Crypto Assets

Crypto assets are assets issued or transferred using distributed ledger technology (DLT) or blockchain technology. DLT allows for simultaneous access, validation and record updating of crypto asset transactions on a decentralized ledger maintained by peers on a network, with each peer holding a complete copy of the ledger. Blockchain technology is a peer-to-peer DLT that’s secured through cryptography. It’s append-only and seeks to be immutable, meaning that the data and transactions can’t be deleted once added and can only be modified through agreement amongst peers (a function known as consensus).

Crypto assets can be exchanged for traditional currency (e.g., U.S. dollars) or other crypto assets at crypto asset trading platforms and other intermediaries (collectively “crypto asset service providers”).

Importantly, a particular crypto asset or crypto asset transaction may be a security, a commodity or another asset type (e.g., property) under applicable law. Many crypto assets lack, or are offered or sold in a manner that isn’t consistent with, the robust regulatory protections and market oversight that investors have under the federal securities laws. Whether a particular crypto asset or crypto asset transaction is a security depends upon whether it meets the definition of a security under federal securities laws. A number of tests and factors, such as the Howey Test and Reves Test, both based on court cases, may be used in evaluating what is and isn’t a security.

Crypto assets—as well as stocks, mutual funds and exchange-traded funds (ETFs) that derive value from crypto assets—may present the potential for price appreciation. However, while all investments have some risk, crypto assets and crypto asset service providers carry both traditional investing risks and additional unique risks. You should understand these risks as you consider what, if any, investments in crypto assets might be appropriate for your investment plans.

If you choose to seek out investments involving crypto assets, here are some of the types you might encounter:

Native Crypto Assets

Native crypto assets (sometimes referred to as “coins”) belong to a specific blockchain. These crypto assets might be perceived as a store of value secured through cryptography and depend on encryption used to store, verify, secure and pass information. Consequently, native crypto assets are sometimes referred to as “cryptocurrency.”

While these crypto assets bear some similarities to traditional currencies (e.g., they can be a means of exchange and can be perceived as having a store of value), crypto assets aren’t issued by central banks and aren’t, except in a handful of smaller countries, designated by governments as legal tender. In addition, the price of native crypto assets, unlike reference currencies like the U.S. dollar, has been very volatile and may be driven primarily by speculation.

Examples of native crypto assets include bitcoin and ether.

Tokens

Tokens are developed on blockchains and depend on the blockchain for their operations. Tokens vary in terms of their purpose. For example, a token can perform a specific utility or purpose through a decentralized application (dApp) and/or the holder might receive governance rights or an ownership interest. Unlike with native crypto assets, multiple blockchains can support tokens.

The ERC-20 token standard is commonly used by developers to create tokens on the ethereum blockchain and uses “smart contracts” to provide holders with additional services and features that extend the functionality of crypto assets. Smart contracts are neither smart nor contracts; they’re simply computer code that automates certain internal operations on a distributed ledger or blockchain.

Here are three categories of tokens:

Crypto Asset Offerings

Some crypto asset developers offer coin or token offerings. In the U.S., if a coin or token is a security or is offered or sold as an investment contract (a type of security), federal law requires that the security be registered with the SEC or qualify for an exemption from registration. However, many coin and token offerings aren’t sold in compliance with these requirements, and even the most comprehensive discussions made available to crypto investors tend to lack the features of prospectuses or other offering documents and disclosures required by federal securities laws. For example, audited financial statements, disclosures about the issuer and its officers, and risk factors to consider before investing might not be provided in connection with coin offerings.

If you choose to consider participating in an offering of crypto assets, review all corresponding information, including the website and any prospectus, white paper, or other memorandum or material associated with the offering. Crypto asset offerings might be very technical and difficult to verify. Be alert to the possibility of misleading or fraudulent information, and be wary of offers that sound too good to be true. Be aware that, even if you have reviewed these materials, the offering might be being made in manner that isn’t consistent with the robust regulatory protections and market oversight that investors have under the federal securities laws. Use FINRA BrokerCheck to research any broker-dealers and investment professionals involved in initial crypto asset offerings.

Further, the opportunity to redeem or exchange a coin offering investment for money isn’t guaranteed, and redemption may be contingent on triggering events, such as the development of a new enterprise and the related future public sale of the crypto asset.

