Unsure if Cryptocurrency Is a Security? There’s a Reason for That

Advisors remain leery of the crypto space for a variety of reasons, but perhaps one of the most uncertain aspects for most advisors is the classification of cryptocurrency. Current regulations are largely lacking, and advisors are left wondering if cryptocurrencies are securities or not, and for good reason, reports CoinDesk.

The meteoric growth within crypto in the last two years has catapulted cryptocurrencies and tokens to the forefront as investors are drawn in by the potential for large returns while risking equally large losses. The newness of digital assets means that for now, they don’t really have any particular regulatory box that they fit into.

So what exactly is a security, and why does it matter so much for cryptocurrencies? A security is defined by the SEC as “the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Under this definition, bitcoin doesn’t qualify as a security because there is no easy-to-identify third-party enterprise, and therefore it is classed as a commodity and falls under CFTC regulations. Other tokens, however, will most likely fall under the definition of a security and SEC regulations.

“Many or most crypto assets have significant regulatory risk, particularly as it relates to being securities under U.S. law, but we think these problems are now solved for bitcoin,” said Andy Edstrom, the head of institutional investment 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 advisors.”

The Impact on Advisors

The reason the classification of cryptocurrency matters so much for advisors is because of the SEC’s custody rules for digital assets. If a digital asset is classified as a security, it must be held by a qualified custodian and not an advisor. Qualified custodians are defined mostly by their cybersecurity and ability to protect assets and keys, as well as their ability to work with a variety of networks.

Congress is working to define and help address issues regarding how crypto fits into current regulations, as demonstrated by a recent meeting with some of the top executives from the crypto industry before the House Financial Services Committee. While no official regulations have come from the meeting yet, it was full of bipartisan members asking thoughtful, targeted questions and being met with fairly honest answers over a wide variety of topics and concerns within crypto.

Investing in Crypto Fundamentals Instead of Cryptocurrencies

For advisors that are sitting on the sidelines of crypto investment because of the uncertainty centered around cryptocurrency regulation, an alternative is to invest in some of the big players within the various segments of the crypto industry while avoiding direct cryptocurrency exposure.

By investing in the companies that are working within the crypto economy instead of directly into cryptocurrencies, investors can diversify their risk from regulatory impacts. The Bitwise Crypto Industry Innovators ETF (BITQ) offers investment into some of the largest companies within crypto within a variety of segments.

BITQ tracks the Bitwise Crypto Innovators 30 Index, an index with at least 85% allocation into companies that are cryptocurrency exchanges carrying bitcoin and other cryptocurrencies, crypto miners, mining equipment companies, and service providers. The remaining 15% is allocated to large-cap support companies with at least one major part of their businesses dedicated to crypto.

BITQ carries crypto companies, including Coinbase Global Inc (COIN), a major crypto exchange, at 10.58%; Silvergate Capital (SI), a bank that provides services for crypto exchanges, at 10.08%; and crypto mining company Hut 8 Mining (HUT CN) at 4.09%.

The fund has an expense ratio of 0.85% and net assets of $123 million.

For more news, information, and strategy, visit the Crypto Channel.

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