There has been much confusion over the classification of cryptocurrencies for regulation as well as consumer protection.
Too many people have lost too much money in exchange hacks and collapses – to say nothing of Initial Coin Offerings that eventually turned out to be scams.
By treating cryptocurrencies like stocks and cryptocurrencies like stock exchanges, it was initially intended to address this lacuna in the financial world. Would that have worked – and should that even have been contemplated, to begin with?
The SEC announcement
Last week, the Securities and Exchange Commission (SEC) of the United States of America (the US) unequivocally stated at the Yahoo Finance Summit that “Ether, the Ethereum network, and its decentralized structure, current offers, and sales of Ether are not securities transactions.”
Traders rejoiced by sending the price of Ether (ETH) up by at least 8%, although that was not the first time the SEC had taken that position on cryptocurrencies as a whole.
Earlier this year in April, the SEC had reported to the US Congress that “as a replacement for currency, Bitcoin has been determined by most people not to be a security.”
These statements have gone a long way towards clearing up the uncertainty in the cryptocurrency scene. That is because, in recent years, governments around the world have been unusually vocal about the possibility of introducing legislative regimes to regulate the scene.
Spurred by fears of money laundering and capital flight, as well as the bad press spawned in the wake of exchange hackings and scam Initial Coin Offerings (ICOs), governments have made all sorts of noises about passing various laws in an attempt to address these concerns.
The uncertainty thus generated had hitherto caused many to adopt a wait-and-see approach to determine if the scene will be straightened out – or merely wither on the vine as a result of curtailing the freedoms so necessary to its continued operation.
The SEC statements are also relevant because they indicate the current status quo in one of the world’s largest cryptocurrency markets.
Many exchanges around the world conduct their trades and transactions in US dollars as well. Therefore, any laws or regulations passed there can not only be expected to have a disproportionate impact on trading prices worldwide but also be copied or otherwise reproduced in other markets. As such, the effect of the SEC statements cannot be underestimated.
Prior examples to draw on
Treating cryptocurrencies as securities are not without precedent. In August last year, the Canadian Securities Administrators issued a notice that warned of the “potential applicability of Canadian securities laws to initial coin offerings…and initial token offering [and] cryptocurrency exchanges and cryptocurrency investment funds.” That was followed up by the head of Canada’s central bank, who noted in an interview given earlier this year that “[cryptocurrencies] are securities technically.”
More importantly, the Swiss government released the world’s first set of guidelines for treating cryptocurrencies as securities earlier this year in February.
The Swiss guidelines have therefore provided a useful starting point with which to assess whether cryptocurrencies should be treated as securities. In fact, the guidelines refer to cryptocurrencies as a sub-category of ICO “tokens”: the Swiss government has adopted a radically different approach from that of the US and Canadian examples in taking aim at ICOs instead of specific cryptocurrencies.
That approach appears to make more sense when considering that ICOs have not only made the news in recent years for all the wrong reasons, but also can and have in fact been used for launching blockchain tokens other than cryptocurrencies.
The Swiss guidelines have listed these tokens accordingly as: “payment tokens,” or cryptocurrencies; “utility tokens,” which are intended to provide access to applications or services; “asset tokens” which represent debt or equity claims such as a share in future company earnings, among other things.
The guidelines also noted that this system of classification is not mutually exclusive, as utility and asset tokens could also be listed as payment tokens – and therefore be deemed as both a means of payment as well as a security.
However, there is no definition in the guidelines as to what constitutes a security – and more pertinently, what a security is as opposed to being a means of payment.
A standard definition of a security is that of an investment product which can be readily exchanged for value and is subject to risk – that is, the possibility that some or all of the invested money in the product may be lost.
A simple application of the definition to the day-to-day business of cryptocurrency traders and exchanges would find a perfect fit: the Internet is awash with people complaining and bemoaning their losses from trades.
Even the vocabulary used has been borrowed from that of more established securities such as stocks and bonds: any talk of cryptocurrency trading will invariably invoke familiar terms such as “volume,” “holdings” and “pump and dump.”
Even so, that definition is not exclusive with being a means of payment. Payments are defined as the transfer of a good, service or financial asset in exchange for another good, service or financial asset, cryptocurrencies can and have already been exchanged for fiat currencies as well as a wide variety of goods and services from food to haircuts.
More than 370,000 businesses in over 200 countries around the world accept cryptocurrencies as payment, with even more set to follow in the foreseeable future. Even the likes of Goldman Sachs has conceded that Bitcoin is money after all.
The Swiss guidelines are therefore correct in stating that cryptocurrencies can be treated as a security as well as a means of payment.
The logical corollary then would be to ask why – given that no country in the world has done so even though cryptocurrencies fit the definition to a tee.
For all the sound and fury generated, the simple truth is that governments want to treat cryptocurrencies as a security because doing so would allow for greater regulatory scrutiny and oversight than in the current state.
That also would, by extension, force cryptocurrency exchanges to clean up their act as they are held to the same high standards as stock exchanges: for one, ICOs would require a lot more than just a song and a prayer, and have a real, functioning token underpinned by a working blockchain.
One or the other
Nonetheless, it is important to bear in mind that regulating cryptocurrencies as a security would not detract from their use as a means of payment.
The ability to transfer cryptocurrencies between wallets at will is fundamental to the very nature of cryptocurrencies themselves.
While stocks and shares cannot be transferred at will between smartphones in the same fashion, that is because they are governed by a separate legislative regime that sets out the conditions that have to be adhered to for transfer and ownership.
The unregulated and untrammeled state of cryptocurrencies right now is vital to their continued use as a means of payment, and if that means that they should not be treated as securities – then so be it.
Governments around the world will just have to be more creative in finding other ways to protect traders and exchanges.
For what it may be worth, the SEC’s statement was not only right – but instructive: “…what about cases where…the digital asset is sold only to be used to purchase a good or service available through the network on which it was created? I believe in these cases the answer is a qualified ‘yes.’”