Perceived vs Real Crypto Operational Due Diligence

As many of us in the crypto investment industry have been doing over recent weeks, I’ve been traveling to various conferences and related events, where in addition to meeting new colleagues and building on existing relationships, I’ve been fortunate enough to be asked to present to institutional investors and speak on the topic of digital asset operational due diligence. 

Yes, it is part of my job at Crypto Insights Group to go out and converse on my area of expertise, but it is also something I enjoy doing. It not only gives me the opportunity to educate investors coming into the space, but also allows me to observe how peers go about advising on implementing due diligence. And it is in such observations that I’ve come to the conclusion that there remains quite a divergence between those who cover crypto as just another asset class to service, and those who live it day to day.

Practical Experience vs Generalists

Institutional investors are constantly inundated with reach outs from various service providers who offer their work to assist clients in allocating capital, and many allocators naturally gravitate towards the familiarity of working with groups they likely had used in past projects for the asset classes they’ve committed to in the past. But as one comes to understand quickly, crypto is unlike other assets.

Take for example the topic of counterparty and custody risk. Many fund managers, allocators and consultants know the issues of the past when it comes to recalling the failures of Celsius, FTX and BlockFi, or the potential conflicts with self-custody, where it is a natural part of the due diligence process to ask questions about how such risks are managed. However, a troubling aspect to this example is the lack of depth and understanding in how such policies and processes are practically applied, both on the part of managers and allocators, and extending to generalist service providers. An illustration of this is as follows:

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The above specificity in questions and research is demonstrative of the result of real-world experience in managing digital assets allocations during periods of volatility, market cycles, systemic failures, and the resulting need for quick adaptation, which in crypto is historically more common than traditional financial asset classes.

Another example is fund terms and structures, where I often see a lack of proper coverage for the many considerations an allocator should be aware of before committing capital to either an open or closed-ended fund. This concept also applies to fund managers raising capital for their products.

From when I was working to allocate capital through a crypto fund of funds structure, or assisting our clients currently looking to allocate, I’ve come across many examples where there is a disconnect between the strategy being managed and what makes sense to an investor managing a portfolio, where crypto is just part of the mix.

In such instances, a manager working with legal counsel may put together a fund structure with terms that apply to what a manager perceives is market fees (i.e., management and performance fees) for running a private placement, or liquidity windows (i.e., lock ups) for which a manager believes they are entitled to enforce. However, what often gets missed is perceiving such a fund offering from the perspective of an investor, or as I often refer to it, “Are the terms commercially viable?”

With all due respect to my legal colleagues in the industry, being a good attorney in forming the structure your fund client requests is a different skill set than advising a manager from a business development perspective. Unfortunately, I’ve been in the middle of many due diligence and legal negotiations where an open-ended fund with a highly liquid strategy looking to lock up capital, or create illiquid side pockets, is often a non-starter for those allocators attempting to fulfil a mandate within the liquid portion of their portfolio. Conversely, many allocators have discussed with me their displeasure of crypto venture funds who were quick to distribute capital back to their LPs, as GPs thought achieving early liquidity exits were preferable, but in reality it threw off calculations and assumptions of many institutions who manage their portfolios in purposeful anticipation of future distributions.

‍Why This Matters

One of the recurring themes throughout digital asset markets is that operational weaknesses often do not reveal themselves during normal market conditions. Rather, they tend to surface during periods of volatility, liquidity stress, counterparty failures, or sudden shifts in market structure, where the practical realities of managing digital assets are put under pressure.

In many cases, allocators and service providers may believe a risk has been adequately addressed because the appropriate topic was discussed at a high level during the due diligence process. But as has been demonstrated repeatedly throughout the history of digital assets, there is a significant difference between acknowledging a risk exists and understanding how that risk is practically managed on a day to day basis.

Whether it be custody arrangements, wallet governance procedures, liquidity management practices, fund structures, or counterparty exposure, the implementation and oversight of operational controls within digital assets often carries nuances that are materially different than those found in traditional financial markets. And while such distinctions may appear minor during stable environments, they can quickly become meaningful during periods of market stress.

The consequence of overlooking such considerations is not simply an incomplete due diligence file or missing documentation, but potentially unexpected investor outcomes during periods where operational resiliency matters most. This can include restricted liquidity, delays in asset recovery, governance disputes, valuation uncertainty, or exposure to counterparties and structures that behave differently than originally anticipated.

And perhaps most importantly, one of the greatest risks for institutional investors is not necessarily the absence of due diligence altogether, but rather the false confidence that a risk has been sufficiently evaluated when critical crypto-specific operational considerations were never deeply examined in the first place.

When Expertise Counts

Going back a number of years, after I had decided to make the career move to crypto, and began to appreciate the nuance of crypto operations and the retooling of my past experience in financial services, it became clear the old ways of practicing due diligence on hedge funds, private equity and even traditional ETFs were not going to meet the realities of the job.

Digital asset investing, infrastructure, and market risks were then, and remain now, a very different set of considerations one must appreciate in order to effectively navigate the space. And it is for these reasons that Crypto Insights Group was formed… to effectively guide those allocating to, or considering an allocation to, the distinct offering and diversification for which digital assets can provide. 

Sitting at the intersection of hundreds of institutional crypto strategies and interested investors, combined with the experience of decades of traditional and crypto investing, has allowed CIG to develop the tools, benchmarking and due diligence expertise necessary to become the premiere source of research and guidance for facilitating the best practices, standards and market knowledge for fund managers and institutional investors, alike. 

It is, therefore, a necessity that a centralized focus on digital asset management be used as a complement to existing due diligence practices for most allocators, as the time and focus required of managing crypto portfolio exposure can easily be elevated to a full time work load on its own.

Get in Touch

Institutions evaluating digital asset managers and infrastructure providers increasingly require specialized expertise across operational risk, counterparty exposure, benchmarking, and ongoing oversight. Crypto Insights Group works with allocators, family offices, fund managers, and market participants to support institutional due diligence and monitoring processes across the digital asset ecosystem. If your organization is evaluating digital asset exposure or refining its diligence framework, reach out to us.