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Distinguishing Securities From Non-Securities in the Cryptocurrency Market

6 mins
Updated by Ali Martinez
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In Brief

  • The classification of cryptocurrencies as securities or commodities raises significant debate, with the Howey Test being a crucial determinant.
  • Some cryptocurrencies, such as Bitcoin and Ether, are not considered securities due to their decentralized nature, while others are deemed securities by the SEC.
  • The regulatory status of cryptocurrencies has significant implications for investor protection, compliance, and the broader market perception.
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The cryptocurrency market raises many questions concerning its financial and regulatory status, including whether cryptocurrencies are securities​​. Securities are typically negotiable financial instruments with monetary value issued by companies or governments, which are also well-regulated, and investors must be informed about potential risks​​.

On the other hand, cryptocurrencies are largely unregulated, and their status as securities remains debated and unclear. Exchanges and crypto developers exercise caution to operate within the law in various financial jurisdictions. However, these laws and requirements differ from one jurisdiction to another, contributing to the issue’s complexity​.

What Is the Howey Test for Crypto?

Classifying cryptos as securities or commodities is a topic of ongoing debate in many jurisdictions. This is primarily due to the unique nature of cryptos and the fact that they do not fit into traditional asset classifications.

The US Securities and Exchange Commission (SEC) proposed the Howey Test to determine which offerings qualify as securities. This test posits that for a transaction or an asset to be classified as a security, it must involve an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Applying the Howey Test to cryptos generates mixed results:

  • Investment in Money: Cryptos pass this criterion as investing in them involves money​​.
  • In a Common Enterprise: This criterion is met to some extent. For instance, in crypto lending services, clients lend out their money expecting a fixed or variable profit based on how an exchange uses it​​.
  • Expectation of Profit: While many crypto investors aim to profit, there are exceptions, like stablecoins, which are used as a store of wealth, not for profit, classifying them more as a currency than a security​​.
  • Efforts of Others: Here, cryptos generally do not pass the test, as no third party is typically involved in ensuring investors’ profits. It is more about collective market sentiment and investor activities. However, due to third-party involvement, stablecoins and certain cases like crypto staking and lending services may pass this test​.

Despite these guidelines, confusion lingers over which cryptos the SEC’s criteria should label as securities.

Conversely, commodities are interchangeable basic goods that commerce utilizes, substitutable with other goods of a similar kind. Some cryptos, particularly Bitcoin, have been considered commodities because any particular entity did not issue it, and their value does not depend on the performance of an underlying company.

Which Cryptocurrencies Are Not Securities?

Often, cryptocurrencies do not meet all the criteria of the Howey Test, which is why they might not be classified as securities.

For instance, the expectation of profits when investing in cryptocurrencies generally depends on market forces of supply and demand, not necessarily on the efforts of a common enterprise or third parties. This distinction separates them from securities, where the issuing entity’s efforts typically generate profits.

The SEC has declared that Bitcoin and Ether, the cryptocurrencies underpinning the Bitcoin and Ethereum networks, respectively, do not fall under the category of securities. This is largely due to their decentralized nature. The agency no longer views them as securities when a cryptocurrency becomes sufficiently decentralized, as Bitcoin and Ether have become.

In contrast, the SEC almost always views smaller initial coin offerings, or ICOs, as securities.

Also, in a landmark case in Connecticut, a federal jury concluded that Paycoin and several cryptocurrency mining-related assets are not securities, marking the first time a federal jury has considered whether a cryptocurrency is a security. The jury followed the Howey Test to determine whether the products constituted an investment contract or security. After deliberation, they concluded that the products at issue did not constitute a security​​.

However, one should note that factors such as the specific details of the cryptocurrency, its underlying technology, and the jurisdiction evaluating it can influence the classification of a cryptocurrency as a security.

Therefore, this information may not apply to all cryptocurrencies, and it is always advisable to consult with a legal professional or regulatory guidance when dealing with these issues.

Which Cryptocurrencies Are Considered Securities?

The regulatory and legal spaces are still grappling with the complex issue of deciding which cryptocurrencies qualify as securities. The SEC typically applies the Howey Test to determine whether a cryptocurrency qualifies as a security.

Recently, the SEC has identified a number of cryptocurrencies as securities. The list of these crypto-assets classified as securities includes:

What Happens If Cryptocurrencies Are Securities?

Suppose a cryptocurrency is classified as a security. In that case, it becomes subject to the regulatory framework governing securities. This includes registration requirements, disclosure obligations, and other legal responsibilities designed to protect investors.

  • Registration: The issuer must register the offering with the SEC unless an exemption applies. Registration involves providing detailed information about the company, its management, and the security itself. This is a substantial process and can be expensive and time-consuming.
  • Disclosure: Issuers of securities must make regular disclosures to the public, including financial statements and information about their business operations, risk factors, and management.
  • Compliance and Enforcement: The issuer must comply with various laws and regulations designed to protect investors. If the issuer fails to comply, it could face enforcement actions from the SEC, which could result in fines, penalties, or other sanctions.
  • Broker-Dealer Rules: If the cryptocurrency qualifies as a security, then anyone participating in its sale might require registration as a broker-dealer. This requirement extends to exchanges that facilitate the trading of the cryptocurrency.
  • Investor Limitations: Only accredited investors, individuals or entities that fulfill certain financial criteria, can purchase some securities. This could limit the pool of potential buyers for the cryptocurrency.
  • Legal Ramifications: Should a cryptocurrency receive a security designation after its issuance, investors may file lawsuits against it, especially if the ICO did not adhere to securities laws.
  • Market Perception: Lastly, being classified as a security may affect the market’s perception of the cryptocurrency. Some investors may see it as a more legitimate investment, while the increased regulation and potential for reduced liquidity may deter others.

Cases such as BlockFi’s interest rates account not being registered as a security highlight the ongoing complexity. This led to a $100 million fine for BlockFi, which neither accepted nor denied the allegation​.

The SEC’s lawsuit against Ripple for not registering XRP as a security presents another example of negatively impacting the industry.

The agency’s view of certain cryptocurrency assets as securities has even led to an investigation of Coinbase. Consequently, many tokens have been delisted from Coinbase, the US-based arm of Binance, and Kraken.

Implications of Cryptocurrency’s Regulatory Status

The unclear regulatory status of cryptocurrencies has significant implications, making the idea of wide-ranging regulation seem unlikely. As long as they are unregulated in one jurisdiction, arguing for their legal status in others will always be challenging. This issue also influences the usage and trading of cryptocurrencies.

Governments considering regulating crypto must also contend with general market risks, such as the irreversibility of blockchain transactions, the potential for scams, hacks, and manipulation, and the volatility of cryptocurrency values​​.

Crypto Regulation Worldwide
Crypto Regulation Worldwide. Source: Statista

Despite the regulatory challenges and uncertainties, the future of cryptocurrencies remains promising. They have the potential to revolutionize various aspects of finance, from payments and remittances to lending and fundraising.

As regulators, industry players, and investors continue to navigate the complexities of this new digital frontier, it is essential to foster an environment that supports innovation while ensuring adequate protection for all participants.

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Bary Rahma
Bary Rahma is a senior journalist at BeInCrypto, where she covers a broad spectrum of topics including crypto exchange-traded funds (ETFs), artificial intelligence (AI), tokenization of real-world assets (RWA), and the altcoin market. Prior to this, she was a content writer for Binance, producing in-depth research reports on cryptocurrency trends, market analysis, decentralized finance (DeFi), digital asset regulations, blockchain, initial coin offerings (ICOs), and tokenomics. Bary also...