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The SEC Chairman Just Issued a Dire Warning for Cryptocurrency Investors

In just two weeks we'll be waving goodbye to 2017, which should henceforth be known as "the year of the cryptocurrency."

Since the year began, the number of investable cryptocurrencies has soared, as have market caps. According to data from CoinMarketCap.com through Dec. 11, the aggregate market cap of all virtual currencies has vaulted from $17.7 billion on Dec. 31, 2016 to $463 billion. That's an over 2,500% increase in 11-1/2 months. It's very possible we could go the rest of our lives without seeing broad-based single-year gains like this ever again.

A rising chart overlaid on a physical gold bitcoin, with a keyboard in the background.
A rising chart overlaid on a physical gold bitcoin, with a keyboard in the background.

Image source: Getty Images.

What's really interesting is that there's not a single factor we can point to that summarizes why digital currencies have catapulted higher. Rather, it seems to be a myriad of factors. Arguably topping that list of catalysts is the emergence of blockchain technology, which is the digital and decentralized ledger that underlies most cryptocurrencies and allows for transactions to be logged without the need for a financial intermediary. Blockchain offers the potential for cheaper transaction fees, since there's no middleman, and quicker transaction settlement times, while also boosting security.

Other factors that have lifted cryptocurrencies like bitcoin include a weaker U.S. dollar, the launch of bitcoin futures trading by CBOE Global Markets, the acceptance of bitcoin as legal tender in Japan, and "FOMO," as the news networks refer to it. This is the "fear of missing out," which is an emotion-based response that has fueled new investors to pile into bitcoin and other cryptocurrencies.

The SEC Chairman has a warning for cryptocurrency investors

But are these gains too good to be true? According to a recently released statement from Securities and Exchange Commission (SEC) Chairman Jay Clayton regarding cryptocurrencies and initial coin offerings (ICO), they just might be.

In Clayton's press release, he fully acknowledges how quickly cryptocurrencies have appreciated in value, and noted that, in some instances, more questions have been created than answers. In particular, though, Clayton suggests that getting to the bottom of these questions requires a lot of in-depth analysis. Here are some of the key takeaways regarding his considerations for the retail investor, who has primarily been in control of cryptocurrency trading up to this point.

A physical gold bitcoin in a mouse trap.
A physical gold bitcoin in a mouse trap.

Image source: Getty Images.

  1. To date, the SEC hasn't approved any cryptocurrency exchange-traded funds for listing in traditional securities markets, and not a single ICO (essentially an initial public offering, but for a new virtual currency) has been registered with the SEC. Clayton recommends cryptocurrency investors be especially wary if anyone trying to get you to invest in virtual currencies suggests otherwise, and notes that there are substantially fewer investor protections in cryptocurrency markets than traditional securities markets.

  2. Secondly, Clayton advises that anyone interested in cryptocurrencies "ask questions and demand clear answers." What questions, you wonder? Some examples include: Where is my money going, and what will it be used for? Are there financial statements, and if so, are they audited, and by whom? If a digital wallet is involved, what happens if I lose the key? These and other questions are critical to improving your understanding of digital currencies before you invest.

  3. If you're guaranteed a return, and the opportunity appears to be too good to be true, exercise extreme caution. You'll note that this warning isn't just pertaining to cryptocurrencies, but any investment.

  4. Understand that cryptocurrency markets span well beyond the borders of the United States, and therefore significant trading can occur in ex-U.S. countries. In other words, the risks of trading virtual currencies can be amplified, and the SEC's ability to pursue cryptocurrency criminals and recover funds may be limited.

A street sign that reads, risk ahead.
A street sign that reads, risk ahead.

Image source: Getty Images.

Two other notable concerns

In addition to SEC Chairman Clayton's considerations before investing in cryptocurrencies, allow me to add two more concerns.

First, it should be noted by prospective cryptocurrency investors that the barrier to entry is exceptionally low. All it takes to develop blockchain technology and a tethered token is some time, money, and a team that understands how to code. The end result is there are now well over 1,300 investable cryptocurrencies, countless proprietary blockchains, and these figures continue to grow. No one really has any idea what blockchain is going to be preferred by big business, making investing in virtual currencies nothing more than a roll of the dice at this point.

The other notable worry is that it's unclear just how the investable coins and tokens play into their underlying blockchains in certain instances. For example, Ethereum, the second-largest cryptocurrency by market cap, has focused entirely on building out its blockchain for enterprise customers, while giving little credence to its Ether virtual currency. It's unclear what role Ether will have in the future, and therefore it's extremely difficult to ascertain a "fair" valuation since there aren't any true fundamental tethers.

I've said it before and I'll say it again: caveat emptor!

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Cboe Global Markets. The Motley Fool has a disclosure policy.