What Advisors Need to Know, and Do Now, About Bitcoin

With recent developments in the regulatory, legal and compliance landscape surrounding bitcoin and a spot bitcoin ETF, some investment advisors may be considering how to potentially integrate bitcoin — or other cryptocurrencies — into client portfolios. 

A spot bitcoin ETF is backed by physical bitcoins. If the value of the digital coins backing the ETF rises, the value of the investment will generally be expected to increase. 

This piece is intended to update the regulatory landscape and inform advisors how to fulfill their compliance and fiduciary obligations should they determine to integrate bitcoin, such as the current Grayscale Bitcoin Trust (GBTC) or anticipated ETFs that will invest in bitcoin or other cryptocurrencies, into client portfolios or assist a client with a requested purchase thereof. 

This column is not and does not serve as an endorsement of bitcoin, or any other cryptocurrency. Advisors must separately educate their investment professionals and clients about cryptocurrencies before integrating them into client portfolios or assisting with a client-directed purchase.

Bitcoin is considered to be speculative, and the Securities and Exchange Commission has been aggressively reviewing cryptocurrency investments during examinations.

Depending upon the scope of an advisor’s assistance with/use of crypto (employing it as a courtesy/client-directed accommodation versus using it as an asset class in client portfolios), both applicable, clear and conspicuous Form ADV disclosure and a separate acknowledgement executed by the client are strongly encouraged.

Regulatory Landscape 

On Aug. 29, the U.S. Court of Appeals for the District of Columbia Circuit ruled in favor of Grayscale Investments in Grayscale’s lawsuit against the SEC for denying the company’s application to convert its Grayscale Bitcoin Trust into a spot bitcoin ETF. 

The ruling, which vacated an SEC order denying Grayscale’s spot bitcoin ETF application, requires the SEC to consider the application anew. The ruling could have far-reaching implications for other spot Bitcoin ETF applications. 

As of Aug. 30, the SEC is considering 14 such applications, including ones from financial giants like BlackRock, WisdomTree and Invesco.

Analysts have predicted that the odds of a spot bitcoin ETF approval are 75% in 2023 and 95% in 2024. With the imminent approval of a spot bitcoin ETF, investment advisors could determine to consider adding a bitcoin ETF to client portfolios.

However, doing so comes with compliance implications, and it is critical for advisors to conduct appropriate due diligence to confirm that such integration is reasonable and suitable for clients.                                                             

Compliance Issues 

Investment advisors registered at the federal and state level are required to maintain a robust compliance program. Advisors who want to integrate a bitcoin ETF, or another type of crypto investment, should update their policies and procedures to address the risks and challenges that bitcoin presents, including:

• Suitability: Before proactively purchasing a bitcoin ETF for clients — versus only per client request/direction — advisors should confirm that these assets are suitable for the client. Bitcoin is historically, and notoriously, volatile, and advisors should assess whether an investment in bitcoin (or any cryptocurrency) is consistent with a client’s long-term objectives and risk tolerance.
• Disclosures and acknowledgements: Advisors should request that clients execute an acknowledgement that, among other disclosures, makes clear that cryptocurrencies are considered to be speculative, and that unlike conventional currencies issued by a monetary authority, cryptocurrencies are generally not controlled or regulated, and that their price is determined by the supply and demand of their market.
• Brochure: Advisors considering proactively incorporating crypto into client portfolios should amend their brochure (i.e., Form ADV Part 2A) to include language that similarly describes the risks associated with bitcoin and how the advisor can integrate crypto into a client’s portfolio, such as on a discretionary/non-discretionary basis, or at specific client direction. 

Fiduciary Duty 

RIAs are fiduciaries and are required to act in the best interests of their clients. As such, they bear the responsibility to:

• Conduct thorough due diligence, including understanding bitcoin’s market dynamics, its correlation with other assets and the technology behind it;
• Educate clients so they can better understand both the risks and potential rewards of investing in bitcoin, or other cryptocurrencies; 
• Disclose the fees — both the underlying investment’s fees and the advisor’s fee — associated with such an investment.

Thomas D. Giachetti is chairman of the Investment Management and Securities Practice of Stark & Stark.

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