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The Great Battle of Asset Classification – Blockchain News, Opinion, TV and Jobs
Guest post by Giovanni Populo
The SEC has charged two major cryptocurrency exchanges: Binance and Coinbase. A common charge between both exchanges is that they offered unregistered securities on their platforms.
1.1 Security vs. Commodity
A security is a financial asset that represents an investment and has an inherent value. It can be traded on a secondary market and its value is derived from a claim on assets or earnings. The Howey Test, established by the Supreme Court and very well-known by the market, is often used to determine whether an asset is a security. The test has four requirements:
- Investment of Money: There must be an investment of money or some form of contribution.
- Common Enterprise: The money must be invested in a common enterprise, meaning that the fortunes of the investor and the promoter are interlinked.
- Expectation of Profit: The investor must have an expectation of profit.
- Efforts of Others: The investor must enter into the investment with the expectation that they will receive a return or profit on their investment. This profit could come in the form of dividends, revenue share, price appreciation, or other financial returns. The key point is that the investor is motivated by the prospect of a financial gain from their investment.
A commodity, on the other hand, is a basic good that is used as an input in the production of other goods or services. Its value is derived from its inherent properties and usefulness. While there isn’t a specific test like the Howey Test for commodities, they generally have the following characteristics:
- Interchangeability: Commodities of the same type are identical to each other, regardless of who produced them.
- Used in Production: Commodities are often used as inputs in the production of other goods or services.
- Inherent Value: The value of a commodity comes from its inherent properties and usefulness, not from the efforts of others.
- Traded on Commodity Markets: Commodities can be bought and sold on commodity markets.
1.2 Easy-to-Understand Examples
An example of security could be a share of stock in Apple Inc. When you buy a share of Apple Stock ($A ), you are buying a piece of the company and have a claim on part of the company’s assets and earnings.
An example of a commodity could be the lithium used in the production process of the iPhone, which is later on transformed into batteries. Lithium from different sources is considered identical and interchangeable. Its price is uniform across the market, barring quality differentials.
II. Applying the Concept to Cryptocurrencies
Bitcoin and Ethereum were NOT mentioned by the SEC in any of the lawsuits, which suggests that their interpretation is more towards commodities than securities – or at least they are not sure about them. In recent hearings, SEC representatives have been inconsistent in their stance, raising concerns over its capacity to interpret digital assets.
But, what would be the technical interpretation of such assets, considering current market understanding and past rulings?
2.1 Bitcoin (BTC)
Bitcoin is a decentralized digital currency without a central bank or single administrator. It can be sent from user to user on the peer-to-peer Bitcoin network without the need for intermediaries.
Let’s see how the Howey Test looks would apply:
- Investment of Money? Check.
- Common Enterprise? Nope, Bitcoin’s value is not tied to the fortunes of a separate enterprise.
- Expectation of Profit? Check, many people buy Bitcoin with the expectation of profit.
- Efforts of Others? Nope, Bitcoin’s value does not come predominantly from the efforts of others.
What about commodities?
- Interchangeability? Check.
- Used in Production: Somewhat. Bitcoin is not used as a direct input in production, but rather energy is. However, Bitcoin is used for the production of the information registry that we usually call blockchain.
- Inherent Value: Check.
- Traded on Commodity Markets: Check.
General market interpretation tends to think of $BTC as a Commodity.
Note: This is not an official classification, but rather an opinion based on common sense and talks by SEC representatives that signal the same direction. As mentioned previously, the SEC is still debating such classifications, and as of now, there are no concrete answers by US government agencies.
2.2 Ethereum (ETH)
Ethereum is an open-source, blockchain-based platform that enables developers to build and deploy decentralized applications (dApps). Its native cryptocurrency is called Ether (ETH).
Let’s try the Howey Test again:
- Investment of Money: Check.
- Common Enterprise: Nope, Ether’s value is not tied to the fortunes of a separate enterprise.
- Expectation of Profit: Check, many people buy Ether with the expectation of profit.
- Efforts of Others: No, Ether’s value does not come predominantly from the efforts of others.
