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Ruth Kise 23 Aug 2023 ◦ 8 min read

What Would It Mean For Crypto To Be Considered Securities?

What Would It Mean For Crypto To Be Considered Securities?

One of the hottest and most controversial topics for 2023-2024 is the regulation of the cryptocurrency market. Government agencies in many countries are puzzled by the rapidly growing popularity of the cryptocurrency market. The banking crisis has also highlighted the overflow of capital and the influx of investors in Bitcoin and crypto assets, which can be explained by a decrease in confidence in the banking system and the transfer of money to cryptocurrency.

The desire of regulators to maintain control over the financial situation leads to the inevitability of market interference. And if cryptocurrencies cannot be completely banned, then the regulatory questions concerning them need to be resolved.

To do this, you first need to determine their status. Many legislations believe that digital assets are more like securities. But is their distribution legal then? The regulatory authorities of the United States, the world center of the crypto industry, stumbled on this issue.

In this article, we explain why the SEC considers cryptocurrency a security and what consequences such a definition has.

Cryptocurrency Status: Different Countries' Approaches

To regulate the crypto industry, legislators from different countries have used their own legal framework, the experience of other countries, and the recommendations of experts. As a result, the rules turned out to be different everywhere, so the legality of working with cryptocurrency in different places is different.

The same goes for the definition of cryptocurrency. For example, in Hong Kong it is recognized as a property, in El Salvador as a national currency, and in Switzerland as a separate class of assets.

There are countries in which regulators have not been able to agree on the status of a new financial instrument. This happened in the United States - the largest center of the crypto industry, affecting the entire market. Therefore, it is in America and its problems in setting the status of cryptocurrencies that all attention is now riveted.

Cryptocurrency Status In The United States

There are two regulators in the US that are responsible for shaping the legal framework for cryptocurrencies: the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). Everyone has their own answer to the question about the status of digital assets. When evaluating the commission, they look at many factors, including algorithms for the operation of coins. Recall that there are two main algorithms:

  • Proof-of-Work (PoW). Miners are responsible for the issue - they connect their equipment for processing tasks to the cryptocurrency network. The reward for the work of miners is new coins. The more equipment - the higher the profit will be. This is how Bitcoin, Litecoin and Dogecoin work.
  • Proof-of-Stake (PoS). In PoS systems, users with the most coins earn more than others. PoS is greener than PoW because it does not require a lot of computing power. Ethereum, Cardano and Solana work on PoS.

Important note: Neither the CFTC nor the SEC issued full-fledged instructions for determining the status of cryptocurrencies, but regularities can be found in the statements of regulators. Probably, someday everyone will present a single official document, but for now we are guided by information from numerous lawsuits against crypto projects.

The CFTC considers cryptocurrency a commodity. At least, Bitcoin, Litecoin and Ethereum were classified as such by the regulator. The first two run on PoW, while ETH runs on PoS. It is likely that the CFTC could classify commodities and other cryptocurrencies on these algorithms.

The regulator proposes to apply a tax regime developed for goods to cryptocurrency and regard the actions of issuers as manufacturers of goods. There are no rules that would oblige issuers to register tokens as a product in the United States.

The SEC believes that all cryptocurrencies except bitcoin are securities. This means that the same rules that are prescribed for securities must be applied to them: register with the regulator and pay taxes according to a special scheme.

Recognizing cryptocurrency as an unregistered security automatically makes it an illegal asset, an operation with which may be punished. Here are a couple of examples:

  • In December 2020, the regulator indicted the California crypto project Ripple.
  • On December 21, 2022, the SEC charged the Thor Technologies project, its CEO David Chin and former CTO Matthew Moravec with an unregistered offer of securities in the form of THOR tokens.
  • On February 13, 2023, the issuer of Binance USD (BUSD), Paxos, faced accusations from American regulators of illegal distribution of securities. As a result, Paxos discontinued BUSD.
  • On March 22, 2023, the SEC announced that the cryptocurrencies Tronix (TRX) and BitTorrent (BTT) fall under the category of "securities."
  • On May 17, 2023, it became known that the SEC considers Filecoin cryptocurrency a security. The Commission's valuation was reported by Grayscale, which had previously planned to launch a coin-based investment trust.

