RIA Compliance and Practice Management Blog

Navigating Cryptocurrency for RIAs

Posted by RIA in a Box

Jun 28, 2022 10:15:35 AM

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Investing by nature is unpredictable, but investing in cryptocurrency takes unpredictability to an entirely new level. This is due in large part to a lack of investor protection, as we’ve seen clearly during the recent meltdown, as shares in Coinbase dropped more than 50%, with Bitcoin and Ethereum plummeting more than 25% and 30% respectively.

The Securities and Exchange Commission's ("SEC") increased focus on cryptocurrency means registered investment advisers ("RIA") need to make sure they’re adequately addressing regulatory concerns. Read this guide to learn more.

Download the 2022 SEC Top RIA Exam Priorities Checklist
Both the SEC and the White House are committed to protecting investors from potential abuse of cryptocurrency. In March, the White House issued an executive order to ensure the responsible development of digital assets. The SEC recently issued a bulletin on crypto-asset accounting, saying risks to investors should be disclosed and assets should be accounted for as liabilities.

In the last few weeks, SEC Chairman Gary Gensler warned the investing public about gambling on crypto, explaining that because cryptocurrencies aren’t regulated as securities, investors aren’t getting the full and fair disclosures they deserve. He called for basic investor protections to be put in place regarding cryptocurrency, including “market integrity, barring front-running customers and anti-manipulation and fraud.” Despite the recent crypto crash, the warnings from policymakers and the clear risks investing in crypto presents, nearly half of all advisors still plan on using cryptocurrency in the future – a statistic driven largely by client request.

Proceed with caution

As RIA compliance consultants, we advise all RIA firms to exercise great caution as it relates to cryptocurrencies.

It’s clear the SEC intends to keep an extremely close eye on cryptocurrency, especially considering the recent increase in companies that allow customers to trade crypto, while maintaining the cryptographic key information needed to safeguard the assets.

Not only did the SEC issue the aforementioned guidance for crypto companies, but they also nearly doubled the size of their crypto asset and cyber unit, indicating crypto is becoming an increasing priority for the commission.

Regulatory concerns for RIAs

RIAs intending to start or continue to leverage cryptocurrency for their clients should keep these regulatory concerns in mind:

Crypto isn’t for every client. There’s debate about whether cryptocurrency should be defined as a security or not. Regardless, it’s a highly speculative investment given its high level of volatility and isn’t suitable for all investors.

Crypto could create a complete loss of client funds. Because crypto is both highly speculative and less protected than traditional accounts, if a crypto company goes bankrupt, your clients could lose assets.

Fees and reporting can’t be handled in a traditional way. Since it’s difficult to accurately value cryptocurrency daily, leveraging a traditional investment advisory fee structure and providing accurate, timely reporting can both prove to be problematic.

Illiquidity risks are high. RIAs should keep “access to funds” considerations top of mind for both themselves and their clients, as any type of disruption, lockout, shutdown, hack or theft could cause illiquidity issues.
There are no consumer protections available. There’s also no Federal Deposit Insurance Corporation ("FDIC") insurance available for crypto assets.

There may be custody issues. It can be difficult to fully understand and identify whether RIA firms are deemed to have custody of client crypto assets.

There may be anti-money laundering ("AML") issues. Considering the significant threat of fraud related to cryptocurrency, RIAs should ensure an AML policy is implemented.

A firm’s errors and omissions (E&O) insurance may not cover crypto claims. RIAs should check with their E&O carrier to see if crypto is specifically excluded from their policy.

Finally, even though cryptocurrency may not be considered a “security,” there could be other regulatory considerations for RIAs to keep in mind, including those related to private, unregistered offerings and Commodities Futures Trading Commission ("CTFC") regulations.

We can’t stress enough the importance of extreme caution and due diligence for RIAs navigating the crypto landscape. By taking the above precautions, you will be better prepared to navigate the world of digital assets for your clients while also protecting all involved parties.

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Topics: RIA Compliance

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

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