Cryptocurrency has been a hot topic in the financial community for years now – and while it’s generally accepted that digital currency is here to stay, there is still plenty of confusion surrounding how, when, why and where crypto belongs in client portfolios (if at all).
From recordkeeping laws to storage options and tax implications, navigating crypto as a financial adviser introduces a whole other level of complexity.
Read on to explore 11 common questions advisers have about cryptocurrency compliance, as well as key considerations to keep in mind before incorporating crypto for your clients.
Related: Navigating Cryptocurrency for RIAs
Nine FAQs advisers should know about cryptocurrency compliance
1. Is crypto considered a security?
The answer: It’s complicated.
To be considered a security (and thus subject to U.S. security laws), regulators have long relied on the Howey Test. The Howey Test uses four main criteria, as described by Investopedia:
- An investment of money
- In a common enterprise
- With the expectation of profit
- To be derived from the efforts of others
If all four of these elements are met, then the transaction is considered an investment contract and falls under the regulatory authority of the SEC.
The emergence of cryptocurrency, however, is murking up those waters for regulators and advisers alike.
SEC Chair Gary Gensler has stated that much of crypto should be classified as a security based on the Howey Test, but noted Bitcoin as an exception. A federal judge echoed that sentiment in an August 2023 case, stating that “cryptocurrencies are considered securities regardless of the context in which they are sold.”
However, an earlier ruling from that same district had stated that cryptocurrencies’ status as a security depended on who was buying them.
Although cryptocurrency hasn’t found an official designation yet, Jon-Jorge Aras of Warren Law Group says that both the SEC and FINRA have indicated they’ll be looking at crypto as a security, and noted that advisers should keep fiduciary duty and proper disclosures in mind when counseling clients on crypto assets.
Note: We recommend seeking legal advice on this topic from a securities attorney.
2. Does fiduciary duty apply to guidance surrounding cryptocurrency?
In short: It is facts and circumstances dependent.
The Certified Financial Planner (CFP®) Board has stated that “A CFP® professional must comply with the fiduciary duty, including the duty of care, when providing all financial advice, including concerning cryptocurrency-related assets.”
However, they also state that CFP® professionals are not required to provide financial advice on crypto-related assets.
Noah Billick, Director of Regulatory, Funds and Compliance at Renno & Co, wrote in a NASDAQ-published article that “…there is no longer any question that advisors, in meeting their fiduciary duties, must be able to intelligently and responsibly provide advice regarding cryptocurrency investment.”
Advisers should consult directly with the organization you are certified or registered with for further clarity.
3. Is crypto prohibited in 401(k) accounts?
While there is no direct law as of yet that prohibits crypto investments in 401(k) accounts, it’s been reported that the Department of Labor plans to investigate any accounts that do so – making it a risky move for investment advisers.
Related: RIA Firms Should Exercise Great Caution Related to Cryptocurrencies
4. What basic crypto terminology should I know?
Crypto terminology is extensive, but there are a few basics that will help you get started.
Forbes offers a full crypto glossary for your reference – from which we’ve pulled a few key terms:
- Bitcoin (BTC): The original, largest and best-known cryptocurrency (followed by Ethereum)
- Altcoin: Any cryptocurrency other than Bitcoin
- Wallet: A digital storage device or location for keeping crypto assets secure.
- Cold wallet: A physical storage device such as a flash drive, hard drive or “solid state” drive used to store cryptocurrency offline
- Hot wallet: A form of online storage for cryptocurrencies, provided either by an exchange or a third party
- Private key: Also known as a secret key, this is essentially the encrypted password to someone’s crypto holdings
- Public key: The public-facing address of your crypto wallet. To receive funds into your account, you have to share your public key. Each public key pairs with a private key, and the private key is only known, in theory, to that user.
5. What are the recordkeeping and reporting rules for cryptocurrency?
Per regulation, investment advisers are required to keep accurate ledgers of all client holdings and transactions. However, crypto is still unregistered with the SEC and remains untraded on a national securities exchange, and is yet to be officially designated as a security. Furthermore, crypto’s volatility makes it difficult to value on a daily basis.
The SEC warns that “crypto asset entities not offering these types of protections [i.e., books and recordkeeping] put investors at risk.”
But as the U.S. Department of the Treasury moves closer to a crypto reporting requirement, experts say it’s “more important than ever to accurately report and track your crypto activity.”
6. Is crypto riskier than more traditional investments?
Yes. Cryptocurrency still lacks clear regulatory guidance (and thus consumer protections), is generally more volatile and has unique security issues.
Unlike traditional investments like stocks or bonds, crypto assets also lack an intrinsic value, thus increasing their risk.
Related: Why information security and crypto assets continue to top the SEC exam priorities in 2023
7. How can I keep my clients informed of the risks of crypto without scaring them away from it?
One of the best ways you can approach crypto-curious clients is through transparency: They should be aware of all the risks involved in buying, selling and owning cryptocurrency. They should also know that it’s an increasingly recognized investment option used by over 420 million people around the world that can add diversification to portfolios.
Investopedia recommends advisers cover six key topics when talking to clients about crypto:
- How it works
- How to get started
- Storage options
- Where you can use/spend it
- Safety and security risks and best practices
- Volatility
These offer a great starting point to guide those conversations without spooking clients. And if they are scared away from investing in cryptocurrency – it may be that more traditional assets are a better fit.
8. What does the CFP® board say about cryptocurrency?
The CFP® Board published a document titled “Notice to CFP® Professionals Regarding Financial Advice About Cryptocurrency-Related Assets” in late 2022.
The 14-page notice offers in-depth guidance on the Code of Standards, recent regulatory updates, risks specific to cryptocurrency, fiduciary responsibilities and more. You can access the full document here.
The IRS provides a helpful FAQ guide for cryptocurrency, which you can find here.
9. Is crypto worth the risk?
Like all other investments, weighing risk versus reward isn’t a straightforward answer – it depends on your clients’ needs, goals, tax strategies, risk tolerance and more.
If you choose to offer guidance on cryptocurrency, be sure to carefully consider both the risks and rewards involved, and communicate those factors to your clients.
As the digital assets and investment strategies continue to evolve, these 11 questions and answers are a great way to stay apprised of cryptocurrency regulations and best practices.
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