Big regulatory issue holds Crypto advisers back

The biggest regulatory question for advisers regarding digital assets today is: are they securities or not?

Digital assets are still fairly new, having only really emerged in the last two to four years, while the central rules governing most financial advisers date back to WWII-era legislation. , such as the Investment Advisers Act and the Securities Exchange Act. So, today’s regulators, such as the United States’ Securities and Exchange Commission (SEC), have a clear job to squeeze the square peg of cryptocurrencies into the round hole of eight-year-old laws. decades.

I recently introduced readers of my newsletter columns to two different digital asset companies entering the Registered Investment Adviser (RIA) market: Swan Bitcoin and HeightZero. Both of these companies have decided to focus on one or two types of cryptocurrency, in part because they fear the regulatory scrutiny that could arise when this big regulatory issue is resolved.

This article originally appeared in Crypto for Advisors, CoinDesk’s weekly newsletter defining crypto, digital assets, and the future of finance. Sign up here to receive it every Thursday.

In Swan’s case, the company is focused solely on bitcoin.

“Many or most crypto assets pose significant regulatory risk, especially as it relates to being securities under U.S. law, but we believe these issues are now resolved for bitcoin,” said Andy Edstrom, Head of Institutional Investments at Swan Bitcoin. “We don’t think this question has been answered for most other digital assets, and they potentially pose problems for intermediaries like financial advisers.”

HeightZero, meanwhile, decided to focus on both bitcoin and ether, but not other alternative coins (altcoins).

“Right now, we want to make sure we’re listening to the SEC and doing everything possible to be compliant and keep our customers compliant,” said HeightZero founder AJ Nary. “We don’t want to be in a position like Coinbase was when Ripple was declared a stock, the SEC continued [Ripple], and [Coinbase] had to remove the token from its platform. If this happens to us, we should advise all of our advisor clients that they are using a title. We want to protect our customers.

Swan believes the ether is security, however.

“The reality is that Ethereum is not really decentralized; ownership is very concentrated, ”said Edstrom of the blockchain. “The proof-of-stake model they’re moving towards is inherently centralized, because when you bet coins you end up getting more coins; thus, if you have more money, you earn more money. Bitcoin is therefore the only one with which we feel comfortable.

The great debate

At the heart of the debate are the SEC’s custody rules. While digital assets such as cryptocurrencies are securities, regulations require that they be held not by an advisor, but by qualified custodians. These rules are the reason why financial advisers don’t own their clients’ assets but look to companies like E * Trade, Schwab, BNY Mellon | Pershing and Fidelity to provide child care.

Most advisers and end investors no longer hold paper stock certificates or bonds, but a digital record of ownership of those investments, while actual assets are held by a custodian on a ledger. centralized within a central securities depository – and only qualified depositories are allowed to hold the assets of that depositary.

But digital assets, basically, were invented to bypass this system via a decentralized ledger and be “self-held.” By holding the cryptographic keys that allow me to access my cryptocurrency holdings, I am responsible for the safekeeping of these assets. These are also digital bearer assets – the person holding the keys is considered the owner of the assets.

What exactly is security?

The SEC defines a security as “the investment of money in a joint venture with a reasonable expectation of profit from the efforts of others.”

According to this definition, bitcoin does not meet the criteria to qualify as a security, because there is no easily identifiable and centralized third-party company.

Earlier this year at the Aspen Security Forum, SEC Chairman Gary Gensler made it clear that many tokens should be considered securities.

Why not the two of them?

At this point, the answer to our big skill-testing question appears to be “both”. Some cryptocurrencies are not securities while others are, at least for now. The SEC seems comfortable with seeing bitcoin itself as a commodity, not a security (a commodity being defined as a tangible item or an item designed to be bought and sold in commerce that is legitimately regulated by the Commodity Futures Trading Commission [CFTC] and not the SEC itself). And industry players like Height Zero are pretty sure the same can be said of ether – like bitcoin, it’s a commodity.

But until more regulatory clarity comes from the SEC and other federal policymakers, other altcoins should still be treated as if they were securities.

What if cryptos were securities?

In November 2020, the SEC sought guidance from the financial industry to help determine whether advisers are working with a qualified digital asset custodian. A December 6, 2020 response from the Open Economy Initiative noted that qualifications for digital assets should be based primarily on cybersecurity. A qualified digital custodian offers an offer ensuring secure key management and interoperability with the various networks.

As advisors begin to have more choices about where to store clients’ digital assets, they should consider whether potential custody providers offer highly secure online custody services (hot wallets), offline services ( cold storage) and potentially “deep cold” storage dividing the custody. recovery between different physical locations, which significantly reduces the risk of losing access to customer assets.

“Anyone who says they know what the SEC is going to do in the long run doesn’t really know what they’re talking about,” Nary said. “I think it’s a good idea to take a very conservative approach to this space, especially if you’re an SEC registered advisor.”

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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