On March 10, 2022, the U.S. Department of Labor’s Employee Benefits Security Administration (DOL/EBSA) published Compliance Assistance Release No. 2022-01, cautioning plan fiduciaries to exercise extreme care before considering the addition of cryptocurrencies to a 401(k) plan’s investment menu. The DOL’s compliance release is intended to help protect the retirement savings of American workers from investments in cryptocurrencies (and other similar digital assets) that are considered highly speculative, inconsistently valued, and inherently volatile.
Cryptocurrency is a digital currency that can be used to buy goods and services much like traditional currency, such as the U.S. dollar. The original and most well-known cryptocurrency is Bitcoin. According to the Bitcoin Foundation, Bitcoin is defined as a “peer-to-peer electronic cash system” that allows online payments to be sent directly from one party to another without going through a financial institution.
Bitcoin uses cryptography which is the science of making and breaking codes. The blockchain, the underlying technology that supports cryptocurrency, is a decentralized network spread across many computers that manage and record transactions. Blockchain technology fundamentally eliminates the digital currency’s need for a central controlling authority.
Cryptocurrency is a decentralized currency, meaning it is issued by private systems and is not regulated by the government. Cryptocurrency exchanges are not backed by the Federal Deposit Insurance Corporation (FDIC), and unlike the traditional government-backed currency, cryptocurrency’s supply is finite.
The crypto market has evolved, but it still comes with substantial risk and a general lack of understanding. As a result, there is significant pricing volatility primarily due to its limited supply and the lack of a central bank to control the supply. But limited supply is a double-edged sword, with proponents saying this is what supports its valuation and appreciation opportunity.
According to the DOL, cryptocurrency investments present a significant risk to retirement accounts for the following reasons:
- Speculative and volatile investments – there are uncertainties with valuing the assets, speculative conduct, an amount of fictitious trading reported, published incidents of theft, fraud, and other factors.
- Challenge for participants to make informed investment decisions – there is difficulty evaluating these assets, even for expert investors, and insufficient knowledge of the cryptocurrency investment can lead to risk and loss. Participants may assume this type of investment is approved by a knowledgeable fiduciary who selected the investment option for the plan, not understanding the risks involved.
- Custodial and recordkeeping concerns – cryptocurrency is not held like a traditional plan asset or in a trust or custodial account, but they exist as lines of computer code in a digital wallet. This may be difficult for traditional custodial or recordkeeping systems.
- Valuation concerns – there is concern about the reliability and accuracy of cryptocurrency valuations.
- Evolving regulatory environment – rules and regulations are evolving for cryptocurrency but the rules are sometimes not followed. Fiduciaries must take into account regulatory requirements that may apply to the issuance, investments, trading, and how these requirements might affect plan participants. Also according to the DOL, Bitcoin and other cryptocurrencies have been used in illegal activity which could lead to law enforcement actions against such platforms.
Because a plan sponsor’s fiduciary responsibilities include acting solely in the interest of the plan participants and their beneficiaries, they should be cautious when considering the addition of cryptocurrency to 401(k) investment options. “Today’s announcement reminds plan fiduciaries of their important role in selecting investment options for 401(k) plan menus,” says Employee Benefits Security Administration Acting Assistant Secretary Ali Khawar. “At this stage of cryptocurrency’s development, fiduciaries must exercise extreme care before including direct investment options in cryptocurrency.”
The DOL expects to launch an investigative program aimed at plans that offer cryptocurrencies and related products and will take action to protect participants from these types of investments. They warn fiduciaries that they must justify offering cryptocurrencies as a plan investment or allowing them through brokerage windows, in light of all of the risks.
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