Crypto is back in the news after the SEC announced it’s suing two of the largest crypto currency exchanges on the planet for acting as unregistered brokers. Once again, the infamously volatile investment category has found itself in the cross hairs of both government oversight and public curiosity.
SEC Chair Gary Gensler said of one of the lawsuits, “We allege that Coinbase, despite being subject to the securities laws, commingled and unlawfully offered exchange, broker-dealer, and clearinghouse functions.” There’s a key message in that quote —that crypto exchanges are subject to securities laws.
Unsurprisingly, Coinbase disagrees, saying that cryptocurrency assets are not securities and therefore are not subject to SEC authority. This fight will undoubtedly wind through the court system for years. But in the meanwhile, what should you, the investor, take away from the disagreement? I think it’s important to understand the fundamentals of the debate before you can get a grasp on what’s at stake.
What are securities?
Simply defined, a security is a tradable financial instrument that is the same as all the other instruments of its type. Take, for example, a stock. If you buy a share of stock in a company, it doesn’t matter which share you buy because they’re all the same. One share of a company’s stock is identical in nature and value to any other share of that company’s stock.
It gets more complicated than that, of course, but for purposes of this blog post, that simplified definition will do. The important thing to take away is that in order to protect investors from bad actors, securities can be regulated.
Why are securities regulated?
Securities have been federally regulated since the Securities Act was passed in 1933.Sharp-eyed readers will note that this was a mere four years after the worst stock market crash in American history and right in the middle of the economic disaster that was the Great Depression. There’s a reason for that!
The stock market crash of 1929 was in large part caused by uninformed investors buying shares in companies which were overinflated in value. Some representatives of those companies made promises of large profits ahead, despite there being little to no actual data to support those predictions. Before the Securities Act, investors had no real way of knowing whether or not the data a company was publishing was true, which meant informed investing often became more a matter of luck than due diligence.
The stock market is not meant to be a casino, and after the “Black Monday” crash of October 28, the government soon realized that stronger, more centralized regulation was necessary in order to prevent such a crash from becoming a routine occurrence. Thus, the Securities and Exchange Commission was created and granted the authority to regulate securities.
How are securities regulated?
Among wide-ranging regulatory powers, the SEC has the ability to erect safeguards to prevent companies from lying to investors about their prospects, financial health or other data needed to make investment decisions. It also has the authority to regulate brokerage firms which are facilitating trades of securities.
Why should I care whether cryptocurrencies are regulated?
Now we come to the important part! If you are interested in investing in cryptocurrencies, you should care whether they’re regulated because regulation will make them a safer investment.
Unregulated investments are much like the wild west. You could have no idea if the investments are sound, the brokerage facilitating the trading of the investments is legitimate or the cryptocurrency itself is genuine — remember, Dogecoin was started as a joke. Those who invested during its early-stage price increases and were unaware of its status or of crypto’s inherent volatility as a whole might well be regretting that decision today.
Even regulated markets can cause chaos amongst investors. Consider the dot-com bubble of the 1990s. Ordinary people noticed tech stocks trending upward, and without having a good understanding of potential performance or even the knowledge of how to gain that understanding, began buying tech stocks.
As those stocks continued to rise in price, many began to fancy themselves investing experts. They even started telling others to invest; they reimagined themselves as quasi-financial advisors, telling themselves they understood investing when they really didn’t. They failed to realize that much of the dot-com bubble was caused by easy access to capital; in other words, venture capitalists were lending out money like it was candy which was allowing questionable dot-coms to get their hands on financing and make themselves look, on the surface, like wealthy, successful companies.
Once the Fed began raising interest rates, that easy capital dried up, companies started to go under, the bubble burst and people who thought they were wise investors ended up losing their shirts. Remember, that was a regulated investment market. Those investors lost money on regular stocks!
Imagine how much more difficult it would be to be an informed investor in an unregulated market. You’d have to rely on information, the reliability of which you’d have no real way of verifying. This is what’s happening in the crypto space currently. The very lack of regulation crypto touts as its strongest asset is really its biggest risk.
If crypto ever falls under similar regulation as stocks, bonds, CDs and other mainstream investments, it might become a “mainstream” investment. But until it does, the risks and volatility are simply too high to consider it for any significant part of a properly-balanced retirement portfolio.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, view points and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not are commendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
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