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Managing Crypto-Inclined Clients

Whatever your view on cryptocurrency, many of your present and future clients likely own, or want to own, digital currency. 
So, how do you manage a client with cryptocurrency investments, particularly if they are outside of your core business offering? Advisors need to tread carefully as cryptocurrencies put them somewhere between the unregulated edges of the markets and dark places where trading patterns, and even basic pricing are hard to compute. Hence, we have tried in this article to create a helpful framework for advisors to use as they navigate and organize conversations with clients on an issue that continues to fascinate many investors, regulators, and securities lawyers.

Do Your Research

For starters, develop a basic working knowledge of cryptocurrencies and blockchain, the technology behind the electronic currency exchanges. Renowned venture capital firm Andreesen Horowitz has compiled a comprehensive canon of cryptocurrency readings and resources, organized from building blocks and basics to more specific topics such as governance, privacy, and security. Coindesk is also a useful resource for news coverage.

Have a Cryptocurrency Chat

Engage your client in an open, judgement-free discussion of their cryptocurrency holdings. What drew them to the investment in the first place? This will assist you in understanding how much they know about the intricacies of the cryptocurrency market and blockchain technology. Welcoming their insight and discussion will also help you stand out from the 44% of planners who feel they’re a fad to be avoided (according to Financial Planning Association’s 2018 Trends in Investing survey).

Tapping into your client’s emotions regarding their cryptocurrency is also an important step in understanding how to manage these volatile assets.

Consider Segmenting Your Client’s Cryptocurrency Portfolio

As with any investment, your client’s cryptocurrency allocation should depend on their risk tolerance and time horizon. However, unlike traditional stocks and bonds, the intrinsic value of cryptocurrencies is a moving target. Many economists, bankers, and investors—including Bridgewater’s Ray Dalio—have argued that Bitcoin is a bubble best to be avoided. Their argument is straightforward: cryptocurrencies only have value if accepted as currencies. The extreme volatility of cryptocurrencies like Bitcoin, and the lack of widespread ownership, have so far prevented their use for the most important transactions in our economy. Without widespread reliability, critics argue, cryptocurrency cannot become a real store of value.

Therefore, assigning cryptocurrency a portfolio allocation is at this point all art and no science, some might further call it guesswork. If your clients are open to high-risk, high-reward, and understand that cryptocurrency investing is at best a speculative game, you may want to perhaps allocate a nominal amount that would not compromise their ability to attain their financial goals if (or when) they lose it. Help them set up a self-directed account structure if you aren’t comfortable including them as part of your overall management services. And keep in mind that you aren’t alone in your skepticism.

Bitcoin offers no means of financial recourse for its users and there’s no FDIC-style consumer protection for stored Bitcoins. Merrill Lynch (among other wirehouses) has banned its financial advisors and clients from trading in Bitcoin, and the SEC has rejected several proposals for a Bitcoin ETF this year amid concern about fraud and manipulation of Bitcoin markets.

Invest in the Technology

While the investment value of cryptocurrencies is debatable, experts are in agreement that distributed ledger (or blockchain) technology holds promise for many industries. Central banks, including the UK and Brazil, are already conducting experiments in the area of distributed ledger technology and the Bank of International Settlements — an international finance entity whose purpose is to serve central banks — has reported that the technology “may radically change how assets are maintained and stored, obligations are discharged.” Meanwhile, the state of West Virginia is rolling out a blockchain-based mobile application in time for their midterm elections.

One way to fulfill your client’s fear of missing out is to allocate their assets to more traditional vehicles that are investing in blockchain technology, rather than trying to play the speculative cryptocurrency game. A handful of blockchain-focused exchange-traded funds (ETFs) are now available, although success to date has been mixed. Another approach is to identify experienced investment managers who understand how to value and when to invest in innovative technology companies. Sands Capital, for example, runs a private venture fund focused on companies driving business innovation (one of their investments is Upgrade, a consumer credit platform utilizing the blockchain protocol).

It is also likely that your client’s equity portfolio already has exposure to blockchain technology and/or the cryptocurrency movement. Some of the world’s largest firms are dabbling in the space. Microsoft, for example, is testing blockchain technology with the IOTA Foundation, a German nonprofit that oversees its virtual currency called IOTA. And Berkshire Hathaway’s BNSF Railway Co became the first Class 1 railroad (the term given to the industry’s largest companies) to join the “Blockchain in Transportation Alliance,” which is working to establish distributed ledger technology standards in freight transportation.

Don’t Forget Taxes

One final talking point with clients should be the tax treatment of cryptocurrencies. On the whole, regulators and government agencies have been slow to catch up with cryptocurrency trading—but they are gaining ground. In January, exchange giant Coinbase lost a court case against the Internal Revenue Service (IRS), allowing the bureau access to the financial documents of around 13,000 exchange customers. Driving the bureau’s actions was its belief that few investors appear to be paying their taxes based on sales.

The IRS views cryptocurrency as property, rather than currency, which means that gains received from the transaction of cryptocurrencies are treated as income, and taxed accordingly. CoinTracking and Bitcoin.tax are two software options that can help you or your client with determining their cryptocurrency taxes.

To be sure, we are still in the early stages of development for cryptocurrencies as an asset class and blockchain technology as a whole. Investors and their advisors should tread carefully as the market evolves and the regulatory bodies standardize their oversight.

Akhil Lodha Author
Co-founder & CEO StratiFi Technologies

Building the industry standard for understanding portfolio risk through cutting- edge technology at Stratifi.

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