OVERVIEW

ESSENTIALS

• Digital assets cover a wide range of investments. A common characteristic is that they use distributed ledger technology (blockchain) to store, record and validate transactions.  

• There are many types of digital assets, including cryptocurrencies, non-fungible tokens (NFTs), stablecoins and security tokens. In addition, investors can participate in coin and token offerings, issued by developers of digital currency to raise money.

• Investors can also gain exposure to digital assets through funds and individual publicly traded companies.

• Digital assets may present investment opportunities and might help you diversify, but they currently lack the robust regulatory protections and market oversight that investors have with stocks and bonds.

• Information about digital assets can come from many sources, some more reliable than others. Avoid investing based on tweets, other social media or videos touting the latest coins or products.

• Avoid investing based on FOMO—the fear of missing out.

• There are many types of digital assets. For instance, there are the documents and photos we save on our computer and widely share with others as digital media files. These types of digital media assets generally have no monetary or investment value.

 

Enter distributed ledger technology: computer code and a technological infrastructure and protocols. Blockchain is a type of distributed ledger technology. It allows for simultaneous access, validation and record updating of digital assets across multiple entities or locations. This blockchain “ledger” provides a framework through which trading and investing in digital assets can occur. Depending on its design, function and use, a digital asset may be characterized as property, a commodity or a security.

Digital assets—as well as stocks, mutual funds and exchange-traded funds that invest in digital asset-related companies—may present investment opportunities. We’ll help you navigate the types of digital assets you might be exposed to, and how and where to buy and sell them. Some assets trade on platforms that can vary considerably in terms of oversight, costs and types of services provided. Risk is present with any investment, and digital assets—and their trading platforms—have their own set of risks. We’ll help you understand, and hopefully avoid, risks that could derail your long-term investment plans.

 

TYPE

As you seek out investment opportunities, here are some types of digital assets you might encounter:

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Cryptocurrency

Cryptocurrency, or crypto, is a broad term for any virtual currency that represents a stored value secured through cryptography, which uses highly sophisticated encryption techniques to store and pass information. For example, bitcoin, the most prevalent cryptocurrency to date, uses blockchain technology to encrypt, verify and record bitcoin transactions. There are thousands of cryptocurrencies, but all share a common feature: Each has a digital representation of value that allows owners to use it as a medium of exchange.

Cryptocurrency differs from what is called fiat currency, such as the U.S. dollar and government-issued coins. The value of fiat money is tied to the government-issued currency, often referred to as legal tender because of its government issuance and backing. In contrast, the value of cryptocurrency derives from the blockchain.

Most cryptocurrencies are referred to as “convertible,” meaning they have a non-digital value in dollars or another national currency. So, if you own bitcoin, ethereum or some other type of convertible virtual currency, you should be able to exchange it for a recognized fiat currency, such as U.S. dollars.

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Storing and securing crypto is quite different from traditional cash or investments. There are two general methods for storing cryptocurrencies, often referred to as "cold" storage—environments not connected to the internet—and "hot" storage—services connected to the internet, including what is often referred to as a cryptocurrency wallet. Cybersecurity precautions are critical.

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Centralized and decentralized currency administration. In a centralized system, there’s a single administrator for cryptocurrency payments and settlements. Currently, for most cryptocurrencies, the administration is decentralized, meaning there’s no central administrator that controls the systems by which the currency is issued and authenticated.

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Regulation of cryptocurrency. Currently, no single U.S. federal enforcement agency regulates cryptocurrencies. Considered a commodity under the Commodity Exchange Act, virtual currency is regulated by the U.S. Commodity Futures Trading Commission (CFTC) when it’s used in a derivatives contract or if there’s fraud or manipulation involving a virtual currency traded in interstate commerce. Other U.S. regulators that might have jurisdiction over crypto, depending upon the specific use, include the U.S. Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), the Federal Trade Commission (FTC) and the Office of the Comptroller of the Currency (OCC), among others. Crypto investments are treated as property by the IRS and taxed accordingly.

