and evidenced to the administrator.

Valuing Loans and Handling Impairment

For a regulated mutual fund, CIMA's Rule on the Calculation of Asset Values requires a written NAV Calculation Policy, disclosed in the offering document and based on IFRS or another permitted accounting framework. It must give priority to unadjusted market prices, then to observable inputs for hard-to-value assets, with unobservable inputs last. Pricing models must be calibrated, and the operators must approve and review the policy and models at least annually.

Most crypto loans have no market price. Their value depends on the borrower's ability to pay and on recovery from collateral if it does not. A loan to a borrower that has missed a margin call, or whose collateral is held somewhere the fund cannot reach, may be worth less than its collateral suggests. The policy should define the evidence that triggers an impairment review, who performs it, and how expected recovery is estimated.

The Rule also addresses manager involvement. Where the investment manager supplies prices or supporting information, the service provider calculating NAV must take reasonable and proportionate steps to verify them, and the offering document must disclose the manager's involvement and resulting conflicts. For a private fund, section 16 of the Private Funds Act requires valuations at an appropriate frequency and at least annually. They may be performed by an independent valuer, the administrator, or the manager where valuation is functionally independent or conflicts are managed and disclosed. The pricing hierarchy for digital assets is set out in our crypto fund valuation policy guide.

Side pockets for impaired loans

An open-ended lending fund should include side pocket powers at launch. When a borrower defaults and recovery depends on enforcement or insolvency proceedings, the loan can be moved into a side pocket. Redeeming investors then do not exit at an uncertain value at the expense of those remaining. Designation criteria, board approval and fee treatment should be fixed in advance. The mechanics are covered in our guide to side pockets in crypto funds.

Redemption Terms Matched to Loan Tenor

Dealing terms should follow from a stressed liquidation analysis of the loan book. That analysis asks how much cash returns within each notice period if borrowers repay only as contractually required and no loan can be sold. Callable overnight loans support monthly dealing with notice. Thirty-day or ninety-day term loans need longer notice, a gate or a liquidity sleeve. Miner and equipment finance generally points to a closed-ended structure.

The same discipline applies in traditional credit. The difference in crypto is speed: collateral can lose value faster and borrowers can fail over a weekend.

The Regulatory Perimeter: VASP Act, SIBA and Lending

The Virtual Asset (Service Providers) Act (2024 Revision), as amended, defines virtual asset service as virtual asset issuance or the business of providing any of five services "for or on behalf of a natural or legal person or legal arrangement". These are exchange between virtual assets and fiat, exchange between virtual assets, transfer of virtual assets, virtual asset custody service, and financial services related to an issuance or sale of a virtual asset. Lending is not listed as a category.

That does not settle the question either way. A lending fund that only lends its own capital and holds collateral through third-party custodians is in a different position from one that safekeeps assets for borrowers or transfers assets on their behalf. The fund's actual operations, not the label on the strategy, should be tested against each limb. The broader analysis is in our article on whether a Cayman crypto fund needs to register as a VASP.

The Securities Investment Business Act should be tested as well. Paragraph 2 of Schedule 1 includes debentures, loan stock, bonds and other instruments creating or acknowledging indebtedness, subject to listed exclusions. Loan agreements and notes held by the fund may therefore be securities, which bears on the investment manager's SIBA position. The Banks and Trust Companies Act defines banking business by reference to receiving and holding money on account repayable by cheque or order. A fund lending its own capital should confirm that nothing in its operations resembles deposit-taking, and should also consider lending rules in each borrower's jurisdiction.

Common Mistakes

• Offering monthly liquidity on a book of term loans that cannot be called before maturity.
• Accepting collateral held by the borrower or at a venue the fund cannot instruct, with no control agreement.
• Leaving rehypothecation unaddressed, so collateral can be reused by a custodian, venue or borrower without the fund's knowledge.
• Valuing loans at par because collateral coverage looks adequate, without any credit impairment review.
• Running margin calls through one person with no out-of-hours deputy or written authority.
• Adding on-chain lending without amending investment powers, risk disclosure and the valuation policy.

The CV5 Implementation Perspective

CV5 Capital is the Cayman-headquartered institutional fund infrastructure platform for hedge fund and digital asset managers who need to launch quickly, operate properly and satisfy serious investors from day one. It operates CV5 SPC for traditional strategies and CV5 Digital SPC for digital asset strategies, both registered with CIMA under the Mutual Funds Act. Each manager receives a segregated portfolio with an independent board and coordinated fund administration, audit, banking, custody and compliance arrangements. CV5 Capital is not the investment manager of the strategies on its platforms.

For a crypto lending manager, the Cayman digital asset fund platform means the governance, administration and valuation framework is already operating. The work concentrates on what is specific to the strategy: borrowers, collateral and custody, margin and liquidation procedure, concentration limits and the impairment policy. The manager retains the credit and lending decisions.

Key Takeaways

• Describe the loan book in writing before choosing between an open-ended mutual fund and a closed-ended private fund.
• Hold collateral in segregated or tri-party custody with enforceable control rights, and prohibit or precisely limit rehypothecation.
• Set initial, margin call and liquidation levels per collateral type, with a 24-hour procedure and named deputies.
• Cap exposure per borrower, borrower group, collateral asset and on-chain protocol, and disclose the limits.
• Write a valuation policy that includes credit impairment, not only collateral value, and build side pocket powers in at launch.
• Test the fund's actual operations against the VASP Act, SIBA and banking definitions before the offering document is finalised.

Frequently Asked Questions

What structure does a crypto lending fund use?

A crypto lending fund is commonly a Cayman vehicle, standalone or as a segregated portfolio. Under Cayman law the choice between an open-ended mutual fund and a closed-ended private fund turns on whether investors can redeem at their option. Short, callable, overcollateralised loans can support an open-ended fund with notice periods and gates, while term loans and less liquid collateral usually point to a closed-ended private fund.

Is crypto lending a virtual asset service in the Cayman Islands?

The Virtual Asset (Service Providers) Act defines virtual asset service by reference to issuance, exchange, transfer, custody and services related to issuance or sale, and does not list lending as a separate category. Whether a lending fund's activities engage the Act depends on what it actually does, for example whether it safekeeps or transfers virtual assets for or on behalf of others in or from within the Islands.

How should collateral be held in a crypto lending fund?

Collateral is commonly held in a segregated custody account or under a tri-party arrangement that gives the fund enforceable control rights on default. The lending documents should prohibit rehypothecation or define precisely any permitted reuse. The administrator should reconcile collateral balances against custodian statements rather than relying on reports from the manager or borrower.

How are crypto loans valued in a fund's NAV?

Most crypto loans have no market price, so they are valued as hard-to-value assets under the fund's NAV Calculation Policy. Collateral value sets the ceiling on recovery, but the valuation should also reflect the borrower's credit position, any missed margin calls and whether collateral can actually be reached. CIMA's rules require calibrated pricing models and verification of any prices the manager supplies.

What happens when a borrower defaults?

The fund follows its lending policy: a margin call with a cure period, then liquidation of collateral if the call is not met. Where recovery depends on enforcement or insolvency proceedings, an open-ended fund can move the loan into a side pocket if its offering document permits it, so that redeeming and remaining investors are treated fairly.

How should redemption terms be set for a lending fund?

Redemption terms should follow from how quickly cash returns from the loan book under stress, assuming borrowers repay only as contractually required. Callable short-dated loans can support monthly dealing with notice, while longer term loans need longer notice periods, gates or a closed-ended structure.