Here are some examples of terms that have been used to describe crypto asset offerings:

• Initial Coin Offering (ICO) – In an ICO, crypto assets are offered for sale directly to investors and distributed via a blockchain network. The structure of each ICO is unique, and the benefits offered to purchasers of the crypto asset, if any, will vary.
• Initial Exchange Offering (IEO) – An IEO is similar to an ICO, except that crypto assets are issued through a crypto asset service provider rather than directly to investors.
• Security Token Offering (STO) – An STO is similar to an ICO, except that the offering involves the sale of a token that the promoters disclose is a security. STO tokens might be issued on public or private blockchains, and the benefits offered to purchasers of the crypto asset, if any, will vary. As securities, STOs must be made in compliance with securities laws.

While some FINRA member broker-dealers sell crypto assets that are securities or offered as securities to investors through private placement offerings, the vast majority of crypto asset offerings aren’t conducted by these regulated entities. Similarly, while certain FINRA member broker-dealers facilitate trading in crypto assets that are securities or are offered and sold as securities through alternative trading systems (ATSs), nearly all buying and selling of crypto assets occurs outside of and without the protections provided by registered broker-dealers and other SEC-regulated institutions.

Notably, some broker-dealers have established relationships with an affiliate or third party to enable customers of the broker-dealer to buy, sell and custody some crypto assets through this affiliate or third party. In these relationships, it’s important to know that these affiliates and third parties aren’t required to comply with the comprehensive regulations applicable to registered broker-dealers, and their customers don’t receive the same protections as customers of registered broker-dealers.

Buying and selling crypto assets can be both similar to and different from buying and selling stocks and bonds.

For example, crypto asset service providers might:

• Allow users to trade certain crypto assets. These crypto asset service providers serve as intermediaries that enable trading, record ownership and facilitate the custody of crypto assets. While crypto asset trading platforms are widely referred to as "exchanges," both by the media and the providers themselves, they aren't registered with the SEC and don’t meet the regulatory standards or provide the investor protections of broker-dealers or national securities exchanges. Some of these entities might be registered as money services businesses, which have certain anti-money laundering—not investor protection—obligations under the Bank Secrecy Act. Additionally, crypto asset service providers operating outside the U.S. might be subject to different rules and regulations than those within the U.S., and there may be limited oversight of those crypto asset service providers—or none at all.
• Offer ICOs, IEOs and STOs. A calendar of ongoing and upcoming offerings might be provided by the crypto asset service provider or by third parties, similar to calendars for initial public offerings (IPOs) of stock. Read materials associated with an offering prior to investing, understanding that information included in these materials is sometimes misleading or fraudulent. Be aware that federal regulators have taken action against crypto asset service providers for making unregistered offerings of securities; failing to register as a broker-dealer, exchange and/or clearing agency; and fraud.
• Offer interest or other monetary incentives to gain new customers and assets. In particular, offers to move assets from one crypto asset service provider to another might come with a payment and/or a high (but sometimes short-lived) rate of interest. Interest rates and promotions vary, so evaluate any such offers carefully before choosing a crypto asset service provider.

Crypto assets can also be purchased or traded person-to-person, through decentralized finance (DeFi) services and through crypto kiosks and specialized ATMs. Each trading mechanism has associated risks (e.g., person-to-person purchases and sales may present higher risk of theft and fraud).

NFT marketplaces involve intermediaries that compete on fees and services (such as assistance with minting NFTs), as well as quality and breadth of content and digital experience. Some NFT marketplaces cater only to specific NFTs or specific types of tokens (e.g., artwork, collectibles or video games), and some have a broad range of offerings. You can also gain exposure to the crypto asset sector through purchasing ETFs or other ETPs, or stock in public companies, that invest in crypto assets, are involved in crypto asset-related activities (e.g., the mining of crypto assets) or otherwise derive their value from crypto assets.

Stocks, ETFs and other ETPs are securities and, as such, are regulated by the SEC. Individuals who sell these products must be registered. You can use FINRA BrokerCheck to research the background and experience of investment professionals and firms that buy and sell securities for customers. 