It is worth noting that at the time of writing, the parties did not come to an agreement on any of the mentioned cases.

SEC Security Determination

When assessing the status of cryptocurrencies, the SEC appeals to Howie's test. It consists of four questions:

  • Is it about investing money?
  • Does an investor invest in an asset with profit?
  • Are we talking about investments in a common enterprise?
  • Is the profit that the investor expects related to the activities of others?

Four positive responses give the SEC reason to consider the asset a security.

The SEC's confidence that Bitcoin is not a security, but a commodity, is based on the fact that it does not have a public founder of the project, but it works for Proof-of-Work. Bitcoin does not have a common enterprise in which to invest, a legally certified registration and a single issuer.

Most other crypto projects have legitimate founders, officials, registrations and other bureaucratic details that make their coins securities according to SEC logic.

It is expected that the next top crypto asset with the largest capitalization, Ethereum, will fall under the regulation of Bitcoin; Ethereum’s transition to PoS only aggravated the situation in the face of the SEC.

CFTC vs SEC?

The SEC's specialization makes it more important in regulating the digital asset market if it is assumed that cryptocurrency is a security. The regulator sees signs of a security in the new financial instrument, and therefore believes that cryptocurrency falls into the field of its legislative field.

There is no arbitration body that can resolve the dispute between the two American regulators, so each department works according to its own vision of the situation. Basically, the SEC judges companies for illegally issuing securities in the form of tokens. And the SEC is filing lawsuits against crypto exchanges for violating the securities law. In June 2023, two of the largest trading platforms, Coinbase and Binance, were in the Commission's crosshairs.

Participants in the crypto community strongly disagree with the assessment of the status of coins using the Howie test, which was invented in 1946. And the SEC is confident that they have enough tools to control the crypto market. This position means that the Commission does not want to develop new tools for working with cryptocurrency.

Implications For Companies And Users

At the time of writing, the SEC managed to recognize 67 cryptocurrencies as securities, including Binance (BNB), Binance USD (BUSD), Solana (SOL), Cardano (ADA), Polygon (MATIC), Cosmos (ATOM), Axie Infinity (AXIE). The teams of these projects will have to prove that the Commission incorrectly assessed the status of their coins, or be punished. It is possible that the proceedings will drag on for many years, as happened with Ripple.

A change in jurisdiction is unlikely to help, as regulators pursue projects for crimes already committed in the United States.

Alternatively, companies will simply pay the regulator a fine (if he agrees to such a settlement of the conflict). This was done by the Kraken crypto exchange, paying $30 million. The Commission's claims against the crypto exchange were also related to violations of securities law.

The bad news is that coins that have not yet been targeted by the Commission risk replenishing the list. In addition to Bitcoin, there are no other cryptocurrencies on the market that are officially recognized by the SEC as a commodity.

The good news is that users have not yet faced claims for the use of illegal assets, so the proceedings of the regulators do not affect them in any way.

Regulation and the possibility of recognizing the assets of the crypto market as securities can significantly harm the cryptocurrency market, because digital assets attract users precisely by their anonymity. Potentially, the market could respond by significantly lowering prices and reducing liquidity. This is due to the fact that the regulation of securities may limit the ability of some investors to trade cryptocurrencies, which may lead to a decrease in demand and, as a result, to lower prices. Also, the recognition of Ethereum as a security can lead to an increase in tax liabilities for investors.

Whether cryptocurrency will be recognized as securities or not, while there is no exact answer, decision-making can last for years. But determined, this will be an important event, and its consequences will change the entire crypto industry.

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