Other Assets

A is correct. The Howey Test establishes that a security exists when there is (1) an investment of money, (2) in a common enterprise, (3) with an expectation of profits, (4) derived solely from the efforts of others. Digital assets meeting all four criteria are considered securities subject to SEC regulation. When token holders rely on a promoter or development team to generate returns, this typically satisfies the Howey Test.

B (Medium of exchange) is incorrect because cryptocurrencies functioning primarily as currencies rather than investments generally fall outside securities regulation. The SEC has indicated Bitcoin functions more as a commodity. C (Own mining activities) is incorrect because profits from one's own efforts do not satisfy the "efforts of others" prong of the Howey Test. D (Transaction fees only) is incorrect because utility tokens with actual network functions rather than investment purposes typically do not meet the Howey Test criteria.

D is correct. The SEC has stated that Bitcoin is generally considered a commodity rather than a security because it functions as a decentralized digital currency without a central promoter whose efforts drive returns. Commodity regulation falls under the CFTC (Commodity Futures Trading Commission) rather than the SEC.

A (Investment Company Act security) is incorrect because Bitcoin does not meet the Howey Test for securities. The lack of a central issuer whose efforts determine value is key to this classification. B (Currency by Treasury) is incorrect. While Bitcoin may function as a currency economically, it is not legal tender and the Treasury does not regulate it as official currency. C (Regulation D exempt security) is incorrect because Bitcoin is not classified as a security at all, exempt or otherwise.

B is correct. The IRS treats cryptocurrency as property, not currency, for federal tax purposes. This means cryptocurrency transactions are subject to capital gains tax rules. When sold, the gain or loss is calculated based on the difference between the cost basis and sale proceeds, with holding period determining whether gains are short-term or long-term.

A (Currency/foreign exchange) is incorrect because despite the name "cryptocurrency," the IRS explicitly does not treat it as foreign currency. Capital gains rules apply, not foreign exchange rules. C (Ordinary income in all circumstances) is incorrect. While cryptocurrency received as payment for services is ordinary income, gains from appreciation are capital gains. D (Tax-exempt) is incorrect. Cryptocurrency receives no special tax-advantaged treatment and all gains are taxable.

A is correct. SEC Rule 206(4)-2 requires investment advisers with custody of client assets to use a qualified custodian (such as a bank, broker-dealer, or registered trust company) and undergo an annual surprise examination by an independent PCAOB-registered accountant. These same custody rules apply to cryptocurrency and other digital assets. The custodian must maintain client assets separately and send quarterly statements directly to clients.

B (SIPC protection) is incorrect because SIPC (Securities Investor Protection Corporation) does not cover cryptocurrency losses. Digital assets lack SIPC or FDIC insurance protection, which is a key risk advisers must disclose. C (FINRA approval) is incorrect. Investment advisers register with the SEC or state regulators, not FINRA, and no special approval is required for digital asset custody beyond meeting standard custody requirements. D (Limiting to Bitcoin/Ethereum) is incorrect. There are no regulatory restrictions limiting custody to specific cryptocurrencies.

A is correct. Because the IRS treats cryptocurrency as property, capital loss rules apply. A holding period of 10 months makes this a short-term capital loss (held one year or less). Short-term capital losses can offset capital gains and up to $3,000 of ordinary income per year, with excess losses carried forward indefinitely. This is the same treatment as losses from stocks or bonds.

B (Not deductible) is incorrect. Cryptocurrency losses are deductible using standard capital loss rules since crypto is treated as property. C (Must be long-term) is incorrect. The holding period determines short-term versus long-term classification. Holdings of one year or less are short-term regardless of the asset's volatility. D (Wash sale rule) is incorrect. Currently, the wash sale rule applies to securities but has not been definitively extended to cryptocurrency under IRS regulations, though advisers should monitor for changes. The client could potentially repurchase without triggering wash sale restrictions.