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Stablecoins

Stablecoins are cryptocurrency that aim to manage price volatility. This can be done by tracking the values of more stable assets, including fiat currencies and commodities; holding well-known cryptocurrencies as collateral; or relying on smart contracts that use algorithms to adjust the supply of the stablecoins based on market demand in order to keep the value stable. Stablecoins are designed to serve as a source of stored value within the blockchain ecosystem, thereby reducing the need to convert digital assets into fiat currency (which typically involves both administrative burdens and significant fees).

Though the name might imply otherwise, stablecoins aren’t without risks for investors, among them potential depegging (moving away) from the “stable” price, cybersecurity risks and risks concerning how reserve assets backing the stablecoin are held and maintained.

Regulation of stablecoins. Stablecoins are not currently regulated. Legislation was introduced in 2022 that, if passed, would regulate and accept stablecoins as an official part of the U.S. financial and banking system.

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Non-Fungible Tokens (NFTs)

NFTs are digital assets that reside as code on a blockchain—often, but not exclusively, on the ethereum blockchain. When you buy an NFT, you buy ownership of that particular bit of alphanumeric code, associated with whatever has been tokenized. NFTs can be digital representations of artwork, a video, music or even a tweet. Each NFT is “minted” by an issuer or creator and bought and sold in primary and secondary marketplaces, generally using cryptocurrency. NFTs have a number of features, including:

• Uniqueness. Each NFT is unique, making the tokens “non-fungible,” meaning you can’t exchange one NFT for another just like it, as you can with dollars or bitcoin. In this respect, NFTs are like artwork. You can’t exchange the “Mona Lisa” for the “Vitruvian Man,” because each piece of art is one of a kind. Like traditional art, there can be numbered copies of an original, each with its own unique blockchain “signature.”

• Provable Control and Provenance. NFT technology offers provable control of the asset and proof of provenance (or origin) because of the reliability of decentralized ledgers within a blockchain. In general, although the artwork may be copied and pasted and may circulate freely on the internet, the original work is the one tied to the token. In addition, once that token is transferred to a buyer, ownership of that work is also transferred. This doesn’t mean, however, that an NFT owner specifically inherits the copyright to the asset.

• Linked Smart Contracts. NFTs might also be accompanied by a “smart contract,” which places conditions on a token-holder’s rights. For instance, the payment of royalties to the original NFT creator might be part of a smart contract.

Regulation of NFTs. The NFT regulatory landscape is evolving, owing in large part to the uniqueness of each token and the sheer breadth of NFT products. This includes debate over whether an NFT is a security.

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Coin Offerings

A coin or token offering is a way for developers of a digital currency to raise money. Offerings come in different formats and might be offered publicly, privately or both. Here are some examples:

• Initial Coin Offering (ICO). In an ICO, a company offers digital tokens for sale directly to investors to fund a certain project or platform and distributes the tokens via a blockchain network. Tokens purchased by an investor in an ICO typically don’t provide a stake in the company, as equity shares in an initial public offering (IPO) would, but might grant access to a service or a share in the project's earnings.

• Initial Exchange Offering (IEO). An IEO is similar to an ICO, except that coins or tokens are offered through a platform or “exchange” rather than directly to investors.

• Security Token Offering (STO). An STO is similar to an ICO but must adhere to laws and regulations in the country and state where the token is being offered. Unlike digital coins or tokens with ICOs and IEOs, security or equity tokens are used to raise capital and represent a stake in an external asset such as equity, debt or a commodity such as crude oil. STOs might entitle the owner to a portion of profits and voting rights. Ownership of security tokens is recorded on an immutable blockchain ledger.

 

Coin offerings often require specialized technology expertise to understand and evaluate. Investors should review all corresponding information, including the website and white paper. This information—which describes the team, the project idea and execution plan, intended goals, and more—might be very technical, difficult to verify or misleading and might even contain fraudulent information. In addition, even the most comprehensive discussions tend to lack the features of prospectuses or other offering documents and disclosures required by federal securities laws for IPOs, such as audited financial statements, disclosures about the company and its officers, and risk factors to consider before investing.

