Two Strategies to Build a Regulation-Friendly Crypto Enterprise
Ethos vs. Coinbase — Announcing Paradigm Paralysis
Hey Ethos Fam!
We have seen a lot of press and action around the recent announcement that Coinbase had acquired a Broker-Dealer (BD), an Alternative Trading System license (ATS) and a Registered Investment Adviser (RIA). There has been a lot of misinformation and lack of understanding around what that means. The general perception is that any regulatory license is a “good thing” and “makes sense” — in this article we will break down what it all means and what the implications actually are.
Let’s start by defining exactly what each license Coinbase announced it is acquiring actually does.
The Broker Dealer (BD)
First, Coinbase announced that they acquired Keystone Capital Corporation to become a regulated broker-dealer. Broker-Dealers are registered with FINRA (Financial Industry Regulatory Authority) and have many different “flavors” which generally fall into “clearing” and “non-clearing” (Introducing) brokers. Clearing involves either a Clearing Broker who clears consumer trades through another Self-Clearing Broker or simply a Self-Clearing Brokerage firm with no middle-man. As such, non Self-Clearing brokers need to operate on top of a self-clearing broker, an example being Robinhood operating on top of Apex Clearing. In Keystone’s case, they operate through a self-clearing firm called ETC.
With the lack of classification and clarity around crypto assets and their regulatory framework, being a non-clearing or introducing broker — in our opinion — won’t help Coinbase very much. The licensing requirements are likely to differ greatly based on the ultimate classification of crypto as securities, commodities, property or simply foreign currencies and whether a broker-dealer can actually transact in them. A broker dealer that operates on top of a clearing firm that cannot clear crypto transactions essentially can’t operate in crypto space. It has been for this reason that many fiat exchanges have opted for MSB licenses and/or have simply moved out of the U.S. and restricted access to their platform.
The Alternative Trading System (ATS)
Next, Coinbase announced the acquisition of an Alternative Trading System (ATS) license by acquiring Venovate Marketplace, Inc.. An ATS is regulated by the SEC under Regulation ATS introduced in 1998 to protect against increasing concerns over alternative trading systems and their influence over securities markets. These systems are often private “dark pools” for institutions and high net worth individuals, not consumers, to trade away from the traditional markets. The reason for this is that the licensing requirement is far less stringent for “non-consumer” types. If an ATS is to see large volumes of tokenized securities, they may have to register as a national securities exchange or at a minimum follow very strict books and records requirements. A list of all national securities exchanges can be found here. However, in the case of Venovate Marketplace, this is not the more traditional Alternative Trading System (ATS) offering electronic trading systems that match orders for buyers and sellers of public securities. It is rather an electronic trading system offering access to alternative assets involving private securities that are only available to accredited investors, which excludes most consumers from participating in these private investment opportunities.
The Registered Investment Adviser (RIA)
Finally, an RIA or Registered Investment Adviser are SEC regulated entities that are authorized to provide investment advice that they have disclosed to regulatory authorities. RIA’s also come in a lot of different “flavors”, each of which has vastly different licensing requirements, jurisdictions, responsibilities, burdens and authorizations. The fundamental idea behind an RIA is that it gives unbiased advice and does not typically take custodial possession of client assets. If an adviser does take custodial possession of client assets, they are subject to much higher levels of scrutiny. These distinctions are important as any variation from this standard makes it less transparent as to whether the interest of the client is being maintained. Because of this, RIAs are required to file form ADVs which publicly disclose a wealth of information about these firms including their management structure and AUM or assets under management. These can be viewed on https://www.adviserinfo.sec.gov.
The RIA that Coinbase acquired appears to be only registered to do business in California and operates with a typical Assets Under Management (AUM) model, meaning they take a fee for any assets being “managed” by the adviser. More importantly, however, it would appear as though investment advice is being offered more as a “Financial Adviser”, through Keystone Capital Corporation’s brokerage license rather than an “Investment Adviser”. Although the terms sound similar, Financial Advisers should not be confused with Investment Advisers as the duties and obligations of the two are quite different. The term Financial Adviser is a generic term that usually refers to a broker who is not a fiduciary and charges transaction based fees. By contrast, the term Investment Adviser is a legal term that refers to an individual or company that provides fiduciary advice for a specific fee.
Fiduciaries are legally obligated to have the best interests of investors in mind, while financial advisers only have to meet a suitability standard.
For a detailed description of these differences, please see the SEC’s comments here.
What Does All That Mean?
With regards to Coinbase, it is unclear why they would need these licenses and if these licenses could be applied to cryptocurrencies at all. Licenses tend to be rather narrow with the activities that are authorized and regulated being disclosed up front. Unless these acquisitions were of regulated crypto firms, these licenses would have to be modified for use in the cryptocurrency space. There exist more than 3,869 broker-dealers in the U.S. and the process for becoming a non-clearing broker-dealer is well known. It is also worth highlighting that the users of Venovate (the ATS) are largely family offices (for high net worth families), foundations, institutions and accredited individuals. Alternative Trading Systems often have high net worth and/or income restrictions as requirements for participation. Digital Wealth LLC, the investment adviser, has very limited registration status and no cryptocurrency activities currently disclosed to the SEC. There currently exist three Digital Wealth LLC advisers registered with the SEC here:
The Form ADV contains required disclosures while part 2 brochures disclose proposed activities. All three of those advisers are only registered in the state of California as advisers authorized to give advice based on the recommendations disclosed in their brochures.
These details are crucial to understand as they make the difference between open and accessible services and restrictive product offerings.
Ethos has secured a major enterprise agreement with Fusion Financial Advisors, a federally regulated “internet-only” Registered Investment Adviser that will license Bedrock to service the Ethos community in an open, safe and fair way for everyone. This partner is an Investment Adviser who operates according to the Fiduciary Standard. You can read more information about Fusion here: https://medium.com/@sfcorliss/regulated-crypto-investment-advice-takes-a-giant-leap-forward-58ed7d7b58b
We also highly recommend reading Fusion’s Brochure which contains a wealth of information relating to its activities and relationship with Ethos. Think of this like Fusion’s whitepaper. This is viewable here: https://adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=512267
Please feel free to reach out to us on telegram at t.me/ethos_io or email our support desk at firstname.lastname@example.org. We hope that this article was helpful and informative.
Founder and CEO
Ethos.io is affiliated with Fusion, and its parent Fusion US Holdings, by virtue of each being under common ownership and control. Specifically, the controlling interests of both Ethos.io and Fusion US Holdings are held by the same individuals. Ethos.io and Fusion may jointly offer Fusion’s services to the users of the Ethos Platform.
Two Strategies to Build a Regulation Friendly Crypto Enterprise was originally published in Ethos.io on Medium, where people are continuing the conversation by highlighting and responding to this story.