Storing and Securing Crypto Assets

Crypto assets are entries on a blockchain ledger, and blockchain technology depends on what is known as “private key encryption” schemes. In these arrangements, messages are encrypted and decrypted using pairs of “keys” that are generally represented as alphanumeric strings or hexadecimal sequences. Each pair consists of a “private key” and a related “public key.” These two keys work in tandem, but it’s the private key that essentially acts as a personal password. Accordingly, storing and securing crypto assets mainly comes down to storing and securing the relevant private keys that control those crypto assets. 

Some crypto investors use a service provider (generally called a “custodian”) to store on their behalf the private keys that control their crypto assets, and other crypto investors “self-custody” by holding the relevant private keys themselves.

Custodians and investors who self-custody use a variety of technologies (known as “wallets”) to store private keys, including general purpose computers (e.g., cell phones, tablets and PCs) running specialized programs known as “software wallets”; separate devices (e.g., flash drives or other storage devices, often with built-in security) known as “hardware wallets”; and printouts of the private keys—or QR codes for the private keys—known as “paper wallets.” Some wallets, called “hot wallets,” are connected to the internet, while others, called “cold wallets,” are not.

All investments carry risks, and crypto assets are no exception. Be mindful of the following realities of investing in the evolving world of crypto assets.

• Crypto assets are risky and often extremely volatile. Crypto assets have experienced higher levels of volatility relative to more traditional investment assets, meaning that price swings—and any investment value—may go up and down dramatically and unpredictably, and the risk of losing all of your investment is significant. Crypto assets are also less liquid than more traditional financial instruments like stocks and bonds, which can exacerbate price volatility and make it more difficult to sell.

• Registration of crypto assets—and crypto asset entities—is limited. Under federal securities laws, securities and the people or entities that offer or sell them typically must be registered. Registration of a securities offering or entity provides important investor protection through rules related to, among other things: disclosure of information about the company, offering and securities being offered; custody of assets; conflicts of interest; standards of conduct; and minimum capital requirements. Whether a particular crypto asset or crypto asset activity is a security depends upon whether it meets the definition of a security under federal securities laws. Unregistered crypto assets, crypto asset broker-dealers and crypto asset exchanges might not provide important investor protections.

  To find out if a broker-dealer is registered, search BrokerCheck. To find out if an asset is registered as a security, check with the SEC.

• SIPA coverage might not apply. Crypto assets that aren’t securities as defined in the Securities Investor Protection Act (SIPA) aren’t protected under SIPA. Even some crypto assets that are securities under other federal securities laws or that are offered and sold as securities under those laws might not be securities under SIPA—in which case, protections afforded to securities customers through SIPA might not apply, even if those crypto assets are held by a broker-dealer that’s a member of the Securities Investor Protection Corporation (SIPC). In particular, an “investment contract” that’s a “security” under other federal securities laws isn’t a “security” under SIPA unless it’s also registered with the SEC under the Securities Act of 1933. Learn more from SIPC about the protections afforded to customers under SIPA and find answers to questions about SIPC customer protection.
• You might interact with unregistered entities. When buying, selling or storing crypto assets through an affiliate of a broker-dealer or another third party with which the broker-dealer has established an arrangement, investors might interact with an entity that’s subject to more limited regulatory oversight or where regulatory clarity is lacking. In these situations, be aware that the entity might not operate under the same investor protection rules and regulations as the broker-dealer.
• Scams and fraud abound. Bad actors continue to exploit investor demand and public interest in crypto assets to perpetrate fraud, including through Ponzi schemes, pyramid schemes, pump and dump schemes, the sale of fake coins, phishing scams, romance scams, “pig butchering” scams, and other forms of market abuse and fraudulent tactics. The pseudonymous nature of crypto assets is another reason behind bad actors’ focus on this space. Whatever the scam, once assets are sent, they’re generally gone for good.
• Theft happens. Theft of crypto assets is a significant risk, and some crypto asset service providers might be better at protecting against cybersecurity risks and theft than others. There are many touchpoints where something can go wrong (such as with crypto wallet providers), and many of these entities might be operating internationally and without any regulatory oversight. As in the case of scams, recovery of stolen crypto assets is rare.
• Spoofing is real. Bad actors have tried to lure unsuspecting investors into storing their public and private keys with fake crypto asset service providers. Fraudsters might befriend investors and entice them to move their crypto asset wallets to a different (fraudulent) crypto asset service provider, or they might fraudulently pose as tech support staff for legitimate crypto asset service providers. It’s important to carefully vet an institution before using its service.
• Tokens might not be received and might have little utility or worth. For crypto assets that are contingent on certain triggering events—such as ICOs contingent on the development of a new enterprise and a related future public sale of tokens—the triggers might not occur, and you might not receive the associated tokens. Even if you do receive tokens, they might be worth nothing or might be redeemable only for goods or services by the token issuer. Furthermore, there might be no ability to trade or exchange tokens.

