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