What about the commodity characteristics?
- Interchangeability? Check.
- Used in Production: Check.
- Inherent Value: Check.
- Traded on Commodity Markets: Check.
General market interpretation, in the case of $ETH, is split due to staking features, but considering just the checklists above, closer to a Commodity than Security.
Note: Same as the previous note, not a formal legal classification, but rather just market opinion.
It is important to understand that crypto assets are very new compared to traditional assets, and the classification guidelines covered above were built only for the latter – TradFi. As proposed by Gabriel Shapiro on Twitter, we should start discussing alternative classifications when dealing with digital assets, as to consider the new variables introduced by blockchain technology. As he proposes, digital assets could be a security and a commodity at the same time, depending on different requirements. His idea would work as below:
Security
- Insiders’ tokens (even if from end-user distributions)
- Tokens sold by insiders to third parties, if the relevant system is not yet functional and decentralized
Commodity
- Tokens from “end user distributions” (mining, airdrop, etc. for a functional system)
- Tokens intrinsically relating to a functional, decentralized system
- Stablecoins
In short, this would interpret tokens as security or commodity depending on how it was acquired (investors, ICOs), use case (e.g. utility vs. stablecoin), and ecosystem decentralization level.
Clearly, such a proposal makes a lot of sense to the crypto market, since it applies key features and characteristics to classify an asset as one or the other. This is just one example of an alternative approach, but that should serve as motivation for us to contribute to the discussion and create our own versions of it.
The legal drama involving the U.S. Securities and Exchange Commission (SEC) and major cryptocurrency exchanges, Binance and Coinbase, has left the crypto world speculating on the potential implications and outcomes. The charges in question pertain to the alleged offering of unregistered securities, including but not limited to ADA, SOL, MATIC, and BNB. As it is critical to understand, these are currently just allegations and the legal process is yet to run its course. The final decision on these cases could serve as a regulatory beacon, profoundly impacting the crypto industry at large. So, what could these implications look like under different scenarios?
In one scenario, the SEC emerges victorious in its lawsuits, setting a precedent for stricter regulatory oversight of crypto exchanges. This would likely mean a redefinition of what constitutes security within the crypto domain, potentially based on parallels drawn from the projects the SEC has claimed to be securities. In this scenario, it’s plausible that we’ll witness an influx of enforcement actions against other platforms that fall within similar operational characteristics. A heavier regulatory environment could stifle innovation or push it offshore, leading to a challenging environment for U.S-based exchanges and Web3 projects. This scenario seems to be unlikely given the complexity of crypto assets and the evolving dynamics of the crypto market. Moreover, as some experts suggest, imposing traditional security laws on crypto assets could create more regulatory confusion rather than clarity.
The other sees the SEC losing the lawsuits, resulting in a much broader interpretation of cryptocurrencies as commodities. This could potentially loosen the grip of regulatory oversight, providing room for the crypto industry to flourish. Yet, the downside is that without proper guidelines, there could be an increased risk for investors, which could, in turn, affect the overall market stability.
Looking ahead, we find ourselves at a crossroads. The conclusion of these legal cases will significantly influence the regulatory landscape for crypto in the U.S. and likely globally. If I were to guess, I’d suggest that the degree of decentralization within networks could become a determining factor in classifying something as a security. Brand new regulation for digital assets also seems to be a likely outcome.
Looking beyond the immediate challenges, we need to continue fostering open discussions around digital asset classifications and encouraging innovation within the regulatory frameworks. We should support efforts that aim to find a balance between facilitating crypto’s immense potential and safeguarding the interests of all participants. After all, the goal is to ensure that the crypto industry thrives, regardless of the legal and regulatory environment it operates in.
Always forward-looking, always ahead of the game. Let’s keep the conversation going.
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June was a tough month for Binance, as it faced stress tests worldwide after the United States Securities and Exchange Commission (SEC) filed a lawsuit against the crypto exchange and its leadership.