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The opportunity to redeem or exchange a coin offering investment for fiat (non-digital) currency isn’t guaranteed, and redemption is often contingent on triggering events, such as the development of a new enterprise and the related future public sale of tokens.

New types of digital asset investments are emerging at a furious pace and will likely continue to do so. Some will succeed. Others will not or will require modifications to address factors ranging from legal decisions and regulatory frameworks to technology advances, costs and consumer demand.

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Regulation of coin and token offerings. In the U.S., if a coin or token offering is a security, or represents itself to be a security, it must be registered with the SEC or qualify for an exemption from registration. Failure to do so could result in regulatory action. Coin and token offerings outside of the U.S. might or might not be registered. Regardless of regulation status, fraud and price manipulation can still occur.

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Individual Stocks and Funds

Another way to gain exposure to the digital asset sector is to purchase securities in public companies that are involved in related financial technology, or fintech, industries, or funds made up of such companies. For example, it’s possible to invest in a company that’s a pure play in the space, like a blockchain company or trading platform. Or you could invest in a company whose revenue stream is supported in part or whole by the digital asset sector. Another alternative is a company that benefits in some way from blockchain technology or has made an investment in cryptocurrency as part of its business strategy. You can also purchase funds (mostly exchange-traded funds) that hold a variety of crypto-related companies.

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Regulation of stocks and funds. Stocks and funds are securities and, as such, are regulated by the SEC. Individuals who sell stocks and funds must be registered. Use FINRA BrokerCheck to research the background and experience of investment professionals and firms.

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BUYING AND SELLING

How or where to buy and sell digital assets depends, in part, on the asset type. For instance:

• Crypto trading platforms allow users to trade cryptocurrencies (and, in some cases, other assets). These platforms serve as centralized intermediaries that enable trading and recording of ownership of cryptocurrencies, as well as facilitate holding cryptocurrencies.

• Crypto trading platforms might also offer the ability to take part in ICOs, IEOs and STOs. A calendar of ongoing and upcoming offerings is often provided by the platform or consolidated by third parties, similar to calendars for IPOs of stock. Be sure to read any analysis or white papers associated with an offering prior to investing, and be aware that federal regulators have taken action against some platforms for making unregistered offerings of securities.

• Some brokerage firms also have an affiliate through which you can buy, sell and store a variety of crypto assets. In general, you can buy and sell cryptocurrency 24 hours a day.

• Cryptocurrency can also be purchased or sold person-to-person or via kiosks and specialized ATMs. Person-to-person sales are perhaps the riskiest option in terms of theft and fraud.

• NFT marketplaces are centralized entities that compete on fees and services (such as assistance with minting NFTs), as well as quality and breadth of content and digital experience. Buying and selling takes place via “active wallets,” which contain public-private key pairings and enable users to buy and sell NFTs or interact with them. Some NFT marketplaces cater only to specific NFTs or specific types of tokens (for example, art or collectibles or video games), and some have a broad range of offerings.

• If you buy and sell stocks or funds in the digital asset space, you do so the same way you purchase any other stock or fund—through an app or online platform, or through an investment professional. Use FINRA BrokerCheck to check the background of any investment professionals you work with or are considering.

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Platforms vs. exchanges. Crypto and other digital asset platforms are widely referred to as "exchanges," both by the media and the providers themselves. Some trading platforms might call themselves “exchanges,” but they typically aren't registered with the SEC and don’t meet the regulatory standards offered by national securities exchanges, such as the New York Stock Exchange and Nasdaq. These trading platforms are, however, required by the Department of Treasury to register as money transmitters with the Financial Crimes Enforcement Network (FinCEN), which brings with it certain regulatory obligations under the Bank Secrecy Act and Patriot Act. Platforms that are registered in jurisdictions outside the U.S. might be subject to limited oversight—or none at all.

