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Is Cryptocurrency A Security?

Are cryptocurrencies securities? What does this mean for investors?

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Cryptocurrency's main advantage and core value has always been removing the middlemen in traditional finance. The vision associated with cryptocurrencies is to have more freedom and more anonymity in the way we approach finance. 

While crypto is still not as officially regulated as your local bank, the government bodies, such as US Securities and Exchanges Commission (SEC), is undoubtedly putting in the effort to regulate the industry. In August 2021, SEC Chairman Gary Gensler stated that every ICO is a security. Also, in a CNBC interview, Gensler noted that the new focus on some crypto projects as potentially being a security for the SEC is ensuring investor protection. 

Is crypto a security and what do regulations mean

What are Securities?

Investopedia tells us: "The term "security" refers to a fungible, negotiable financial instrument that holds some monetary value. It represents an ownership position in a publicly-traded corporation via stock; a creditor relationship with a governmental body or a corporation represented by owning that entity's bond; or rights to ownership as represented by an option."

There are primarily three types of securities:

  • Equity, which provides ownership rights to holders.
  • Debt, essentially loans repaid with periodic payments.
  • Hybrids, which combine aspects of debt and equity.

The ownership rights are part of some cryptocurrencies. Since the holders can influence and make decisions on specific crypto networks, this triggers questions about cryptocurrency qualifying to be a security. 

Classifying Cryptocurrency: Security, Commodity, or Currency?

We covered the definition of securities in the previous section. Now let's talk about commodities, which are goods used in commerce, especially as raw materials for producing other goods and services. For example, Amazon stock is a security, and a bottle of olive oil that you can buy on Amazon is a commodity. 

So how do these traditional definitions translate into cryptocurrency? After all, the category they fall into can say a lot about cryptocurrencies' future and digital finance regulations. 

If cryptocurrencies are classified as commodities, they will be regulated by The Commodity Futures Trading Commission (CFTC). If cryptocurrencies are classified as securities, the SEC will regulate them. 

There are pros and cons of both situations. If cryptocurrencies are officially classified as securities, the industry might face more regulations. On the bright side, the scale of the crypto market will massively increase, creating new opportunities for both investors and founders alike. For example, investing in cryptocurrency will be along the same lines as investing in the stock market. While some investors have already diversified their portfolio to include cryptocurrencies, an official classification can help cryptocurrencies broaden their appeal to a wider audience.

If cryptocurrencies qualify as a commodity, the regulations will be lighter, but they might be more limiting in terms of future growth. 

Table 1: Differences between commodities, securities and currencies
Table 1: Differences between commodities, securities and currencies

What Makes a Coin a Security?

Cryptocurrencies have been developing rapidly, and we can apply the same logic to everything that comes under the term "crypto". There are different projects and cryptocurrencies. The way they fundraise and provide potential rewards to the owners or the investors depends mainly on the structure of each crypto project. 

ICOs and Securities in Cryptocurrency 

In traditional finance, you have probably heard the term "go public", which means that a company starts selling their stocks on the stock market. Stocks equal partial ownership of the company. The rhetoric here is similar—ICOs use the same logic, but they sell tokens. ICOs (Initial Coin Offerings) can be seen as the cryptocurrency industry's equivalent to an initial public offering (IPO), where a company looking to raise money to create a new coin, app, or service launches an ICO as a way to raise funds.

The definition of ICO closely matches the definition of security. Securities are regulated by the SEC—Gensler told the Investor Advisory Committee: "This is an asset class that belongs inside public policy frameworks of looking after investors, guarding against illicit activity, and protecting our financial stability."

The Howey Test 

The SEC has been around for a long time. There is a systematic approach to evaluating different financial vehicles and seeing whether they are considered a security for regulation and conditions. It is called the Howey Test. Originated with the case in the US Supreme Court in 1946, SEC vs Howey, there are four main parts of the test: 

A transaction is only an investment contract if:

  • It is the money investment
  • There is an expected profit associated with the investment
  • The money investment is a joint enterprise
  • The profit comes from the third-party or promoter's efforts

According to the test, the deciding factor is whether the investor has control over the profit of the investment. If the answer is no, the investment can be considered as security. But, if the investor has a critical influence on how the investment is managed, then it is not a security.

It is also a convenient method for investors to appraise cryptocurrencies that they’re considering investing in, especially when they are conducting fundamental analysis

What Makes a Cryptocurrency a Security

As an example, below is a comparison between an ICO and Bitcoin. As the ICO is a blockchain-based version of IPO, it passes the Howey Test and qualifies as a security. However, Bitcoin doesn't pass the Howey test as a security because the structure of BTC and how it can bring rewards to the investors is fundamentally different from an ICO. 

Table 2: Identifying if a crypto is a security with the Howey Test

Is Bitcoin a Security?

Based on the above, the short answer is no. The long answer is how Bitcoin was built and in the way one can make financial gains from buying, selling, and staking BTC. It operates as a currency and never used fundraising methods in its inception or afterwards. There is no "Bitcoin company" where retail investors invested money in a corporation, like Amazon or Facebook. This is in contrast with Ripple, which, according to the SEC accusations, had the benefit of a public offering and used retail investors, qualifies as a security.

SEC Chair Jay Clayton also clarified that Bitcoin is not a security. "Cryptocurrencies are replacements for sovereign currencies…[they] replace the yen, the dollar, the euro with bitcoin. That type of currency is not a security," he said in an interview with CNBC. This clarification is necessary because the SEC is not coming after all cryptocurrencies, but the ones that pass the Howey test and qualify as a security based on definitions of existing regulations. 

What Does This Mean For Investors?

While there is a considerable debate over the subject and what it means for the future of cryptocurrencies and everyone who invested in it, investors can benefit. As Gary Gensler repeatedly mentions in his CNBC interview - the primary motivation of the SEC, in this case, is to protect the investors from losing money. If some cryptocurrencies and crypto projects qualify as securities, there will be increased investor protection. Classifying some cryptocurrencies as securities might positively affect the further adoption, since people who are sceptical of the lack of regulations around cryptocurrencies will consider using and investing in crypto. Simply put, crypto will have the potential to be a mainstream financial vehicle due to these new SEC regulations, as investors will start looking at crypto as they look at the stock market. 

Start Investing in Cryptocurrency Safely with Cabital

As regulators work to integrate digital assets as a regular financial service, the increased legitimacy of crypto makes cryptocurrency an appealing upcoming investment opportunity for investors. 

At Cabital, we believe that the initiatives to regulate the cryptocurrency industry bring clearer guidelines on data privacy and information security, which in turn will ensure better standards of securing the personal information and digital assets of investors against hackers. We also have our own crypto security measures to keep your assets safe and protected from cyber threats.

You can buy cryptocurrencies on Cabital via SEPA, Faster Payments, or Plaid in Europe and the UK. After depositing cash, you can convert your funds to established cryptocurrencies like Bitcoin, Ethereum and USDT

Once you've converted your cash to crypto, it's time to start leading interest rates on your deposits with our crypto interest accounts.

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