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The Murky World of Crypto Compliance: What Advisors Need to Know

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The Murky World Of Crypto Compliance: What Advisors Need To Know

It was another wild year for cryptocurrencies. One of the biggest banks in the sector, Silvergate Bank, had to liquidate because of a run on deposits. A catalyst for this was the implosion of FTX. Co-founder and former CEO Sam Bankman-Fried was convicted on seven counts, including fraud, conspiracy, and money laundering. Then there was the bombshell about Binance, the world’s largest token exchange. The firm agreed to a $4.3 billion fine from federal regulators. Its CEO, Changpeng Zhao, agreed to a $50 million fine and pleaded guilty to violating anti-money-laundering laws. 

Despite all this, the crypto market was in the bull mode for 2023. The year-to-date return on Bitcoin is more than 150%. For advisors, this means more clients are calling to inquire about investing in crypto.  

“I hear cautious interest from clients,” said Jim Shagawat, a CFP and partner at AdvicePeriod. “Some dabble with modest amounts independently, while generally maintaining a cautious stance.”

But advisors have to tread carefully. The compliance issues are still murky. Here are a few factors to consider:

Custody questions. Crypto has unique custody requirements. A client can purchase assets from exchanges like


and store them in digital wallets. There are two main types:  

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Hot Wallets: These are easy to set up and make transactions. But since a hot wallet is connected to the Internet, it can pose higher risks for hacks.  

Cold Wallets: These are hardware, like a USB drive, that store the crypto and generally are more secure. However, the owner can only access the asset by using a private key, which is a long password. If they lose it, they won’t be able to get access to the asset.  

Another option is to set up a separately managed account for clients using a third-party custodian. But given the potential liability exposure, advisors often try to avoid taking custody. Yet they may unwittingly do so anyway. For example, by having access to the credentials of a crypto wallet, they can be considered a custodian.

Crypto regulations. They are complicated, even for attorneys. The Securities and Exchange Commission tends to view crypto as securities whereas the Commodity Futures Trading Commission (CFTC) considers them commodities. Then the Internal Revenue Service classifies crypto as property.

Regulatory conflicts can make it difficult to know how to work with clients, but that is no defense against enforcement from federal agencies. Also, there is potential for civil suits for violations of fiduciary duties. Industry groups could also take action. For example, the Certified Financial Planner Board of Standards also has a disciplinary process, which means CFPs can lose their designation for violations. 

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Another issue for advisors is the difficulty of valuing digital assets. This could cause problems with SEC examinations for calculating regulatory assets under management.  

Be conservative. Crypto is an area you don’t want to experiment with. “Key issues are compliance with your fiduciary duties and treating crypto securities as securities,” says Teresa Goody Guillén, who is a partner at BakerHostetler and co-leader of the firm’s Blockchain Technologies and Digital Assets team. “This includes ensuring that risks are adequately disclosed, recommendations are consistent with clients’ particular circumstances and risk tolerance, and to generally act in their clients’ best interest.” 

An advisor should conduct thorough due diligence on any crypto asset before making a recommendation and make sure the investment is aligned with a client’s risk tolerance, she says. 

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Compliance software. There are various systems that can help advisors manage compliance. One is Comply, which provides digital-asset trade monitoring for employees of advisory firms.  

“The market consensus regarding the Investment Adviser Code of Ethics rule is that financial institutions regulated by the SEC must monitor their employees’ holdings and transactions of securities to prevent insider trading, front-running, and other unethical activity,” says David Bliss, who is the chief product officer at Comply. He says his firm’s program can provide compliance teams with real-time “automated, comprehensive monitoring and violation tracking” for their employees’ cryptocurrency holdings and transactions.

Another offering comes from AML Bot. It provides compliance for AML (anti-money-laundering) and KYC (know your customer) procedures as well as digital-asset tracking. 

“Using software tools for compliance nowadays is an integral part of everyday business,” says Slava Demchuk, who is the founder and CEO of AML Bot. “Without such software tools, doing business practically would be impossible as it would be very time-consuming and costly.”

Tom Taulli (@ttaulli) is a freelance writer, author, and former broker. He is also the author of the book ChatGPT and Bard for Business Automation: Achieving AI-Driven Growth.

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