The world has gone crypto-crazy. From the dramatic 180-degree turn taken by bitcoin prices over the past 18 months; to the record rise of Ethereum; to million-dollar digital art; to the emergence of millionaires minted on Dogecoin, a digital token created as a joke spoofing the emergence of other cryptocurrencies—retail investors have zealously plunged into digital assets.
Financial advisors, on the other hand, have been slower to react. Only 9.4% of advisors allocate to digital assets within their client portfolios, according to the “Bitwise/ETF Trends 2021 Benchmark Survey of Financial Advisor Attitudes Toward Cryptoassets.” That leaves crypto-curious clients on their own to claim a stake in the latest digital gold rush.
The No. 1 reason advisors don’t allocate client assets to cryptocurrencies, according to Bitwise, is regulation, something over half of them said in the survey. But their other concerns include volatility, a lack of investing vehicles, a lack of understanding of digital assets and no clear understanding of how to value those assets. The advisors in the survey called for better regulation, more education, a bitcoin ETF and better custodial solutions.
“The reality on regulation and digital assets is that advisors can pretty much do whatever they want, they just have to do it right,” says Tyrone Ross, founder of Onramp Invest, an investment platform for young advisors. “There are even good custody options. They’re expensive, but it’s not an excuse any longer.”
Ross, an early adopter of digital assets, has not only urged advisors to educate themselves on cryptocurrencies, but also advocates for them both as alternative banking tools and investments.
For the average investor, cryptocurrency investment has become quite simple. Payment applications like Venmo and PayPal now offer access to crypto, as do many investment platforms, including the ever-popular, commission-free trading application Robinhood.
But for advisors, there are only a handful of places to custody clients’ digital assets since the major custodians—Schwab, BNY Mellon | Pershing and Fidelity—don’t offer ways for advisors to work with digital assets, either directly or through the various available non-registered cryptocurrency funds.
“RIAs don’t know how to access this asset class on behalf of their clients,” says Eric Satz, founder and CEO of Alto IRA. “I suspect many of them are getting client calls about how to get exposure to crypto, and for most of them the answer is still ‘I don’t know.’”
Alto IRA offers advisors three ways to help their clients access crypto: via private funds like the Grayscale Bitcoin Trust, via separately managed accounts and by allowing their clients to access and self-manage digital assets directly, Satz says. Alto is also in the process of building advisor technology and integrating with existing technology providers to help advisors handle cryptocurrencies alongside clients’ traditional assets.
BlockFI is also developing technological solutions to help advisors work with digital assets, but notes that custody is still a problem for advisors.
“There is not yet a platform that has a solution where an advisor can open an account and trade cryptocurrencies on behalf of their clients,” says David Olsson, BlockFI’s vice president and global head of institutional distribution.
“I think previously this wasn’t one of those things considered to be part of the asset allocation framework that advisors use, but now that institutional adoption of cryptos has ramped up, we’re seeing requests every day for advisors looking to on-board and do things on behalf of their clients.”
Another crypto-friendly custodian, Prime Trust, recently struck a deal with AdvisorPeak, a portfolio trading and rebalancing fintech firm, to offer a simple custody and technology solution for advisors. This creates the first platform on the market that enables digital assets to be traded and rebalanced alongside traditional assets using the same software.
“We’ve talked about this for years, but until around 12 months ago we didn’t really see demand from advisors,” says Damon Deru, AdvisorPeak’s founder and CEO. “Now, with the run-up in digital asset prices, advisors are seeing people come in with cryptocurrencies taking up a sizable portion of their portfolio that they need to do something with—but the custody issue continues to be a problem.”
But these solutions aren’t what advisors are really looking for, says Teddy Fusaro, president of Bitwise Asset Management. He points out that most advisors are only looking to allocate a small portion of existing client portfolios to digital assets.
Most advisors’ demand for digital currencies stems from their desire to diversify portfolios, since the currencies are relatively uncorrelated to other assets. But they balk at the thought of adding a new custodial relationship to manage 1% to 2% of their AUM.
“Advisors don’t want to have to manage new relationships and build out a whole new technology stack to get brand new exposure to a commodity or asset class,” says Fusaro. “We think they’d rather use a vehicle—like an ETF—that from a compliance and technology perspective already fits their existing business model effectively.”
While firms like Fidelity and BNY Mellon have made strides toward working with cryptocurrencies, most of their offerings are not available to advisors investing on behalf of their clients, says Deru.
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.”