Contents
With the rise of Bitcoin and other cryptocurrencies, the question of whether or not digital assets are considered securities has come to the forefront. In this blog post, we’ll explore the definition of a security and whether or not crypto assets fall under this category.
Checkout this video:
Introduction
Cryptoassets, or “cryptocurrencies,” are a type of digital asset based on cryptography. Cryptocurrencies are decentralized and often anonymized, making them popular among some users who value privacy. Bitcoin, the first and most well-known cryptocurrency, was created in 2009. Cryptocurrencies are often bought and sold on decentralized exchanges and can also be used to purchase goods or services. Some countries have taken steps to regulate cryptocurrencies, but their use remains largely unregulated globally.
Cryptocurrencies are not considered securities in the United States. The U.S. Securities and Exchange Commission (SEC) has stated that cryptocurrencies are not securities and that cryptocurrency exchanges are not required to register with the SEC as broker-dealers. However, the SEC has also indicated that some digital assets may be considered securities, depending on their structure and use. For example, initial coin offerings (ICOs) may be considered securities if they meet certain criteria.
What is a security?
A security is a tradable asset of any kind. More specifically, a security is a financial instrument that represents some type of financial value. For example, common stocks and bonds are both considered securities.
The key distinguishing factor that separates securities from other assets, such as commodities or real estate, is that securities can be bought and sold easily on public markets. This liquidity makes them attractive to investors who want to buy or sell quickly and without having to go through a long and complicated process.
Cryptocurrencies, such as Bitcoin and Ethereum, are often considered securities because they can be bought and sold on public markets. In addition, many ICOs (Initial Coin Offerings) have also been classified as securities by regulators.
The main reason why cryptocurrencies are considered securities is because they meet the definition of an “investment contract.” An investment contract is an agreement between two parties (typically an issuer and an investor) in which the investor agrees to provide capital to the issuer in exchange for some type of future financial benefit. For example, when you buy a stock, you are investing in the company and expecting to make money from the appreciation in value of the stock or from dividends paid out by the company. With cryptocurrencies, you are often investing in the development of the underlying blockchain technology and expecting to make money from the appreciation in value of the token or from dividends paid out by the company.
While not all cryptocurrencies are considered securities, many ICOs have been found to meet the definition of an investment contract and have been regulated as such by various governments around the world.
What is cryptocurrency?
Cryptocurrency is a type of digital asset that uses cryptography to secure its transactions and to control the creation of new units of the asset. Cryptocurrency is decentralized, meaning it is not subject to government or financial institution control. Bitcoin, the first and most well-known cryptocurrency, was created in 2009. Cryptocurrencies are often traded on decentralized exchanges and can also be used to purchase goods or services.
The Howey Test
In order to determine whether a financial product is considered a security, courts in the United States apply the so-called Howey test. This test was laid out in a 1946 Supreme Court case, SEC v. W.J. Howey Co., and it has been used ever since to evaluate whether certain transactions qualify as “investment contracts.”
Under the Howey test, a transaction is an investment contract if (1) there is an investment of money, (2) in a common enterprise, (3) with the expectation of profits, principally from the efforts of others. In the cryptocurrency context, courts have held that virtual tokens may be considered securities if they satisfy all three prongs of the Howey test.
For example, in 2017, the U.S. District Court for the Eastern District of New York held that virtual tokens called “GTOs” were securities under the Howey test because investors reasonably expected to profit from the managerial efforts of others. The court reached a similar conclusion with respect to virtual tokens called “WeTokens” in 2019.
Other courts have disagreed on whether particular virtual tokens are securities. For instance, in 2018, the U.S. District Court for the Northern District of California found that virtual tokens called “BCOs” were not securities under Howey because they were not purchased with the reasonable expectation of profits derived from the entrepreneurial or managerial efforts of others—even though there was an investment of money and a common enterprise.
The SEC has also taken action against companies that it believes have sold unregistered securities in the form of digital tokens. In 2019, for example, it charged an internet social media company and its founder with defrauding investors by selling digital tokens that were purported to be investments in two new cryptocurrency ventures.
Applying the Howey Test to Cryptocurrency
In order to answer the question of whether or not cryptocurrency is considered a security, we must first apply the Howey Test. The Howey Test is a legal test that is used to determine whether or not an investment is a security. Let’s take a closer look at how the Howey Test is applied to cryptocurrency.
Investment of money
To answer the question of whether crypto is considered a security, we must look at the definition of an “investment contract” under U.S. Securities Law. In 1946, the U.S. Supreme Court created the Howey Test in order to determine whether certain transactions qualified as “investment contracts.” In order for a transaction to be considered an investment contract under the Howey Test, it must involve:
1.An investment of money
2.In a common enterprise
3.With an expectation of profits
4.To be derived from the managerial efforts of others
If all four of these factors are met, then the transaction will likely be considered an investment contract (and therefore a security) by U.S. regulators
Common enterprise
The first part of the Howey Test requires that there is a common enterprise. In the context of cryptocurrency, a common enterprise typically means that investors pool their money together in order to purchase cryptocurrency. For example, if you and 10 other people each contribute $100 to an investment, you would have $1,000 to purchase cryptocurrency. In this case, all 11 people are invested in a common enterprise.
There are a few different ways that people can pool their money together to purchase cryptocurrency. The most common way is through an initial coin offering (ICO). With an ICO, investors send money (usually in the form of Bitcoin or Ethereum) to a blockchain project in exchange for new tokens that will be used on the project’s platform. For example, if you wanted to invest in the development of a new cryptocurrency, you could send Bitcoin to the team behind the project and receive their new tokens in return.
Another way to pool money together is through a cryptocurrency exchange. On a cryptocurrency exchange, people can buy and sell existing cryptocurrencies like Bitcoin and Ethereum. For example, if you wanted to invest $100 in Bitcoin, you could go to an exchange and purchase $100 worth of Bitcoin. You would then own those Bitcoins and could hold onto them or sell them at a later date.
Expectation of profits
In order to determine whether a digital asset is a security, we need to look at the expectations of profits associated with the investment. The “Howey Test” is a test created by the US Supreme Court to determine whether certain transactions qualify as “investment contracts”. If something meets all of the criteria of the Howey Test, it is considered a security. So, how does this apply to cryptocurrency?
The key question is whether there is an “expectation of profits”. In order for there to be an expectation of profits, there must be an investment of money. There must also be a common enterprise – meaning that investors pool their money together in order to invest in something. Finally, there must be a third party who manages the enterprise and distributes the profits to investors.
When it comes to cryptocurrency, we can see that there is an investment of money (in the form of buying cryptocurrency tokens). There is also a common enterprise – most cryptocurrencies are invested in through a cryptocurrency exchange. And finally, there is a third party involved in managing the enterprise (in the form of the exchange). Based on this, it seems that cryptocurrency would qualify as a security under the Howey Test.
Conclusion
It is still unclear whether or not crypto is considered a security. However, the SEC has said that some digital tokens may be securities and therefore subject to federal securities laws. The SEC has also been taking action against companies that have conducted initial coin offerings (ICOs) without registering them as securities offerings. For now, it is advisable to consult with a lawyer before conducting an ICO to ensure that it does not violate securities laws.
