The gold rush in cryptocurrencies continues, and the success of bitcoin is just one of the many ways that cryptocurrency investors have gotten rich. As with any gold rush, there's always a temptation to take shortcuts on the path to riches, and the U.S. Securities and Exchange Commission is doing what it can to try to protect bitcoin investors from the many dangers of cryptocurrency investing.

On March 7, the SEC divisions of enforcement and trading and markets released a new public statement that showed a new approach from the regulatory body in trying to oversee cryptocurrency tokens. In the statement, the SEC urged investors who are using trading platforms to buy and sell bitcoin and other crypto-assets to ensure that those platforms are properly registered as exchanges with the regulatory agency. That way, they'll get the protections that the securities laws provide to market participants in other financial markets.

Three piles of gold-colored coins with the bitcoin symbol on top of a representation of a circuitboard.

Image source: Getty Images.

Why exchange regulation is appropriate

The SEC has argued before that the cryptocurrency coins and tokens sold in initial coin offerings closely resemble securities, sharing many of the same characteristics as corporate stock and other business interests. Most people invest in ICOs in the hope of seeing the value of their investment go up, and creators of crypto-assets often offer them to the public at large to maximize their potential distribution and popularity.

By that argument, if cryptocurrencies are securities, then the companies that specialize in buying and selling cryptocurrencies are subject to regulatory requirements governing securities exchanges. That requires either registering with the SEC or qualifying for an exemption from the registration requirements. By imposing those restrictions, the SEC seeks to protect investors and prevent fraud and trade manipulation from occurring.

The biggest problem right now

Of particular concern to the SEC is the fact that many companies that provide a marketplace for the purchase and sale of cryptocurrencies already refer to themselves as exchanges. In regulators' eyes, that can improperly mislead investors into thinking that such a marketplace is complying with the regulations that exchanges in other types of securities must follow.

That's definitely not the case with many crypto-asset exchanges. Exchanges aren't having the SEC look over and approve the standards that they have for determining which types of cryptocurrencies they'll make available for purchase and sale on their platforms, nor are they letting the SEC look at the way in which they handle trade executions, order listing, and other trading protocols. Many exchanges have made buy and sell orders transparent, mimicking the formal order books that you routinely see with stock exchanges, but the SEC refuses to vouch that those order books give investors information that's as reliable as what you'd find on the New York Stock Exchange or Nasdaq Stock Market.

What crypto-investors should do

In the SEC's eyes, it's up to the public to demand that the crypto-companies with which they do business acknowledge the value of complying with regulatory frameworks. Accordingly, the regulatory agency suggests that you should ask questions in several areas:

  • The threshold questions are whether the exchange handles securities trading, and if so, whether the cryptocurrency exchange is registered as a national securities exchange.
  • You should also be able to get information about individuals operating the exchange through FINRA's BrokerCheck system.
  • Knowing how the exchange chooses which cryptocurrencies it allows to trade gives you a sense of how selective it is.
  • Questions like who can trade, what protocols are in place, how users of the platform are treated and whether treatment is equal across the platform, and any fees can give you a sense of the integrity of the platform. Information on efforts to fight hacking is crucial to determine whether your crypto-assets will be safe.

Be smart with your crypto investments

Many investors in bitcoin and other cryptocurrencies would find the idea of enforced SEC oversight completely antithetical to the founding principles underlying their creation. Yet for many new crypto-investors, ideological fervor takes a back seat to the desire to make a profit. For them, greater regulation would be a good thing, and even if it takes the evolution of bitcoin in a different direction from what its founders might have intended, it might turn out to make bitcoin and other cryptocurrencies more legitimate investing vehicles in the future.

Dan Caplinger has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has a disclosure policy.