- Recently, the Department of Labor has become more aggressive about issuing guidance to plan fiduciaries regarding their investment decisions that goes beyond the general fiduciary standards in ERISA. On March 10th, the Department issued a Compliance Assistance Release cautioning fiduciaries of defined contribution plans about Cryptocurrencies. This follows on the recently issued regulations regarding ESG investing and a cautionary letter stating the Department does not view private equity as an appropriate investment in most defined contribution plans.
- The release is clear that the Department is highly skeptical about cryptocurrencies. While the release does not explicitly prohibit investing in cryptocurrencies, it would seem wise for fiduciaries to hold off on any decision to add cryptocurrencies for the foreseeable future.
- The Release is largely devoted to describing the well understood fiduciary standards in ERISA. The release “cautions plan fiduciaries to exercise extreme care before considering adding a cryptocurrency option to a 401K plan’s investment menu…” The Department‘s concerns about the prudence of allowing participants to invest in cryptocurrencies rests on a number of factors including the price volatility of cryptocurrencies, the reliability of valuations, and the fact that cryptocurrencies trade outside of established regulatory frameworks.
- The language in the release implies that in future Department audits, plan fiduciaries will be asked about cryptocurrencies.
Facts About Cryptocurrencies
- Cryptocurrencies are digital assets in a decentralized system that allow for secure online payments. Traditional currencies are backed by a government agency – usually a central bank. Cryptocurrencies have no backing from either a private or public entity. There are now many cryptocurrencies with a total value estimated at $2 trillion. The most popular are Bitcoin and Ethereum. Bitcoin represents about 40% of the outstanding value of all cryptocurrencies.
- The investing public has become increasingly interested in cryptocurrencies due, in large part, to the meteoric rise in the value of Bitcoin. At the beginning of 2011, Bitcoin had a value in US dollars of $0.31. As of the beginning of 2020, the value had soared to $8,023. During March of this year, Bitcoin was trading in the range of $47,000.
- A primary advantage of cryptocurrencies is they can be utilized to complete transactions without an intervening third party. This is unlike traditional currencies (such as the US dollar) where a bank, credit card company or some other entity must be involved. While ease of transacting was a primary reason for the creating of cryptocurrencies, most individuals holding these currencies are speculators with little interest in transacting.
- Unlike traditional currencies, cryptocurrencies can fluctuate more in value. The value of cryptocurrencies has been highly volatile. During the 52-week period ending in March of this year, the value of Bitcoin ranged from a low of $28,893 to a high of $68,789.
- Due to the decentralized architecture of cryptocurrencies, it has been assumed that they would be widely held. In fact, ownership is very concentrated. It is estimated that 11,000 people own 40% of the outstanding Bitcoin.
- An important question for plan fiduciaries is the legality of cryptocurrencies. Only El Salvador has formally legalized cryptocurrencies as a method of tender. China has outlawed cryptocurrency exchanges. Cryptocurrencies are legal in the European Union and the United States although how they will be regulated going forward is unclear. Currently, futures in cryptocurrency trade on the Chicago Mercantile Exchange.
- The Securities and Exchange Commission has stated that Bitcoin and Ethereum are not securities. The Internal Revenue Service has taken the position that cryptocurrencies are property and therefore capital gains realized can be taxed.