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Platforms and interest accounts. Platforms might offer interest or other monetary incentives to gain new customers and assets. In particular, offers to move assets from one platform to another might come with a payment and/or an enticingly high (but sometimes short-lived) rate of interest—similar to marketing from traditional banks looking to acquire and retain customers. Interest rates and promotions vary, so evaluate such offers carefully before choosing a platform.

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RISKS

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

• Some digital assets are extremely volatile. Different cryptocurrencies experience varying degrees of price volatility, but the sector, in general, has seen extreme volatility relative to more traditional investment assets. This means 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.

• Regulation is limited. Regulation of digital assets isn’t as clearcut as it is with stocks, bonds and other traditional securities. The lack of regulatory clarity regarding some digital assets might increase the risk for fraudulent schemes and deceptive tactics—and might leave investors with little recourse to recover funds invested or hold parties accountable.

• Scams abound. They include Ponzi schemes, the sale of fake coins—paid for with real crypto—and phishing scams where crooks pose as reputable people or entities and try to steal tokens and personal information. There are even romance scams where laptop Lotharios talk their online dates into sending them crypto to invest on their dates’ behalf or pay for some “emergency.”  Whatever the scam, once assets are sent, they’re generally gone for good.

• Theft happens. Theft of digitally stored coins and tokens is a real risk, and some digital asset platforms are better at protecting against cybersecurity risks and theft than others. There are many touchpoints where something can go wrong (such as with digital 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 digital assets is rare.

• Platform spoofing is real. Bad actors have tried to lure unsuspecting investors into storing their public and private keys with fake trading platforms. Fraudsters might befriend investors and entice them to move their digital wallets to a different (fraudulent) platform, or they might pose as fake tech support staff for legitimate platforms. 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 digital 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.

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

 

KEY TYPES 

Altcoin
Altcoin is a term used to describe any cryptocurrency 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 is maintained by various participants in a network of computers. Blockchains use cryptography to process and verify transactions on the ledger, providing comfort to users and potential users of the blockchain that entries are secure.

Cold Storage
Cold storage is a method of storing crypto in which private keys reside 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.

Cryptocurrency
Cryptocurrency, or crypto, is a broad term for any virtual currency that represents a stored value secured through cryptography, which uses highly sophisticated encryption techniques to anonymously store and pass information.

Crypto Key
A crypto key is a piece of information, usually a string of numbers or letters that are stored in a file which, when processed through a cryptographic algorithm, can encode or decode cryptographic data. There are public keys, such as an email address, and private keys, which use an alphanumeric code such as a password to access your cryptocurrency.

Crypto Wallet
A crypto wallet is a type of software that can be installed on any internet-connected device that stores your public and private crypto keys. Cryptocurrency wallets include desktop wallets, mobile app wallets and online wallets.

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

Decentralized Finance (DeFi)
DeFi refers to financial activities conducted without the involvement of an intermediary like a bank, government or other financial institution. 

Digital Asset Security
A digital asset that’s a security is referred to as a “digital asset security.” As such, it’s regulated by the SEC.

Digital Fiat Currency
This is a type of currency that represents a fiat, or government-backed currency, on the blockchain. For example, digital fiat in the U.S. would be pegged to the U.S. dollar.

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

Hot Storage
Hot storage is a method of storing crypto that uses services connected to the internet to store cryptocurrency keys.

Initial Coin Offering (ICO)
An ICO is a way that funds are raised for a new cryptocurrency project. ICOs are similar to initial public offerings (IPOs) of stocks.

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.

Non-Fungible Tokens (NFTs)
NFTs are units of value used to represent the ownership of unique digital items like art or collectibles. NFTs are most often held on the ethereum blockchain.

Private Key
The encrypted code that allows direct access to your cryptocurrency. Like your bank account password, you should never share your private key.

Public Key
A public key generally refers to your crypto wallet’s address, which is similar to your bank account number. You can share your public wallet key with people or institutions so they can send you money or take money from your account when you authorize it.

