Legendary investor Warren Buffett says “cryptocurrencies basically have no value and don’t produce anything.” Yet, according to a recent study, 94% of America’s state and local government pensions—often regarded as the dumbest institutional investors in the world by Wall Street—are gambling on cryptocurrencies.

If you are a participant in a state or local government-sponsored pension fund, then a portion of your hard-earned retirement savings is likely invested in cryptocurrency or a cryptocurrency-adjacent enterprise. According to a 2022 study published by the CFA Institute, 94% of state and government-sponsored pension funds are invested in one or more cryptocurrencies despite the obvious risks. The attraction to this high-risk asset class is largely driven by the perception that cryptocurrencies have delivered spectacular returns over the last 12 years. Never mind that legendary investor Warren Buffett says “cryptocurrencies basically have no value and don’t produce anything,” America’s public pensions—often regarded as the dumbest institutional investors in the world by Wall Street—think they’re smarter than Buffett and are eager to gamble on cryptocurrencies. (Likewise, Buffett’s repeated warnings about private equity and hedge funds have long been ignored by public pensions.)

According to Anessa Allen Santos, a Florida attorney and Special Magistrate who specializes in blockchain and fintech, one glaring reason why no pension fund should be toying with cryptocurrencies right now is “the rapid increase in regulatory hostility exercised without restraint toward cryptocurrency issuers by several federal administrative agencies.”

Attend any meetup, conference or gathering for cryptocurrency, blockchain, fintech, NFTs or the metaverse and you’re sure to hear grumbling about the lack of regulatory guidance coined as regulatory uncertainty, Santos observed. In reality, several federal agencies have issued an abundance of regulations that grant these agencies increasing latitude to bring civil enforcement actions and criminal charges resulting in a legal framework overtly hostile to the industry, she says. For example, the SEC’s position under both the Trump and Biden administrations is that nearly every cryptocurrency ever released is an unregistered public offering of securities. The SEC is so aggressive about prosecuting unregistered digital asset securities that they have dedicated an entire webpage to listing Crypto Assets and Cyber Enforcement Actions that can deter even the most diligent blockchain entrepreneur. Although the SEC has recently been accused of “selective enforcement” of the regulations against unpopular digital asset issuers and exchanges, the more likely explanation, says Santos, is that the SEC simply lacks the resources to prosecute all the schemes they’d like to target. Consequently, how any pension plan could ever justify investing in cryptocurrencies that are likely to be deemed unregistered securities or exchanges is beyond the pale.

In the past, the SEC and CFTC have made non-binding statements that Bitcoin
BTC
and Ethereum
ETH
are not securities, but are commodities subject to CFTC regulation and oversight for instances of fraud or manipulation in spot markets, and for commodity pools, futures contracts, and other derivatives. Santos believes, given the choice, the industry would generally prefer to be regulated by the CFTC rather than the SEC because of the belief that CFTC compliance is less onerous. For this reason, most blockchain developers try to model their projects after Bitcoin and Ethereum which have successfully avoided an SEC smackdown to date. However, due to recent changes in regulations across a bevy of jurisdictions worldwide, these models no longer provide the safe harbor they once did. Moreover, with the CFTC’s recent formation of the Office of Technology Innovation designed to focus on financial technology, she anticipates a flood of enforcement actions charging staking pools as unlicensed commodity pool operators. As a result, she believes pension funds caught investing in these unlicensed financial products may find themselves the subject of class action lawsuits that would be justified under the circumstances.

To further complicate matters, if a crypto-commodity serves as a generally accepted payment alternative to the dollar—like Bitcoin—then it will also be regulated by the Financial Crimes Enforcement Network (FinCEN). The sister agency to the SEC and the CFTC, FinCEN oversees the administration and enforcement of the Bank Secrecy Act (BSA) that regulates financial institutions, dealers in precious metals and gems, and money transmitters, among others. The cost of BSA compliance is steep, says Santos, and it extends not just to regulation by FinCEN, but to each state financial regulator as well, resulting in a 51-jurisdiction compliance quagmire that has incentivized more than a few legitimate blockchain companies to start their startup somewhere else. Although Wall Street is more familiar with this agency’s zero-tolerance policy for error, young innovators are not. They are falling like dominos before a hurricane to FBI dawn raids complete with tactical vehicles and weaponized drones for selling Bitcoin for a profit or a fee without a license, according to Santos. FinCEN enforcement actions involving cryptocurrency usually focus on the failure to implement an effective anti-money laundering program compliant with BSA requirements. The challenge, however, says Santos, is that FinCEN has made no statement describing the factors that determine when a cryptocurrency has gained such widespread acceptance as a means of payment that transmission of it requires registration and licensure. Pension funds and their operators are likewise regulated by FinCEN and must comply with the BSA. Thus, they must take note of this patent ambiguity, and failure to recognize this regulatory gap in their investment strategy is almost certainly a violation of the fiduciary duties owed to plan participants, in her view.

And if all the above weren’t enough to curtail even the most gunslinging of public pension fund managers, digital assets programmed with multiple properties may create hazards uniquely difficult to overcome. A recent example cited by Santos involves the online gaming platform Sand Vegas Casino Club. Designed by anonymous developers, Sand Vegas released for sale more than 12,000 NFTs programmed with profit-sharing rights to the public on the OpenSea NFT marketplace. While NFTs are usually considered commodities, the attribute of profit-sharing motivated the states of Texas and Alabama to issue emergency cease and desist orders claiming the NFTs were securities. When the identities of the programmers could not be confirmed, the cease and desist orders were served on OpenSea to stop the sale of unregistered securities to residents in their states. In response, OpenSea delisted all the NFTs lest they be regulated as an unregistered securities exchange.

The lesson here, says Santos, is that pension fund managers must take extreme care to understand the properties of each digital asset at the time of the investment, and they must continue to monitor that asset for potential programming changes that could render the investment unlawful per one or more applicable regulatory frameworks. Consequently, unless the current regulatory framework is changed by an act of Congress, she believes no pension fund can in good faith invest in any of these crypto-products.

As I point out in my book, Who Stole My Pension? public pensions are overseen by lay boards which utterly lack even rudimentary investment knowledge. Further, the lavishly-compensated, bloated investment staffs at the even the largest state funds are no match for Wall Street hucksters. Will public pensions will be able to fully understand the extreme risks related to rapidly-evolving digital assets, as well as continuously monitor for potential changes? Easier for a gluttonous camel to pass through the narrow eye of a micro-needle.