The custody of cryptocurrencies is difficult, not because of their digital nature, but because they are “bearer assets”—like bearer bonds, the person holding the asset is considered to be the owner of those assets.
Olsson says there’s a divide between those who see cryptocurrencies as being like the kind of commodity regulated by the Commodity Futures Trading Commission (CFTC) and those who see digital assets behaving like unregistered securities. Advisors have more leeway to get involved in CFTC-regulated digital assets, but “it’s clear that regulators don’t want people getting involved in unregistered securities like Ripple and other ICOs (initial coin offerings),” Olsson says. “They don’t even want those marketed to retail investors. If advisors tick towards the tokens that are security-like, they’re more likely to be safe.”
That has led some advisors to separately managed accounts like the type offered by Eaglebrook Advisors. According to the firm’s CEO, Chris King, Eaglebrook’s accounts include cryptocurrencies custodied by Gemini Trust.
“There’s actually low regulatory risk adding something like bitcoin or Ethereum,” King says. “There’s clear guidance from the [Securities and Exchange Commission] on those assets. There’s less help on the due diligence side of things, so advisors really have to understand how custody works and document all of that.”
The SEC Steps In
Earlier this year, the SEC decided to allow some special-purpose broker-dealers to custody cryptocurrency assets, creating a five-year safe harbor from enforcement action for those B-Ds choosing to accept digital assets.
At the same time, the agency established a set of changes to its custody rules to account for advisors and other financial intermediaries who want to advise on cryptocurrencies.
A crypto-custodian must operate only in the realm of digital asset securities. It would be required to ensure access to both the digital assets themselves and be able to transfer them across the blockchain, and the custodian would have to protect the private keys used to access digital assets from theft or hacking.
Satz says that if digital assets are held correctly in cold storage, they are secure and safe from theft and hacks.
According to the SEC, custodians will also have to examine digital assets to see if they should be subjected to the agency’s registration requirements and find out if they are exempt from legislation. In addition, custodians will be subject to the same business continuity and disclosure requirements as other broker-dealers.
In the Bitwise survey, advisors seemed to be holding out for an ETF, with nearly two out of three advisors describing it as their preferred way to access digital assets.
“A crypto ETF would be huge for advisors, because then the ETF itself would be the issue,” says Todd Cipperman, founder of Cipperman Compliance Services. He adds that a lot of the recent communication from regulators has made advisors reluctant to use digital assets directly and increased the number waiting for a U.S.-domiciled ETF.
But Ross says that a cryptocurrency ETF defeats the purpose of digital assets.
“I think it’s an incredibly stupid money grab,” he says. “You shouldn’t take a 21st century asset and put it in a 20th century structure. It’s going to happen because it’s about money, but why take beautiful, elegant technology and place it into a wrapper where it stops trading 24/7/365? It also destroys the one thing digital assets are really good for, which is helping the financially underserved.”
Cipperman thinks custody concerns and regulations are no longer good excuses not to handle digital assets on behalf of clients.
“Digital assets are assets, people are buying them, and they’re not going anywhere,” he says. “At the end of the day, we’re going to have to figure these things out. In 1999, no one knew what an ETF was, but we eventually learned and came to embrace the ETF. The same thing has to happen here. From a compliance perspective, everyone needs to stop throwing up their hands and saying ‘We can’t do this’ or ‘We can’t understand this’ anymore.”
Ross says most advisors shouldn’t be in a rush to offer digital asset investing to clients.
“There are too many advisors who are embarrassing themselves on social media and shouldn’t be touching this stuff,” he says. “They should be educating themselves and learn more about it. Learn and then lead. In many cases, your client knows more about this than you do, even when they come asking about bitcoin.”