Over the past five years, a heated debate has been raging between US market regulators and the crypto faithful on whether cryptocurrencies are securities or commodities. 2023 could mark the boiling point of this debate.
Is the crypto you invested in a commodity or a security? To help you stay ahead of the crypto regulatory development,t we have analyzed commentary from the US Security and Exchange Commission (SEC) in this article.
The Great Crypto Debate: Security or Commodity
Let’s get the basics out of the way. What is the difference between a security and a commodity?
Security: According to the Howey Test, a financial product is considered a security when investors invest in it in expectation of profit obtained from the effort of others (typically the promoter.)
Stocks and bonds are the most common forms of securities. Securities are heavily regulated. Promoters must disclose all the risks and additional information to the public.
Commodities: Commodities are essential goods that are used in the production of other goods and services. Commodities also serve as a medium of exchange and a store of value in some cases.
Natural raw materials and agricultural products are classified as commodities. Commodities are subject to less regulation than securities.
Is Your Crypto a Security or a Commodity?
The legal battle between the US SEC and blockchain company Ripple is seen as a landmark development. The SEC sued Ripple and its executives in December 2020 for illegally raising over $1.3 billion by selling XRP tokens. The SEC argued that XRP tokens were “investment contracts” and, therefore, a security under the federal securities law.
This court case has referenced a 2018 speech from William Hinman, former director of the division of corporation finance at the US SEC, time and time again. Hinman’s speech is an important document in the security-commodity crypto debate.
In his speech, Hinman argues that a cryptocurrency initially deemed a security may no longer be considered a security if the cryptocurrency becomes “sufficiently decentralized” over time.
At the time, Hinman said, “putting aside the fundraising” ETH tokens should not be considered securities due to the decentralized structure of the Ethereum network.
“Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required … I would like to emphasize that the analysis of whether something is a security is not static and does not strictly inhere to the instrument,” added Hinman.
Hinman’s speech is controversial. The US SEC has repeatedly said that the speech represents Hinman’s personal views and not the market regulators. Internal SEC emails from 2017 to 2020 released to the public in June 2023 showed that the speech was vetted by several members of the SEC.
Counter Arguments: Why Does the SEC Think Your Crypto Is a Security?
Here are the reasons why ETH and the majority of cryptocurrencies are considered securities by the US SEC:
The majority of cryptocurrency projects, including Ethereum, raised capital to aid their development via ICOs. ICOs involve investors exchanging their fiat currency for crypto tokens, a setup similar to an initial public offering (IPO) where companies sell shares to the public.
Moreover, the funds raised via ICOs were pocketed by development teams, suggesting that investors depended on third parties for future price appreciation (profits) of the tokens they received.
Bitcoin is one of the few cryptocurrencies that did not undergo an ICO.
2. Selling to investors and not users
Cryptocurrencies are marketed as digital currencies that can be used as a medium of exchange on the internet. However, most people buy cryptocurrencies in expectation of token price appreciation. The US SEC has said that merely calling cryptocurrencies “utility tokens” does not prevent the crypto from being a security.
3. Development teams
A corporate entity may not manage a crypto project, but the project may have individual promoters with substantial hoards of tokens. These promoters may be motivated to work to increase the value of their cryptocurrency holding, ultimately making the project dependent on these individuals.
Is SEC Regulation Bad for Cryptocurrencies?
Time for some unpopular opinions. Regulation of cryptocurrencies is not all that bad. The billions of dollars lost to scams, rug pulls, and crypto bankruptcies may well warrant some form of regulation in this wild crypto market.
The purists will not agree with this opinion as they believe that cryptocurrencies are the world’s one true chance of a decentralized financial system. One that champions transactional transparency while protecting user privacy.
As far as the US SEC is concerned, they want to regulate cryptocurrencies to help investors make informed investing decisions. Cryptocurrency projects will have to disclose risks, members of the development teams, financial results, and more on a timely basis to the public if they are regulated by the SEC.
What Are the Important Questions to Ask When Evaluating Cryptos?
Here are some questions to ponder when evaluating the status of a cryptocurrency.
- How decentralized is the crypto network? Does the blockchain depend on a centralized entity to manage, upgrade,e and operate its system?
- How concentrated is the token holding among the development team?
- Who is issuing the cryptocurrency? Who is pocketing the proceeds? What are the proceeds being used for?
- Is the development team raising funds after the ICO?
- Is the ICO targeting the general public or potential users of the blockchain?
- What is the utility of the cryptocurrency?
At the time of writing, regulatory uncertainty is the biggest concern among investors. The US SEC turned on the heat in 2023 by suing two of the world’s biggest crypto exchanges – Binance and Coinbase – for selling “unregistered securities.”
Only bitcoin looks to be safe from this regulatory wave as US SEC chairman Gary Gensler suggested that only BTC is a commodity. Meanwhile, the Commodity Futures Trading Commission (CFTC) has openly come out to say that BTC is a commodity on its website.
The status of ETH and other cryptocurrencies is still in question.