Understanding SEC’s Classification of Crypto-assets: Securities or Commodities?

Beginner’s Guide / 11.06.2020

Cryptocurrency growth in the last decade has taken the technological world by storm, and with this growth came a lot of questions and concerns. The classification of cryptocurrency is, primarily, a chief concern. The subject is one that courts, government agencies, and even financial markets struggle to grasp. 

The primary debate begs an answer to an essential question: are they securities, or are they commodities? 

Cryptocurrency traverses local, national, regional, and international boundaries. Hence the need for classification is both a national and international concern. This contentious issue is evident in that agencies within a country cannot agree, let alone different countries reaching a consensus. 

Are crypto-assets securities or commodities in the USA? Are they under the purview of the Securities and Exchange Commission (SEC) or the Commodity Futures Trading Commission (CFTC)? 

Difference Between Securities and Commodities

In an attempt to understand the categories that crypto-assets would fit in to, one needs to comprehend what the two words mean. The Howey Test appears to be the most revered way to define them. It does this by asking these three questions: 

  • Are there any future profits expected when the money is invested? 
  • Is the money invested in a common enterprise? 
  • Are the profits as a result of a promoter or third party? 

Securities

Securities are tradable financial assets. These assets yield a profit to a common enterprise. This profit is usually a percentage of the potential profit arising from the enterprise. The ownership of the part of the enterprise’s capital structure does not change, whether a profit is made or not. 

This definition doesn’t sit right with many crypto-assets. Returns on investment largely depend on market supply and demand. Besides, most crypto-assets are decentralized and change hands rather quickly. 

Commodities

Commodities, on the other hand, are goods, assets, and property that are bought and sold on an exchange. They don’t generate a return from a common enterprise, as is the case with securities. Instead, investors grow or cultivate them. The value of commodities heavily relies on patterns of supply and demand

By this definition, crypto-assets such as cryptocurrency and tokens would fall under the category of commodities. They give greater returns when demand is high, and supply is low. They are also decentralized and not linked to common enterprises, which categorically classifies them as commodities. 

Controversial Guidelines By the Agency

The United States’ SEC previously defined cryptocurrencies as securities – assets invested with the expectation of returns. SEC cited that they met the parameters of a security as defined by federal security laws. The belief that anything traded through an exchange platform qualifies as a security, including cryptocurrency, contributed heavily to this classification. 

Another agency redefined cryptocurrency classification that differed from the one given by the SEC. The new classification followed a judge’s ruling to authorize the CFTC to regulate digital currencies as commodities. As such, the currencies fell in the same category as coffee and oil. 

Furthermore, the Internal Revenue Service (IRS) provided its definition of crypto-assets, declaring them taxable property for federal tax. 

Two more agencies also gave their guidelines; the US Office of Foreign Assets Control (OFAC) and the Financial Crimes Enforcement Network (FinCEN). The OFAC announced that it characterized digital currency in the same way it did fiat currency, while FinCEN brought cryptocurrency into the same blanket as money. This was unlike all others that classified them as commodities, property, or assets. 

These differing definitions by different agencies within the same government demonstrate the dilemma by both governments and businesses to legally classify cryptocurrencies. However, there have been steps to merge the meaning of cryptocurrencies. SEC recently clarified that it does not consider Ethereum and Bitcoin as securities but rather Initial Coin Offerings (ICOs). This statement at, the very least, narrows down the idea of cryptocurrencies within the United States. 

SEC Regulations

SEC has various regulations and guidelines regarding cryptocurrencies and ICOs. For starters, ICOs must be followed by processes of disclosure and protection of investors, as is required by securities laws. The law stands for all ICOs, whether they are representative of securities or not. In essence, replacing a centralized business ledger with a decentralized one built on a blockchain does not change the substance, only the form of transaction. 

Secondly, referring to cryptocurrencies as currency-based transactions does not mean they are not securities. Cryptocurrency features include anonymity and privacy, public verification of transactions, the inability to tamper with records, lower transaction costs, and making transfers without intermediaries or the impediment of distance. These features have led to the belief that cryptocurrency is beyond the purview of the SEC. However, the Commission warns that despite consensus on the legality of cryptocurrencies, laws will be applied depending on the characteristics of specific digital assets. 

Given the contentious nature of the topic of cryptocurrencies, the rules will keep evolving as time goes by. The Commission advises businesses, lawyers, accountants, and the likes to remain vigilant and informed to avoid brushes with the law. 

Conclusion

Cryptocurrency is growing in an unprecedented manner and will keep growing in the years to come. It has made its way into numerous platforms such as financial markets, gaming, and technology, and its legality has raised many questions. It is a new technology being incorporated into conventional methods. 

As such, there should be adjustments to accommodate their effects. The United States is working to achieve this by trying to categorize cryptocurrency to fit its legal, financial parameters. Definitions from the likes of the SEC, CFTC, and FinCEN go to show how diverse the technology can be. These definitions and categorizations will only keep evolving as cryptocurrency gains momentum. 

After realizing the setbacks of centralization in the financial industry, Carol has dedicated her career to apprise everyone on the benefits of blockchain technology. When she is not writing, she’s probably somewhere in the park reading a book.