Is cryptocurrency a security?

23.08.2022

Although largely unregulated in most countries, it took over a decade for the crypto market to reach a trillion-dollar market cap. Hence, the question is cryptocurrency a security? Gary Gensler, the Chairman of the top US financial regulator, the Securities and Exchange Commission (SEC), noted in 2021 that every initial coin offering (ICO) is a security, and that's why the SEC is focusing on crypto projects with potential to become securities, in the bid to offer consumers some protection. In this article, you'll learn what is a security in cryptocurrency, and whether cryptos are securities.

What are securities?

Financial securities are transferable and tradable instruments sold to raise capital. They are tradable assets in both private and public markets. For an asset to be considered a security, it must be traded, bought, sold, or exchanged in a market. There are three types of securities:

  • Equity: this grants holders ownership of the underlying asset.
  • Debt: debts are loans and mortgages repaid in installments.
  • Hybrids: hybrid securities are a mix of debts and equity.

Is crypto a security? Securities may be currencies, exchange-traded funds (ETFs), stocks, bonds, Treasury bonds, Treasury bills, or even municipal bonds. There are also derivative securities; an example is the unpopular mortgage-derived securities that became popular in 2007.

Based on these definitions, you may ask: is cryptocurrency considered a security? The question is essential considering the explosive growth that cryptocurrency has enjoyed in recent years. In the last two years, individuals and companies have invested considerable amounts in buying bitcoin, the leading crypto.

Cryptocurrency: security, commodity, or currency?

Is cryptocurrency a security

While most owners see their assets as alternative money or a store of value, experts and regulatory bodies may have opposing views about them. Some countries, such as El Salvador, consider bitcoin as a currency. Some others, such as India, recognize bitcoin as a digital token but have not recognized or regulated crypto. Is a cryptocurrency a security? Is crypto a security or commodity? First, it is essential to define securities, commodities, and currencies.

What is security?

A security is any asset or instrument that is tradable or transferable and sold to raise capital. Securities are traded in public and private markets.

What is a commodity?

A commodity is a resource, typically natural materials, agriculture produced with economic values sold or exchanged.

What is a currency?

Currency is a tangible form of money used in a financial system and popular within a geographic location.

What are the advantages and disadvantages of a cryptocurrency in any of the three categories?

What happens if crypto is a security? Are there advantages to it? If a cryptocurrency is considered a security, holders can earn from price growth while the offering company will raise capital. However, the cryptocurrency will run several risks that all securities face; market, liquidity, regulatory, credit, horizon, inflation risks, etc.

If a cryptocurrency is classified as a commodity, investors can trade it for other items or sell and buy it for fiat. It will also be a hedge against inflation, spread investments, and massive potential returns, but the risks of volatility, asset concentration, and market exposure exist.

If a cryptocurrency is classified or adopted as a currency, it becomes the means of financial exchanges, facilitates trades, gets regulated, and becomes more stable. However, the reduced volatility decreases the potential profits.

Here's a table comparing securities, commodities, and currencies.

Securities

Commodities

Currencies

Tangible

No

Yes

Yes

Investment duration

Longterm

Short term

Short term

Used as exchange

No

No

Yes

Traded in the stock market

Yes

No

No

Examples

Stocks, bonds, debts, public shares

Wheat, oil, silver, gold

JPY, USD, GBP, EUR

There's another way to determine how cryptocurrencies should be classified; the Howey test.

What is the Howey test? - the answer to the main question

What is the Howey test

The answer to what is a security crypto may lie in response to the Howey test.

What is the Howey test?

In 1946, the SEC had a case against WJ Howey Co. (SEC vs. Howey) that landed in the US Supreme Court. The case was about an agricultural contract WJ Howey Co. had with investors, which was not reported to the SEC as the law demanded. The defendants offered real estate contracts to buyers. The tracts of land had citrus groves, which Howey then received via a lease from the buyers to tend the groves and return profits to them.

Ultimately, the Supreme Court decided that the contract was indeed a financial one and should have been reported. The Supreme Court then set up a test to determine the status of a financial instrument as an investment contract and, consequently, as security. The test became known as the Howey test. The Howey test consists of three questions:

  1. Is there an investment of money with the expectation of future profit?
  2. Is there an investment in the common enterprise?
  3. Is there a profit from the promoter's efforts or a third party?

If the features of the financial instrument fit all conditions and answer “yes” to the three questions, it would be considered a financial security. When considering is cryptocurrency a security or commodity, the SEC will look at: the creators or company behind it, the promoters, and all involved in the back end, and if they stand to gain profits. And then the investments and the means of investment.

Is bitcoin a security?

Is bitcoin a security

Is crypto a marketable security? Is crypto staking a security? Based on the Howey test, bitcoin is not considered a security because of two essential factors: the structure and function of bitcoin.

Bitcoin’s structure

Bitcoin is open-source software built on blockchain technology. No one company created or owns Bitcoin or offered it as a financial asset. There is no crowdfunding for the Bitcoin ecosystem or selling tokens to raise capital for Bitcoin projects. This is opposed to Ripple, where the creators offered tokens to raise capital for the company, as alleged by the SEC.

Bitcoin’s function

Although Bitcoin works like a currency, it is primarily a token for a decentralized ecosystem. Bitcoin owners earn bitcoin by staking, buying, selling, or exchanging. Bitcoin functions like a currency but is neither a security nor a fiat currency.

SEC position

The SEC Chairman, Jay Clayton, has also confirmed that bitcoin is not a security but that cryptos are currencies replacing sovereign currencies such as the Dollar, Euro, Yen, etc. The SEC does not regulate cryptocurrencies but will regulate all cryptocurrencies that pass the Howey test and are considered financial securities.

Conclusion

crypto owners need to find answers to questions such as is crypto currency a security? Although cryptocurrencies are popular in the US and many other countries, there are different opinions about their status. One of the fine points that many agree on is that cryptocurrencies will become securities and be regulated at some point. Top regulatory bodies in the US, Europe, India, Asia, and South America are working to protect consumers from associated risks. But what’s the main advantage of bitcoin and other cryptocurrencies becoming securities?

Risk is a significant factor that many investors consider before investing in any asset. The risk associated with unregulated financial markets such as cryptocurrency poses a more substantial deterrent for many, leading to the slow adoption of cryptocurrencies. If cryptocurrencies are classified as financial securities and regulated by financial bodies, many skeptics will change their position and use them. Cryptocurrencies have the potential to become financial instruments if they become regulated, just like the stock market.

Is cryptocurrency a marketable security? Yes, but there is another way to acquire bitcoin without the risk associated with investing funds in the coin. With hosting mining, you can earn bitcoin without risking funds to purchase or trade bitcoin and become subject to volatility risks. Bitcoin hosting mining also provides a way to get bitcoin at a lower price, translating into potential profits.

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