Interest in cryptocurrencies is intensifying again, as some investors take another look at digital assets as a store of value.

This comes after Bitcoin’s wild ride between 2017 and 2018, when it rose to nearly $20,000, only to fall to under $3,000 a year later. By mid-2019, it had risen to $10,000, aided in part by the June announcement that Facebook plans to launch its own cryptocurrency, Libra, in 2020. Among Libra’s backers are Visa, Uber and venture capital firm Andreessen Horowitz.

Cryptocurrencies remain a relatively new asset class, but Bill Taylor, chief investment officer for Fintek Capital, says the space is evolving. A few years ago, virtual coins “were basically a token attached to a project—or a dream—with no intrinsic value,” he says. “Think of cryptocurrencies of a few years ago as penny stocks of years past.”

But since then, they have matured. Now most security token offerings (STOs), which are a more credible and regulated form of initial coin offering (ICO), are backed by real assets such as gold, real estate and, in the case of Libra, a group of global fiat currencies, Taylor says.

Additionally, there’s now a futures contract on Bitcoin. Meanwhile, the Securities and Exchange Commission now considers Bitcoin and its competitor, Ethereum, to be currencies as opposed to securities.

Still, most financial advisors familiar with cryptocurrencies, as well as professionals focusing on securities law, say advisors should remain cautious about holding any client assets in digital currencies. These experts recommend that advisors get comfortable with the concept by learning about the major crypto names and how they work. Although it might be too soon now to invest in digital assets on behalf of clients, these assets are not going away and someday will likely play a role in client portfolios.

Custodial Conundrum

Aside from acknowledging that Bitcoin and Ethereum are currencies (not securities), the SEC hasn’t given advisors much more guidance than that, says Marta Belcher, intellectual property litigation attorney at Ropes & Gray.

“There has been regulatory uncertainty for years regarding whether—and under what circumstances—digital assets are securities, and that uncertainty has often been cited as hampering the growth of the industry,” Belcher says.

The biggest sticking point for RIAs who might want to invest in digital currencies for clients is the custody rule, says Melissa Bender, asset management partner at Ropes & Gray. So far, the only traditional custodian to open a cryptocurrency custody and trade execution operation is Fidelity, which debuted Fidelity Digital Assets in March.

Since other traditional custodians aren’t in the space, that leaves advisors with more limited options, including the possibiliity of having to self-custody and the risks that come with that, Bender says.

Not Ready For Prime Time

Financial advisors who personally own cryptocurrency assets say that compliance departments and regulations keep them from advising clients because of the custody issues. That also keeps them from recommending that clients buy digital currencies via third-party platforms like Coinbase. But if clients ask, these advisors say they will talk about digital assets in general terms.

Chris Gure, financial consultant at Fortress Financial Partners in Raleigh, N.C., notes that most of his firm’s clients who own cryptocurrencies have very little interest in selling them. Gure’s philosophy is that he’s doing holistic planning anyway: Any asset the client holds that is less than 5% of his or her total net worth would not jeopardize a financial plan in any case. 

Andrew Whalen, CEO at Whalen Financial in Las Vegas, says he won’t recommend cryptocurrencies to clients until a Bitcoin exchange-traded fund is available. If and when that happens, he says he would allocate a very small portion for clients because he believes digital currencies are an asset class that can play a role in a portfolio. As of press time, the SEC had yet to approve a Bitcoin ETF.

How To Have The Talk

Tyrone Ross, a financial consultant who specializes in cryptocurrencies, says the advisor-client conversation about digital assets should include what coins clients own, when they bought them, how much they own and whether they’re up to date on their currency’s taxes.

Another thing to ask, he says, is how clients store their coins. For security reasons, all cryptocurrencies should be kept in “cold storage” or a “cold wallet”—kept offline, in other words, which keeps them safe from hackers, he says. Cryptocurrency exchanges have reportedly been hacked and coins stolen because custodians have the assets in “hot storage,” or something connected to the internet.

Cryptocurrencies evolved to be decentralized and out of institutional control, Ross says. That means retail buyers have better custody options than institutions, and the platforms have evolved to cater to retail buyers’ needs. He adds that one of the best places for clients to store small amounts of cryptocurrencies is at Coinbase, which is backed by the New York Stock Exchange, USAA Bank (the investment arm of the insurer) and other entities. Coinbase stores its coins in cold wallets.

Once clients have sufficient digital assets, Whalen and Ross both recommend moving the coins off the exchange and into hardware wallet storage that’s held in a safe-deposit box. Whalen says he stores his Ethereum coins on a PIN drive (a USB drive requiring a personal identification number to access the data). Ross uses a Ledger hardware wallet designed for cryptocurrencies (and available at Ledger.com).

For now, Ross recommends that advisors start studying cryptocurrencies to prepare for eventual client questions. If clients ask, advisors should say, “‘I’m learning about it; you should learn about it. When the time is right, when there is an opportunity that makes sense when I can add it to your portfolio, it can be something we can do,’” he says.