Is crypto a commodity or a security?

The crypto industry is eagerly awaiting the decision of Judge Analisa Torres of the Southern District Court of New York in the Securities and Exchange Commission (SEC) versus Ripple Corporation case. Ripple owns the popular XRP cryptocurrency, which currently remains in the top 10 of Coinmarketcap.com, a popular token tracking website.

The SEC charged in December 2020 that “Ripple raised funds, starting in 2013, through the sale of digital assets known as XRP in an unregistered securities offering to investors in the United States and around the world. Ripple also allegedly distributed billions of XRP in exchange for cash consideration, for for example labor and market-creating services.”

In addition, the indictment alleges that company executives Christian Larsen and Bradley Garlinghouse “also made personal unregistered sales of XRP totaling approximately $600 million.” It further alleges that “the defendants failed to register their offerings and sales of XRP or satisfy any exemptions from registration, in violation of the registration provisions of the federal securities laws.”

This issue goes beyond the survival of Ripple and XRP. It actually sets the stage for the SEC to charge many of the other cryptos as securities. The trading of commodities such as sugar, wheat, oil and gold is governed by the Commodity Futures Trading Commission (CFTC), and much of the crypto industry would prefer to see itself regulated under this regime. The price of crypto depends on buyer versus seller sentiment driven by a number of factors such as individual token news, but also macro factors such as inflation and employment which also affect other commodity prices.

Usually, when the following happens, the price of crypto goes up. These events include excess liquidity, quantitative easing, monetary excess, high M2 supply, and low interest rates. Conversely, the price of crypto can tend to go down when you have high inflation with the quantitative tightening and higher interest rates that central banks (including the Fed) use to try to reduce inflation.

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However, if crypto is declared as a security, it may be subject to additional reporting requirements such as annual reports, profit and loss accounts and environmental, social and governance (ESG) reports. There are some tokens that have decided to register with the SEC as a security. This move is clearly extremely unpopular with most token issuers in the industry.

The XRP case has been mired in controversy from the start due to well-reported public statements by former SEC Chairman Jay Clayton stating that both Bitcoin and Ethereum are not securities and are instead more of commodities such as sugar, oil, gold and the like .

When current SEC Chairman Gary Gensler—a former MIT professor of blockchain technology—took over, the mood changed. Gensler is now more inclined to consider many cryptocurrencies, with the exception of Bitcoin, as securities.

In American jurisprudence, the way to determine whether something is a security or not is something called the Howey Test. SEC versus WJ Howey Company was a case involving orange plantations in Florida that was decided by the Supreme Court in 1946. The Supreme Court basically gave four criteria for something to be considered a security. The four elements are as follows: [1] An investment of money [2] in a joint enterprise [3] with expectations of profit [4] to come from the efforts of others.

Crypto definitely involves the first three considerations. First, people use their money to buy crypto. Second, the tokens can be called a joint venture because the token generally has a special purpose. Third, most people who buy crypto want to make money. So what’s the wait?

The tricky part is the fourth condition, which basically states that most investors of securities depend on a certain group of people, such as the management of the company that owns the security, to ensure that profit is the result of their joint endeavor.

For example, Bitcoin was started by Satoshi Nakamoto, which is a pseudonym for possibly one or even a group of people. We do not know who this person (or persons) is and where he/she lives. So how can he/they be held accountable if we don’t even know who is in charge?

In addition, a new type of organization called a Decentralized Autonomous Organization (DAO) has emerged. People with a particular token pool their resources in a DAO and jointly decide how to proceed to achieve the goals. However, since ownership is decentralized, condition four of the Howey test becomes difficult to establish. This is reinforced by the fact that many people in crypto also use aliases and pseudonyms.

Nevertheless, Gensler will not back down. He has been condemned in various places for “regulating by enforcement” rather than clearly setting out the policy for crypto that the various tokens can follow. That will most likely change when the US Congress decides on clear laws to regulate the growing crypto sector, but it is challenging because many people do not understand what crypto and blockchain are.

Elected officials in the US have very polarized views on how it should be handled. Some want to ban it, while others want the US to retain a global leadership role and only want to regulate it.

Whatever Judge Torres decides will not necessarily derail the development of crypto and blockchain into our everyday lives. Indeed, clearly defining whether crypto is a commodity or security will clarify the way tokens can proceed going forward.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice regarding your specific situation.

Zain Jaffer is CEO of Zain Ventures with a focus on investments in Web3 and real estate.

This article was published through the Cointelegraph Innovation Circle, a researched organization of top executives and experts in the blockchain technology industry who are building the future through the power of connections, collaboration and thought leadership. Opinions expressed do not necessarily reflect those of Cointelegraph.

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