How Are Cryptocurrencies Being Regulated?

By Jake Altobello

With the proliferation of cryptocurrencies within the past year, “bitcoin”, “etherium” and “litecoin” have become buzz words synonymous with rapid gains of wealth. However, the level of risks associated with such “investments” poses significant risks for the traditional investor. Due to the fact that cryptocurrencies are not being backed by any governmental body, regulatory schemes have largely been absent as the trend of investors gravitating towards cryptocurrencies has increased. What is essential to understand when looking at these “investments” is just how fast one can gain or lose wealth. In the nine-year history of Bitcoin, it has seen five peak-to-trough declines of more than 70%. As recent as December 2017, Bitcoin was trading at a price of nearly $19,783 per coin. However, in the new year Bitcoin is already down roughly 60%, trading at around $7,000. These sharp swings illustrate how illiquid and volatile digital currencies are in relation to its stock, bond or currency counterparts.

How then, do FINRA and other regulatory schemes protect unsophisticated investors who believe cryptocurrencies offer a “get-rich-quick” opportunity? While most regulatory schemes are premised on transparency, investor protection and market integrity, there is little activity surrounding cryptocurrencies that complies with this regulatory approach.  FINRA’s 2018 Regulatory and Examination Priorities Letter, released in early January, highlights the focus FINRA now is placing on cryptocurrencies. Along with this regulatory report, FINRA has also updated their website with warnings regarding cryptocurrencies, informing investors to be wary of the promise of unrealistic gains.  Furthermore, FINRA issued an alert to warn investors to be cautious when considering the purchase of shares of companies that tout the potential of high returns associated with cryptocurrency-related activities without the business fundamentals and transparent financial reporting to back up such claims. One of the ways FINRA is attempting to regulate this newly emerging investment opportunity is through deepening their understanding of broker-dealer’s involvement with initial coin offerings (ICO). Specifically, FINRA is tasking themselves with identifying high-risk firms and brokers, as well as applying pressure on firms to have stronger supervisory practices. Additionally, they intend to review cryptocurrencies that operate as securities. In doing so, their goal is to ensure firms have put mechanisms in to place comply with federal securities laws and regulations, as well as FINRA rules.

These proposed solutions by FINRA are easier said than done, however, meaning many investors must be wary of these products being offered by their brokers. Due to the way in which cryptocurrencies are exchanged, they ambiguously skate the line between currency and securities. Because the SEC does not have direct oversight of currency transactions, the ambiguous characterization of cryptocurrencies leaves regulators in a tough position to regulate them effectively. However, while the SEC may not have regulatory oversight for currency exchanges, they still have investigatory powers. By having these investigatory powers, as well as FINRA protecting the traditional investor, consumers have some level of protection. It remains to be seen if the protections currently available are adequate though.