Remember: Never invest more than you can afford to lose. Investing always involves some degree of risk. Two key investing principles—asset allocation and diversification—are critical to managing investment risk.

Report potential crypto asset fraud to:

• FINRA using the Regulatory Tip Form;
• the U.S. Securities and Exchange Commission’s tips, complaints and referrals system (TCRs) or by phone at (202) 551-4790;
• the Federal Bureau of Investigation’s tip line at 800-CALLFBI (225-5324) or a local FBI office;
• the Internet Crime Compliant Center (IC3) (particularly if a firm is trying to recall a wire transfer to a destination outside the U.S.); and
• your local state securities regulators.

Address
An address is an alphanumeric string derived from a user’s public key using a hash function, with additional data to detect errors. Addresses are used to send and receive crypto assets.

Altcoin
Altcoin is a term used to describe crypto assets other than bitcoin. There are thousands of altcoins in existence today, many with little or no market value.

Blockchain
Blockchain is an electronic distributed ledger or list of entries that’s maintained by various participants in a network of computers. Blockchains use cryptography to process and verify transactions on the ledger. Blocks store data on the network in groups. Each block of new data is appended onto the previous block, forming a chain of blocks of data.

Centralized Network
A centralized network is a network configuration where participants must communicate with a central source to communicate with one another. Since all participants must go through a single centralized source, the loss of that source would prevent participants from communicating.

Cold Storage
Cold storage is a method of storing private keys for crypto assets in an environment that isn’t connected to the internet. Examples include storing keys on disconnected hard drives, printing or writing them on a piece of paper, or storing them on USB drives. Also see Hot Storage, Wallet.

Crypto Asset
A crypto asset is any asset that’s issued or transferred using distributed ledger technology (DLT) or blockchain technology.

Crypto Asset Trading Platform
These are platforms that allow users to trade crypto assets (and, in some cases, other assets). Platforms serve as intermediaries that enable trading and recording of ownership of crypto assets, as well as facilitate holding crypto assets.

Crypto Key
A crypto key is a piece of information, usually a string of numbers or letters that are stored in a file that, when processed through a cryptographic algorithm, can encode or decode cryptographic data. See Public Key, Private Key.

Decentralized Autonomous Organization (DAO)
A DAO is a “virtual,” collectively-owned organization that operates on a distributed ledger or blockchain with governance and decision-making that’s formalized, automated and enforced using software.

Decentralized Finance (DeFi)
DeFi commonly refers to financial products, services, activities and arrangements that use distributed ledger or blockchain technologies (DLT) to operate in a disintermediated and decentralized manner by eliminating some traditional financial intermediaries and centralized institutions and enabling certain direct investment activities.

Decentralized Application (dApp)
This is a computer application that runs on a distributed computing system.

Distributed Ledger
A distributed ledger is spread across a network among all peers in the network with each peer holding a copy of the completed ledger.

Distributed Network
A distributed network is a network configuration where every participant can communicate with one another without going through a centralized source. Since there are multiple pathways for communication, the loss of any participant won’t prevent communication. This is also known as a peer-to-peer network.

Exchange
In the context of crypto assets, “exchanges” are crypto asset trading platforms that let users buy, sell, exchange and, in some cases, store cryptocurrencies or other digital assets. Crypto asset platforms might call themselves exchanges but don’t meet the regulatory standards applicable to national securities exchanges. 

Hot Storage
Hot storage is a method of storing private keys for crypto assets in an environment that’s connected to the internet, including desktop wallets, mobile app wallets and online wallets. See Cold Storage, Wallet.

Howey Test
The Howey test is named for the U.S. Supreme Court case that set forth the criteria for determining whether a contract, transaction or scheme qualifies as an "investment contract" and is therefore considered a security and subject to disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934.