In a nutshell, over the past 30 days, the Belgian financial regulator ordered Binance to cease all crypto services, the exchange failed to obtain a license in the Netherlands, Binance’s Brazil head has been subpoenaed to appear before Congress concerning a Ponzi scheme investigation, and just a few days ago, another ongoing investigation in France became public.
And there’s more: Binance’s United Kingdom-based subsidiary canceled its registration with the Financial Conduct Authority, and in the U.S., the exchange still has a long road ahead in its struggle with regulators. Moreover, the exchange was denied a crypto custody license in Germany and lost its euro banking partner.
Yet, despite all these developments, Binance remains untouched as the top dog among centralized exchanges, with $58.11 billion in total value locked, down from $63.8 billion on June 1, according to data from DefiLlama. The exchange’s next big focus is in the United Arab Emirates, an allegedly “prime destination” for crypto businesses seeking a clear path forward.
“We keep building,” Binance CEO Changpeng Zhao said in a tweet on June 28, following a long and hectic month.
This week’s Crypto Biz looks at the story behind Binance’s debanking in Australia, Bitcoin (BTC) miners preparing for the next halving, MicroStrategy’s latest Bitcoin purchase and Bitfinex’s expansion in Latin America.
Binance Australia got 12 hours’ notice before it was debanked, exec says
There was no prior warning, consultation or redress. In the middle of the night, Binance Australia’s team was suddenly told it would be “cut off” from the country’s banking system. Binance regional manager Ben Rose shared details of the exchange’s debanking in the country at the Australian Blockchain Week on June 26. In May, the company announced that its dollar services were suspended after its payments provider Zepto was told to discontinue support for Binance. According to Rose, the move impacted around 1 million Australian-based customers, with Binance now seeking an alternative payment provider.
Riot Platforms to add 33,000 Bitcoin miners ahead of 2024 halving
Bitcoin miner firm Riot Platforms is loading up for the next halving cycle by purchasing 33,280 “next-generation” rigs for its Texas facility, costing $162.9 million. The miners, which were sourced from MicroBT, will boost the firm’s self-mining capacity by 7.6 exahashes per second (EH/s) to 20.1 EH/s once the machines are installed in the first quarter of 2024. Among the machines, 8,320 are M56S+ models with a hash rate of 220 terahashes per second (TH/s), while the remaining 24,960 M56S++ are slightly more powerful at 230 TH/s.
MicroStrategy buys $347 million worth of Bitcoin amid market thaw
MicroStrategy announced the purchase of 12,333 Bitcoin on June 28, worth $347 million at publication. MicroStrategy now owns 152,333 BTC worth $4.52 billion, with an average purchase price of $29.668 per coin. The coins were bought between April 27 and June 27, with the purchase partly financed by the issuance of new stock. MicroStrategy has been actively purchasing Bitcoin using cash and stock financing during the crypto bear market, sometimes irrespective of price. In Q1 2023, the firm reported its first profitable quarter since 2020 due to a one-time income tax benefit.
MicroStrategy has acquired an additional 12,333 BTC for ~$347.0 million at an average price of $28,136 per #bitcoin. As of 6/27/23 @MicroStrategy hodls 152,333 $BTC acquired for ~$4.52 billion at an average price of $29,668 per bitcoin. $MSTR https://t.co/joHo1gEnR0
— Michael Saylor⚡️ (@saylor) June 28, 2023
Bitfinex launches P2P trading platform in Venezuela, Argentina and Colombia
Digital asset exchange Bitfinex is expanding its operations to Latin America. The crypto company has launched a peer-to-peer trading platform in Venezuela, Argentina and Colombia, allowing users in the South American nations to buy and sell Bitcoin, Ether (ETH), Tether (USDT), Tether’s euro-pegged stablecoin, Tether EURt (EURT), and Tether Gold (XAUT). In April, Bitfinex’s El Salvador arm received a digital asset service provider license from the National Digital Asset Commission. Last month, the exchange partnered with Chile-based crypto platform OrionX to support local education and financial literacy programs.
Crypto Biz is your weekly pulse of the business behind blockchain and crypto, delivered directly to your inbox every Thursday.
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