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It has become nearly impossible for even the biggest skeptics to ignore cryptocurrency’s spread, and that’s especially the case for financial advisors.
Even for advisors who today swear up and down that they will never touch cryptoassets, it still requires being educated on the subject for when clients inevitably ask about bitcoin headlines. And for those wondering how crypto would fit into their practice and client portfolios, there’s an important learning curve to climb for this still young area.
When it comes to that learning curve, many advisors identify regulatory clarity as the biggest area of concern. Registered Investment Advisors have a fiduciary responsibility to manage client assets with the utmost care and prudence. Being aware of the regulatory oversight and compliance requirements provides the baseline against which they make investment management and financial planning decisions.
In this column, I’ll touch on cryptoasset regulatory issues around the following:
- Portfolio Management
- Books and Records
The Regulatory Backdrop
Unfortunately, regulation is a bit of a gray area, to say the least. U.S. financial regulators have been unable to come to a consensus when tasked with answering even two fundamental questions:
- What type of security should cryptoassets be classified as, if classified as a security at all?
- If categorized as a security, what regulatory body is responsible for oversight?
On the topic of bitcoin, the IRS treats it as property; the SEC views it as a nonsecurity; and the Commodity Futures Trading Commission views it as a commodity.
It’s easy to see why many advisors view the regulatory environment as opaque and ever-changing. When it comes to new and niche asset classes, advisors will often choose inaction to avoid adding unnecessary risk to their practice.
However, there has been recent guidance provided by the SEC, IRS, and Finra regarding what the future of cryptoasset regulation will look like.
The SEC and CFTC may be coming together to provide the investment community with more clarity on cryptoassets via the Eliminate Barriers to Innovation Act of 2021. Passed by the House of Representatives in April 2021 and now up for vote in the Senate, this act mandates the creation of a “crypto task force” whose sole purpose is to serve as general counsel to both commissions on how they should address the digital-assets market. The creation of a dedicated team would show commitment to the future development of the crypto economy and hopefully should result in clarification on whether cryptoassets are securities subject to SEC oversight or commodities supervised by the CFTC.
While the recent SEC/CFTC legislation framework offers a framework for a path forward, it follows on other efforts. In 2019, the IRS added to its previous 2014 commentary by publishing specifics on the tax implications of owning cryptoassets. (You can find a 2019 FAQ here.) The report shed light on important tax topics such as how it defines cryptocurrencies, determining their cost basis, the implications of a hard fork (such as what occurred to the Ethereum blockchain in the wake of The DAO’s 2016 hacking) gifts and donations, and more.
In July 2020, Finra released a notice encouraging investment firms to inform it of any activities involving cryptoassets, even if they are technically considered nonsecurities. While the regulatory notice was nothing substantial, the main point was this: At a minimum, Finra wants to be briefed on what advisors are doing in the cryptoassets space (if anything at all). If blind to how and if advisors access cryptoassets, Finra is hindered when attempting to update regulatory standards for brokerage firms and exchange markets.
The SEC has released commentary pertaining to cryptoassets on multiple occasions. In 2017, SEC chair Jay…