Cryptocurrency Regulation: What it Means for Financial Advisors

One of the most crucial elements influencing Bitcoin’s price is regulation. Cryptocurrencies are by their very nature decentralized, with no ties to national boundaries or specific government entities. Although financial advisors ignore cryptocurrencies’ growth, they have to make investment management and financial planning decisions based on their understanding of regulatory supervision and compliance needs. However, policymakers who are accustomed to dealing with assets that have clear definitions have a challenge.

The following are two unanswered questions about Bitcoin regulation:

1. If cryptoassets are regarded as security, what sort of security should they be?
2. Which regulatory body should supervise cryptoassets?

Nothing exemplifies the ambiguity surrounding cryptocurrencies more than how US regulatory bodies classify them. The IRS considers Bitcoin to be property, the SEC considers it a nonsecurity, and the Commodity Futures Trading Commission considers it a commodity.

Recent developments by the SEC, IRS, and Finra may indicate that the cryptocurrency regulation landscape is evolving. In April 2021, the SEC and CFTC proposed the Eliminate Barriers to Innovation Act — a new bipartisan legislative proposal to the United States Congress that defines the States’ regulatory policing of cryptocurrencies conclusively. The bill aims to form a joint operating team of experts and elected officials from the SEC and the CFTC, to evaluate and improve the existing legal and regulatory framework for digital assets in the United States.

Other efforts in terms of cryptoassets were also undertaken in recent years. For instance, in 2019, the IRS published a report detailing the tax implications such as how cryptocurrencies are defined, calculating their cost base, the consequences of a hard fork, gifts, contributions, and more. Finra issued a notification asking investment companies in July 2020 to report any actions involving cryptoassets, even if they are technically nonsecurities. Similarly, in 2019 and 2020, the SEC chairman had stated that Bitcoin and ether were not securities, and in 2019, a three-year exemption of cryptocurrencies from securities regulations was proposed.

The SEC issued a risk alert on digital assets in February 2021, wherein five areas of attention for financial advisors were highlighted in the alert:

1. Portfolio Management: Advisors need good processes in place when it comes to cryptoasset portfolio management, and they must understand where cryptoassets fit into a wider portfolio, do extensive due research before investing, and establish methods for evaluating and managing risk, among other things.
2. Books and Records: Because the crypto market is continually open, extremely liquid, and has no wash-sale rule, regular and precise documentation is critical via customer relationship software.
3. Custody: Proper tracking for any unlawful transactions, assuring adequate custody with certified custodians, and verifying proper storage of cryptoasset security procedures must be done by the regulators.
4. Disclosures: Disclosures will include legal, operational, technical, and market risks. The regulators will assess disclosures related to market fluctuations, volatility, evaluation methodology, related-party transactions, and conflicts of interest.
5. Pricing: The valuation techniques employed, particularly those used to establish primary markets, fair value, valuation after key moments, and identification of forked and airdropped digital assets, will all be scrutinized.

Though there are some regulatory concerns, the SEC and CFTC should unite and provide clarification and guidance on cryptoassets; regulators should also learn and adapt to the available regulations for future SEC audits.

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