Security or commodity? Crypto just wants to know

Editor’s note: Mergers and Money is a monthly column by senior reporter Chris Metinko that covers deals and the flow of venture capital.

Although crypto has historically tried to evade some labels — like “trend” or “fashion” — the industry seems ready for one from the US government.

While most people are fixated on the major declines cryptocurrencies have seen during the current “crypto winter,” perhaps the most interesting twist in the industry occurred last month when the US Securities and Exchange Commission filed insider trading charges against a Coinbase executive and two others who declared nine digital assets on the exchange platform were securities.

Why does it matter? Because it made what was scary even more opaque about how the US will categorize crypto and which agency will regulate it.

Item vs. Safety

It is probably important to have a cursory understanding of the differences between commodities and securities before delving too much into why crypto is important.

In layman’s terms, a security provides returns from a joint venture or company. Commodities are usually a “basic commodity” that can be bought, traded or bartered – think grain, beef or gold. Commodities are often considered stores of value because they hold their value over time – unlike, for example, shares in Webvan at the time, which were securities.

Some cryptoassets such as Bitcoin certainly share the characteristics of a commodity. They are inherently designed to be decentralized and therefore do not provide returns from a joint enterprise or business. Cryptocurrencies were also created as something that can stand in place of money, such as the US dollar, making it a store of value.

These characteristics have led to crypto being regulated by the Commodity Futures Trading Commission – not the SEC.

That position has only seemed to be strengthened by recently proposed bills like this month’s Digital Commodities Consumer Protection Act of 2022 and the Responsible Financial Innovation Act announced in June, which seek to set new rules for the growing digital asset space, but which will apparently keep industry under the control of the Commodity Futures Trading Commission.

So what’s going on with the SEC and Coinbase?

That’s what makes the SEC indict the industry. SEC Chairman Gary Gensler has issued stern warnings and offered skepticism about the digital asset market in the past. While he agrees that Bitcoin is a commodity, Gensler points out that initial coin offerings bear more than a passing resemblance to securities since they are attempts to raise capital for a business or project.

Being seen as a security can change the industry. Commodities are generally considered more lightly regulated, while securities require greater transparency and increased reporting from companies in that market.

For that reason, the general feeling is that keeping crypto under the CFTC’s view would be a win.

For its part, Coinbase made clear where it believes it stands regarding the SEC action.

“Coinbase does not list securities on its platform. Period.” wrote Coinbase’s Chief Legal Officer Paul Grewal in a blog after the SEC announced charges.

The SEC action even drew the attention of CFTC Commissioner Caroline Pham, who tweeted that the action was “a striking example of ‘regulation by enforcement'” by the SEC.

“The SEC’s allegations could have broad implications beyond this single case, and underscore how critical and urgent it is for regulators to work together,” she added.

Where we are

Where the SEC’s action and the increased talk this year about crypto and regulation leads is anyone’s guess. However, it seems likely that the discussion of how crypto and digital assets are defined and categorized will only begin.

“I think this is the beginning of this debate about how it will be regulated,” said William Powers, a partner at Nossaman LLP who has worked with crypto advocacy groups on lobbying compliance.

Powers said that while bills on crypto regulation have been proposed, President Joe Biden’s executive order on crypto from March called for a report from all relevant government agencies on the future of money and payment systems — so the conversation is still strongly evolving.

It is also possible that crypto may not fit any definition and needs to be regulated in a different way – something many in the industry believe. Even Gensler said earlier this year that his agency is considering how to divide oversight of the industry between the SEC and the CFTC.

While that might make sense, both agencies are overseen by different Senate committees, so it might be a difficult path to chart.

One thing that is certain is that from investors to founders to everyone else in crypto, almost everyone just wants to know the rules going forward – be it labeled as a security or a commodity.

Investors, for example, hate uncertainty. While the crypto venture market has remained robust this year — with more than $10 billion invested so far, according to Crunchbase data — those in the market will undoubtedly want answers sooner rather than later.

“The common theme is that people want clear rules,” Powers said. “They want to know which definition applies. They want clarity.”

Further reading:

Illustration: Dom Guzman

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