“Crypto Creep”: Retirees and Conservative Investors Are Discovering That Their Brokerage Accounts Are Becoming Increasingly Exposed to the Speculative Risks of Cryptocurrencies like Bitcoin. Your Financial Advisor Has a Duty to Disclose These Risks

Few would dispute that Cryptocurrency – whether Bitcoin, Ethereum, or the thousands of other smaller coins – is a speculative and risky investment. The volatility alone in these coins was showcased this past weekend, with Bitcoin suddenly plunging over 25% from nearly $57,000 to just over $42,000 per unit. This is mere weeks after Bitcoin had dropped from its all-time high of roughly $69,000 in early November. Needless to say, investing in crypto is not for the faint of heart and certainly not the type of investment you would see in the portfolio of a risk-averse retiree. Yet it is possible that retirees and conservative investors who rely on financial advisors to manage their retirement assets are receiving exposure to Bitcoin and other cryptocurrencies without even realizing it.

Crypto is a polarizing topic, with some insisting that it is the future, others distrusting it as a Ponzi-type pump and dump, and many more who have no understanding of what it is at all. World governments have traditionally been reluctant to adopt crypto because they see it as a threat to their central banks and control over their fiat currencies, but approaches to regulation vary.  China has outright banned crypto, El Salvador has fully adopted Bitcoin to allow its citizens to shop and pay taxes with, and most other countries (including the United States) are still figuring out how to regulate it.

Financial institutions have been even slower at the notion of adoption because the nature of blockchain transactions poses a threat to the “middleman” place of these institutions in brokering everyday global transactions. Jamie Dimon, the CEO of JPMorgan Chase, has been famously on record for nearly a decade, repeatedly calling Bitcoin “worthless,” “fool’s gold,” and a “fraud.” Yet now it is becoming commonplace for retailers to accept certain cryptocurrencies as payment directly from their customers, with no more hassle than it is to process a credit card or any other electronic payment.

These differences and uncertainties are precisely what makes crypto such a speculative and risky investment. More than ever, it is becoming harder to deny the observable awakening of crypto around the world, as well as its increasing acceptance in U.S. media and culture. Though it is up for some debate as to whether crypto is developing (or has already developed) into its own separate asset class, cautious investors who want to steer clear of crypto’s volatility should be aware of the different ways that crypto may have already “creeped” into their retirement portfolios.

Although the SEC has publicly taken the stance that cryptocurrencies meet the definition of a “security,” there are no crypto coins that have actually been registered with the SEC for trading directly within a retail investor’s brokerage account. However, there is an increasing emergence of crypto-related equities that are registered and sold in the U.S. stock market that provide exposure to crypto more indirectly. Retirees and conservative investors who do not understand these differences, or who are simply unaware and choose to trust their stockbroker to manage their investments, are at greatest risk and may become surprised to learn that their portfolio may already have significant exposure to crypto.

In October 2021, after nearly a decade of SEC rejections, ProShares Bitcoin Strategy ETF (BITO) became the first cryptocurrency-focused exchange-traded fund (ETF) to be traded in the U.S.  Generally, ETFs are investment vehicles that track the performance of a group or “basket” of assets, usually with a particular theme (e.g., technology), which can typically be purchased like any equity (i.e., stock) for one’s brokerage account, providing a one-stop-shop as opposed to buying each of the assets in the basket individually. Bitcoin ETFs such as BITO follow the value of Bitcoin without being tied to the spot price of Bitcoin and without investing in Bitcoin directly. But this does not mean that there is any less risk than investing directly; in fact, there is arguably more risk.

Whether investors realize it or not, they are paying a premium to buy Bitcoin indirectly over buying it directly from a crypto exchange, as ETFs have management fees to manage the buying, selling, and allocation of assets within the ETF. Investing via an ETF vehicle also opens the possibility of short selling shares of the ETF, a bearish trading practice available in the stock market (and not in the cryptocurrency market) that applies downward selling pressure on the share price of the ETF, but will have no effect on the price of Bitcoin itself. So despite paying a premium, your shares in the ETF are inherently worth less than the assets contained within the ETF.

In addition to the emergence of cryptocurrency ETFs, there has been a slew of new public companies traded on the NYSE whose entire business models rely on the price of cryptocurrencies to appreciate. Most notably are the wave of crypto mining companies, which employ powerful computers to mint new coins and process cryptocurrency transactions. Like ETFs, these companies are also subject to the practice of short selling. The premium that investors pay for these companies may be even greater than ETFs given the costs of managing a public company generally, the cost for purchasing and maintaining the mining hardware, not to mention the extremely high electricity bills that mining rigs typically generate. The extreme volatility in the price action of these crypto mining companies is also a feature that should scare away most conservative investors.

The increased accessibility to Bitcoin and other crypto-related equities, along with their growing popularity in mainstream media, means that retail investors need to be wary when their financial advisor recommends such purchases for their portfolio. Like any other security, these investments are not suitable for every person, especially retirees who are typically more concerned with preserving wealth and minimizing market risks. Typically, investors with low risk tolerance and those who anticipate an imminent need for liquidity should stay away from crypto-related assets because of their volatility. This includes people who intend to use their investments to buy a house or have other investing goals that require preservation of capital. Even investors with longer time horizons and higher risk tolerance who have the time to “ride-out” fluctuations should consider what value Bitcoin ETFs and crypto-related equities might bring to their portfolios. Diversification, high growth potential, and lack of government regulation are all valid reasons for incorporating such assets into a portfolio, yet conversely, significant volatility, lack of historical analysis, and that same lack of government regulation are reasons why investors should think twice.

Your financial advisor has a legal duty to know your investment goals (FINRA Rule 2090 – Know Your Customer) and to recommend securities that are suitable (FINRA Rule 2111 – Suitable) and in your best interests. Moreover, your broker has a duty to disclose all material risks about anything he or she recommends to you, meaning that your broker cannot just tell you about the potential upside, but must fairly warn you about the potential risks and downsides. FINRA Rule 2210 – Communications with the Public requires that all such communications “must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service. No member may omit any material fact or qualification if the omission, in light of the context of the material presented, would cause the communications to be misleading.”

If you are a conservative investor or retiree and believe you lost money in crypto-related ETFs (e.g., BITO, BTF, GBTC) or crypto-mining companies (e.g., MARA, RIOT, GREE, HUT) recommended by your financial advisor, you can call Malecki Law for a free consultation.  For over twenty years, our New York securities attorneys have successfully recovered millions of dollars from financial advisors and brokerage firms who failed to make adequate risk disclosures or suitable recommendations to their customers.

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