By Andrew K. Sledd, CPA, CFE, Business Assurance & Advisory Services Partner | Financial Services Industry team
Cryptocurrency is one of the hottest investment opportunities currently in the capital markets. Bitcoin was the first well-known digital currency, but now there are a host of others including Ethereum, Ripple, Dash, and Litecoin. There are even more obscure currencies like DogeCoin, named after the popular Shiba Inu-themed memes making the rounds on social media. While more sophisticated investors may not be eyeing the adolescent currencies like DogeCoin, they may be enticed by the larger and more established exchanges. Cryptocurrencies have grown leaps and bounds faster than other investments in recent years. In fact, in 2017, the cryptocurrency market grew at an average 1,600%. With such drastic growth, it is understandable that investors are considering putting some money into this market. While the market volatility may not be possible to circumvent, understanding the security challenges for cryptocurrency investment can help investment managers better estimate the potential impact these currencies will have on their portfolios.
Challenges Inherent in Cryptocurrencies
Today, digital currencies are one of the most volatile assets available for investment. They are traded on individual markets rather than a central exchange like most other investments. Because there is no standardized mechanism to determine a currency’s “true” value, the purchase price for a unit of cryptocurrency can vary between markets.
Digital currencies are also inherently risky because they are not backed by a central bank or government; cryptocurrency has value simply because the public believes it has value. To help address this instability, cryptocurrency transactions are recorded in a digital ledger known as a “blockchain.” While blockchains are not regulated, they are publicly verifiable digital footsteps. They show the currency’s history, beginning with how it was mined, and record the movements it has made in the digital space. This provides some level of certainty to the purchaser.
Another challenge with digital currencies is that it cannot be as easily liquidated as other investments, like stocks, for example. There are fewer exchanges that deal in cryptocurrency, and there are fewer purchasers in the market, which can make it difficult for individuals to find interested buyers when they are ready to divest. Additionally, digital currencies, unlike traditional currencies, are very rarely accepted as tender, which is yet another barrier to a person looking to leave the marketplace.
Investors and their managers will also have to consider risks that originate outside of the marketplace – namely in securing the assets. Investment managers must be able to sufficiently protect the investor’s crypto wallets so that their assets remain secure.
Steps Investment Managers Can Take to Help Investors
Cryptocurrencies are risky investments; there is no doubt about that. However, investment managers can take steps to alleviate some of these risks.
- Aside from educating investors so that their clients fully understand the potential consequences, they can hire a TPA. A TPA, or a Third Party Administrator, can serve as an independent back office solution for both investment company reporting as well as an independent verification service to provide investors with assurance that managers are actually investing their funds in a digital currency. In this role, these entities can ensure that the investments are stored securely, and that they are being held, traded, and reported in accordance with SEC and IRS regulations.
- Investment managers would also be wise to invest in an annual financial statement audit by a qualified CPA firm. During the audit, the CPA firm can confirm that all investment transactions are accounted for, and that they are valued appropriately. An annual audit can also serve as a marketing tool for managers to showcase their historical performance when suiting potential investors. A great CPA firm will also be able to spot inefficiencies in a company’s processes so that they can be remedied going forward.
- Lastly, investment managers can invest in a good-quality digital wallet management software.This type of software does not store the digital assets; rather, it stores the user’s public and private keys that are required to interface with blockchains.This software allows users to monitor their balance and make transactions safely and securely.
The cryptocurrency market is changing every day, and we cannot predict the direction it will take from here. However, Keiter can help you manage the risks to your business so that you can deal in this marketplace if you decide to do so. If you would like to learn more about the audit, tax and consulting service solutions Keiter offers to the cryptocurrency market, contact our Financial Services team directly. 804.747.0000 | Email.
Additional Financial Services Industry Resources
- Cybersecurity remains focus for financial institutions and service firms' regulators
- FINRA to focus on high risk firms and brokers for 2018
- Are changes coming to the SEC?
- The fiduciary rule's impact on the retail investment industry
- Tax reform: The impact on a financial services business
- Financial Services Industry Blog
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.