Immutable
Data that’s immutable can only be written, not modified or deleted. 

Initial Coin Offering (ICO)
In an ICO, a company offers crypto assets for sale directly to investors and distributes the crypto assets via a blockchain network. 

Initial Exchange Offering (IEO)
In an IEO, a company offers crypto assets for sale to investors but, unlike an ICO, issues these assets through a crypto asset service provider.

Mining
Mining refers to complex mathematical processes used to develop new coins, such as bitcoin, or verify new transactions. Mining usually involves many computers working to solve complex mathematical calculations on a block of transactions. Once solved or “mined,” the new coin is added to the blockchain.

Money Services Business (MSB)
An MSB is any person doing business, whether or not on a regular basis or as an organized business concern, in one or more of the following capacities: currency dealer or exchanger; check casher; issuer of traveler's checks, money orders or stored value; seller or redeemer of traveler's checks, money orders or stored value; and/or money transmitter.

Non-Fungible Tokens (NFTs)
NFTs are a type of crypto asset that has unique identification codes and metadata such that it can’t be exchanged for an equivalent asset. NFTs can be associated with unique digital items like art or collectibles. The benefits and rights (if any) offered to purchasers of NFTs will vary. 

Private Key
A private key is an alphanumeric or hexadecimal sequence that can be used to control crypto assets credited to an associated blockchain address. Like a password, you should never share your private key. 

Public Key
A public key is an alphanumeric or hexadecimal sequence that can be used to verify that a message has been digitally signed by the associated private key. A public key can be used to generate an "address" that can be used to send and receive crypto assets.

Reves Test
The Reves test is a four-factor test to help determine which “notes” are securities subject to federal securities law. Like the Howey test, the Reves test derives its name from a U.S. Supreme Court case.

Security Token Offering (STO)
An STO involves the sale of a token that the promoters disclose is a security.

Smart Contract
A smart contract is a token which operates an algorithmic program that runs on a blockchain. 

Stablecoin
So-called “stablecoins” are crypto assets that are claimed to have a value that’s pegged to some other non-digital currency or commodity; however, those claims have been demonstrated to be false in many cases.

Traditional Currency
Traditional currency is currency that’s issued by a government (or group of governments) and not on a blockchain. For example, the traditional U.S. currency is the U.S. dollar. When this currency isn’t backed by or exchangeable with the issuer for a commodity, it’s commonly referred to as “fiat” currency.

Transaction Fee
A transaction fee is an amount charged to process a blockchain transaction, such as the “gas” fees paid to ethereum validators. These fees are generally paid to the persons who process the transactions and add them to the blockchain using the network’s native crypto asset.

Wallet
A crypto wallet is used to store the private keys that control crypto assets. Wallets can provide “cold” or “hot” storage. See Cold Storage, Hot Storage.

White Paper
A white paper is a document containing a promoter’s descriptions of a blockchain-related project.

The following articles and information can broaden your knowledge of crypto assets and help you decide whether they have a role to play in your finances.

• FINRA Investor Insights:
  • Bitcoin Basics
  • 3 Things to Know About Stablecoins
  • ‘Pig Butchering’ Scams: What They Are and How to Avoid Them
  • Storing Crypto Assets
  • What is a Blockchain, and Why Should I Care?
  • How to Avoid Cryptocurrency-Related Stock Scams
• SEC:
  • Crypto Assets
  • Howeycoins
  • Investor Alert: 5 Ways Fraudsters May Lure Victims Into Scams Involving Crypto Asset Securities
  • Investor Alert: Exercise Caution with Crypto Asset Securities
  • Investor Alert: Public Companies Making ICO-Related Claims
  • Investor Bulletin: Crypto Asset Interest-bearing Accounts
  • Framework for "Investment Contract" Analysis of Digital Assets
  • Ponzi Schemes Using Virtual Currencies
  • Statement on Potentially Unlawful Online Platforms for Trading Digital Assets
• ABA Foundation: Crypto Investment Scams
• CFTC: An Introduction to Virtual Currency
• FTC: What To Know About Cryptocurrency and Scams
• NASAA:
  • Informed Investor Advisory: Crypto
  • Informed Investor Advisory: The Metaverse
• British Columbia Securities Commission: Crypto Scams