The very real volatility of cryptocurrency has grabbed headlines in recent years, as investors have seen their funds in digital assets plummet, and scandals of fraud and misuse of client funds have engulfed the industry.
Volatility is one aspect of cryptocurrency investing that you need to tell your clients about. However, it is not the full story. Some investors profit from crypto, too.
Your clients may have only heard the terms “cryptocurrency” or “digital assets,” and they may not know what they mean or how they work. Others may have limited knowledge, and still others may have already invested in crypto and used it to buy goods and services. Because of the range of possibilities, it is best to ask your clients first what they know about the subject.
Key Takeaways
- When clients ask you about cryptocurrency, they need to know its plusses and minuses.
- One key fact is to tell your clients that cryptocurrency can be a highly volatile investment.
- Another is that cryptocurrency can be a secure payment form, which is accepted all over the world by both large and small vendors.
It is part of your job as a financial planner or advisor to present your clients with a range of investment options, evaluate these options, and explain how investing in cryptocurrencies may help or hinder them from reaching their goals. Although economists may disagree on the longevity of cryptocurrency, many believe that it’s likely to be around for years to come.
What Is Cryptocurrency?
A cryptocurrency is a decentralized digital currency that relies on cryptography for security. You can help your client understand that cryptocurrency can be used like traditional fiat currencies such as U.S. dollars and euros, as an investment, or to pay for everyday goods and services.
There were over 25,000 digital currencies with a combined market capitalization of $1.14 trillion as of May 31, 2023, according to CoinMarketCap. The largest by far is Bitcoin, released in January 2009 by the pseudonymous Satoshi Nakamoto.
The early digital products were easy to replicate, which was an inherent challenge to digital currencies until Bitcoin launched with safety measures in place. Now the use of cryptography and blockchain technology ensures that cryptocurrencies are nearly impossible to counterfeit or double-spend, despite being digital.
What Is a Blockchain?
A blockchain is a distributed database shared among the nodes of a computer network. As a database, a blockchain stores information electronically in digital format. Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin, for maintaining a secure and decentralized record of transactions. The innovation of a blockchain is that it guarantees the fidelity and security of a record of data and generates trust without the need to use a trusted third party.
One key difference between a typical database and a blockchain is how the data is structured. A blockchain collects information in groups, known as blocks, that hold sets of information. Blocks have certain storage capacities and, when filled, are closed and linked to the previously filled block, forming a chain of data known as the blockchain. All new information that follows that freshly added block is compiled into a newly formed block, which then also will be added to the chain once filled.
A database usually structures its data into tables, whereas a blockchain structures its data into chunks (blocks) that are strung together, as its name implies. This data structure inherently makes an irreversible timeline of data when implemented in a decentralized nature. When a block is filled, it becomes part of the permanent record and of this timeline. Each block receives an exact time stamp when it is added to the chain.
6 Things Your Client Needs to Know About Crypto
- How it works: Cryptocurrency is like fiat or traditional currency because you can use it to buy items and services. It’s different, however, because it’s digital-only. One simple way to spend cryptocurrency at retailers and vendors is through gift cards purchased on platforms like Bitrefill. Among the retailers that accept cryptocurrency through the third-party app are Starbucks Corp. (SBUX), Nordstrom Inc. (JWN), Best Buy Co. Inc. (BBY), Walmart Inc. (WMT), and Overstock.com Inc. (OSTK).
- How to start using it: First, create a crypto exchange account, and then purchase coins through an exchange, such as Coinbase. You can also buy crypto with traditional currency using debit cards or bank accounts.
- How to store it: Transfer it to a noncustodial crypto wallet to secure your funds. A wallet validates your transactions and keeps your private key information safe.
- Where you can use it: Crypto funds are always available at any place in the world because they aren’t tied to a bank or a government.
- How it safe is: Cryptocurrency can be safer to use because you don’t need to provide personal information to a vendor, lessening the chances of identity theft or fraud.
- How stable it is: Not at all. Cryptocurrency is volatile, which can be good or bad. Let’s say you have $2,000 in your crypto account. The value can increase, meaning you have more in your account. However, if it dips in value—to $750, for example—there’s nothing you can do to recover the lost funds but wait it out, hoping that the value will increase. It may not.
CFP Board Issues Crypto Guidelines
On Dec. 5, 2022, the Certified Financial Planner Board of Standards, Inc. (CFP Board) released a new guide about cryptocurrency-related assets to help CFP professionals. The guide, named the “Notice to CFP Professionals Regarding Financial Advice About Cryptocurrency-Related Assets,” was developed in response to questions about financial advice on cryptocurrencies and other crypto-related assets.
In its notice, the board recommended CFP professionals follow regulatory guidance when providing financial advice about crypto-related assets since both the Department of Labor (DOL) and the Financial Industrial Regulatory Authority (FINRA) have expressed concerns about potential risks when investing in crypto-related assets. In March 2022, the DOL’s Employee Benefits Security Administration (EBSA) published compliance assistance warning 401k plan fiduciaries against cryptocurrency investments.
According to the board, CFPs are not prohibited or encouraged to provide crypto-related advice but should be familiar with the asset and its risks when discussing crypto with clients. In addition, the board highlighted the specific risks associated with crypto-related assets, including speculative and volatile nature, difficulties in analyzing, custodial and valuation issues, potential unregistered status, and the potential for additional regulation.
More compliance resources, including FAQs, videos, fact sheets, case studies, and other guidance resources to help CFP professionals understand and comply with the Code and Standards, can be found at CFP.net/compliance.
With a noncustodial crypto wallet, you have control of your private keys, which in turn control your coins and can help provide proof that the funds are yours. With a custodial wallet, another company would control your private keys, and if that company goes bankrupt or gets hacked, your funds go with it.
What Is a Digital Wallet?
A digital wallet (or e-wallet) is a software-based system that securely stores users’ payment information and passwords for numerous payment methods and websites. By using a digital wallet, users can complete purchases easily and quickly with near-field communication technology.
What Is a Distributed Ledger?
A distributed ledger is a database that is consensually shared and synchronized across multiple sites, institutions, or geographies, accessible by multiple people. It allows transactions to have public “witnesses.”
What Is a Fiat Currency?
A fiat, or traditional, currency is a currency that is backed by a government, such as the U.S. dollar, the Mexican peso or the European Union’s euro. It came about when governments would mint coins out of a valuable physical commodity, such as gold or silver, or print paper money that could be redeemed for a set amount of a physical commodity.
The Bottom Line
Clients may be hungry for information about cryptocurrencies, whether they plan to use them or not. As their financial advisor or planner, it’s your job to explain to them this relatively new form of currency, which has investment potential and a clear downside. Be ready with the facts.
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