SEC Urges Caution on Crypto Investing

Regulator warns of possible conflict of interest

SEC Under Fire As Wall Street Investment Banks Falter
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The Securities and Exchange Commission (SEC) has issued an alert reminding investors that cryptocurrency offerings may be illegal because they are not registered with the regulator.

Key Takeaways

  • SEC issued an investor alert on crypto asset securities.
  • The warning follows a string of regulatory actions against crypto platforms.
  • The regulator warns of possible conflict of interest and warns against proof of reserves.

The move is in line with the string of regulatory actions brought against numerous crypto platforms since October 2022, when FTX famously imploded. To date, the regulator has gone after Terra, Coinbase, Kraken, Paxos, and Binance, claiming the companies violated investor protection laws or had illegal securities offerings. Just yesterday, the SEC took action against the founder of Tron and celebrities that touted investments in the cryptocurrency.

SEC Claims Conflict of Interest

According to the alert, crypto exchanges may offer a combination of services that are normally offered by separate firms. By offering exchange, broker-dealer and custodial functions, platforms create conflicts of interest that pose a risk to investors.

SEC-registered entities must comply with a number of rules to protect investors. However, according to the regulator, “none of the major crypto asset entities is registered with the SEC as a broker-dealer, exchange, or investment adviser—so investors may not get the protections afforded by the rules applicable to these entities.”

Warning on Proof of Reserves

The regulator also addressed proof of reserves, which has been commonly used to show an entity has enough reserves to cover the amount held in customer accounts. This proof assures customers that their funds are safe and available to withdraw on demand. 

“These types of services may not provide any meaningful assurance that these entities hold adequate assets to back their customers’ balances. Further, crypto asset entities might use these in lieu of audited financial statements in order to obscure and confuse customers about the safety of their assets,” the SEC said.

The alert explains proof of reserves does not provide the same level of assurance as an audit of financial statements. Proof of reserves should not be relied upon by investors to conclude a crypto asset entity has sufficient reserves to cover customer liabilities, according to the SEC’s statement. 

Crypto Under a Microscope

The warning from the SEC is nothing new. It simply puts the legality of crypto investing under a more laser-focused microscope.

According to the SEC's Office of Investor Education and Advocacy, crypto asset securities are still a risky investment. They warn investments in crypto asset securities, in addition to being exceptionally volatile and speculative, may lack important investor protections on platforms where they can buy, sell, borrow, or lend them.

Individual investors who participate in transactions involving crypto assets, including crypto asset securities, may face a significant risk of loss and are urged only to invest what they can afford to lose completely—something the crypto industry has preached for years.

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