Smart Contract
A smart contract is an algorithmic program that enacts the terms of a contract automatically based on its code.

Stablecoin
A stablecoin is a digital asset that pegs its value to some other non-digital currency or commodity

Stablecoins are digital assets that aim to manage volatility by tracking the values of more stable assets, such as fiat currencies like the U.S. dollar. Though the name might imply otherwise, stablecoins are not without risks for investors. Here are three things to know about stablecoins.

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1. Stablecoins were created to manage digital asset volatility by linking to more stable assets.

Stablecoins are designed to serve as a source of stored value within the distributed ledger technology (DLT, also known as blockchain) ecosystem, thereby reducing the need to convert digital assets into fiat currency, which typically involves both administrative burdens and significant fees. Stablecoins can also serve as a bridge between DLT markets and traditional financial systems by offering payment methods that are equivalent in both worlds, e.g., as a substitute for cash payments in transactions to buy or sell other digital assets. Several other potential use cases for stablecoins currently are being explored to facilitate payments and cash management within the traditional financial system.

Stablecoins achieve this functionality by linking their value to assets such as fiat currencies, commodities (e.g., gold), or a pool of digital assets. The applicable traditional or digital assets are then typically held in reserve to back the value of the stablecoin.

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2. There are currently four main categories of stablecoins. 

• Fiat-backed stablecoins are the most prevalent type of stablecoins in the digital asset marketplace. The issuer of a fiat-backed stablecoin holds one or more fiat currencies (e.g., U.S. dollars, Euros, Japanese Yen, etc.) in reserve, typically in a bank or other type of financial institution. The value of the stablecoins are then generally pegged 1:1 to the value of collateral held in reserve. However, it can be difficult, if not impossible, for the public to verify how much fiat currency the issuer actually holds or what percentage of stablecoins are backed by reserve assets.

• Commodity-backed stablecoins are tied to tangible assets, such as gold or other precious metals. These stablecoins may appeal to individuals seeking exposure to physical assets in a way that is more accessible and provides greater liquidity. For commodity-backed stablecoins, one coin is typically worth one predetermined unit of the referenced commodity (e.g., one ounce of gold or one barrel of oil). The applicable commodity is frequently held with a third party that stores these assets in reserve. Depending on how they are structured, commodity-backed stablecoins may be open to questions about the accuracy of the reserve holdings, which in turn may impact the value of the stablecoins themselves.

• Crypto-backed stablecoins may be pegged to a fiat currency, but collateral comes in the form of other digital currencies (such as bitcoin or ether). The amount of collateral is structured so that the value of reserves is larger than the value of the outstanding stablecoins. Such "over-backing" is done to limit the potential volatility of the stablecoin, but also requires individuals to tie up capital that could otherwise be used for other purposes. Again, it can be difficult for the public to confirm the extent of any over-backing.

• Algo-based stablecoins do not hold any form of collateral, and instead rely on smart contracts that use algorithms to adjust the supply of the stablecoins based on market demand in order to keep the value stable. These stablecoins are generally considered to be the most novel, complex and rare form of stablecoins. Risks that are central to algo-based stablecoins relate to the ability of the algorithm to accurately respond to changing market forces and ensuring that the algorithm cannot be manipulated.

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3. There are risks to consider before transacting in stablecoins. 

Stablecoins share many of the same risks associated with other cryptocurrencies, including those related to cybersecurity and regulatory uncertainty. In addition, certain stablecoins may present enhanced cybersecurity risks in comparison to traditional digital assets (for instance, when the safe storage of other digital assets creates the basis for the value of a stablecoin), as well as when algorithms are used to maintain the value of the stablecoin.

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Moreover, stablecoins may also carry potential risks concerning how any reserve assets backing the stablecoin are held and maintained. Accordingly, it is worth doing some research about the company, its history and principals and, to the extent possible, find reliable information on how collateral associated with a stablecoin is held and what safeguards (e.g., auditing) are in place to verify a stablecoin's value.