C is correct. Stablecoins are designed to maintain a stable value by pegging to fiat currencies, most commonly the US dollar. Examples include USDT (Tether) and USDC. The stability depends on the issuer maintaining sufficient reserves of fiat currency or other assets to back the tokens. This peg attempts to reduce the extreme volatility characteristic of other cryptocurrencies.

A (Bitcoin/cryptocurrencies) is incorrect because pegging to volatile cryptocurrencies would defeat the purpose of stability. Stablecoins specifically aim to avoid cryptocurrency volatility. B (Technology stocks) is incorrect. Stablecoins are not pegged to equity baskets. Their value proposition is maintaining a 1:1 ratio with fiat currency. D (CPI) is incorrect. While some proposed digital assets might adjust for inflation, stablecoins specifically maintain a fixed exchange rate with fiat currency, not an inflation-adjusted value.

C is correct. Cryptocurrency lacks SIPC (Securities Investor Protection Corporation) or FDIC (Federal Deposit Insurance Corporation) protection, which is a unique risk compared to traditional brokerage accounts and bank deposits. If a cryptocurrency exchange is hacked, goes bankrupt, or experiences fraud, investors have no insurance safety net and may lose their entire investment. This is a critical disclosure point for investment advisers.

A (Market/volatility risk) is incorrect because while cryptocurrency is extremely volatile, traditional securities also face market risk. This is not unique to digital assets. B (Interest rate risk) is incorrect because both cryptocurrencies and traditional fixed-income securities can be affected by interest rate changes, though the mechanisms differ. D (Liquidity risk) is incorrect because many securities, particularly small-cap stocks and some bonds, face liquidity challenges during market stress. This is not unique to cryptocurrency.

B is correct. NFTs (non-fungible tokens) are unique digital assets where each token is different and not interchangeable with another. In contrast, Bitcoin and other standard cryptocurrencies are fungible, meaning each unit is identical and can be exchanged one-for-one. One Bitcoin has the same value and properties as any other Bitcoin, but each NFT is distinct with unique attributes and value.

A (NFTs fungible, Bitcoin unique) is incorrect because this reverses the correct relationship. The term "non-fungible" means not interchangeable. C (NFTs always securities) is incorrect. Whether an NFT is a security depends on the Howey Test. Some NFTs may be securities if they represent investment contracts, but many are simply digital collectibles and not securities. D (Not on blockchain) is incorrect. NFTs are blockchain-based tokens. The blockchain records ownership and transaction history of these unique digital assets.

D is correct. The regulatory framework for digital assets remains an evolving area with significant uncertainty. The SEC claims jurisdiction over digital assets that meet the definition of securities (applying the Howey Test), while the CFTC regulates those considered commodities. Many digital assets fall into a gray area where the classification is disputed or unclear. This regulatory uncertainty represents a material risk that advisers must disclose to clients.

A (All cryptos are securities) is incorrect. Bitcoin, for example, is generally considered a commodity rather than a security. Each digital asset must be evaluated individually. B (Exempt from securities laws) is incorrect. Digital assets that qualify as securities must comply with federal securities laws including registration or qualifying for exemptions. C (Only US exchanges) is incorrect. Securities laws can apply to digital assets regardless of where they trade if they are offered to US investors. The location of the exchange does not determine regulatory obligations.

A is correct. When cryptocurrency is received as compensation for services, it is treated as ordinary income at the fair market value on the date of receipt. This is the same treatment as receiving payment in cash or property. The fair market value becomes the taxpayer's cost basis. If the cryptocurrency is later sold, any additional gain or loss is calculated from this basis and treated as a capital gain or loss depending on the holding period from the receipt date.

B (Long-term capital gain) is incorrect because compensation for services is ordinary income, not capital gains. Only subsequent appreciation from the receipt date generates capital gains. C (Tax-exempt) is incorrect. Cryptocurrency income receives no tax-advantaged treatment. All compensation is taxable as ordinary income. D (No reporting until sold) is incorrect. Receipt of cryptocurrency as payment is a taxable event that must be reported as income immediately, even if the tokens are not converted to cash. Deferring reporting until sale would understate current year income.