Education
What is Cryptocurrency — And why should this matter to you?
•
Published
Wednesday, September 21, 2022
•
3 min read
Published
Wednesday, September 21, 2022
•
3 min read
One attractive aspect of cryptocurrency is that it has historically existed, to a great extent, outside the purview of government regulation - and, as some would incorrectly like to think - taxation. This lack of oversight has allowed cryptocurrency to operate and be traded almost instantly among a large cohort of users. However, the lack of regulation has also allowed crypto to be extremely volatile, susceptible to fraud, and without sufficient investor protections.
Both the US Commodities Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) have attempted to lay claim to regulating crypto (with the US Department of the Treasury chiming in too, of course, as we now see in our tax returns).
One reason for digital assets having largely skirted more meaningful regulation to date is because defining just what they are has been such a challenge. And until these assets are definitively categorized as a security or a commodity, neither the CFTC nor the SEC can assert full jurisdiction over regulating them.
So what are the factors that may determine whether crypto will fall to the long arm of the CFTC or the even longer arm of the SEC?
Digital assets would have to meet the definition of a commodity to be regulated by the CFTC - and, in some ways they do. You may think of a commodity as raw materials, like grains, iron ore, or even gold and silver. And you would be right. What these things all have in common is that they are fundamentally fungible (i.e. interchangeable) with each other. A bushel of corn is a bushel of corn. The same can be said for digital assets. One ETH or BTC is as good as another ETH or BTC.
Plus, they are traded in a decentralized fashion - between peers.
For a digital asset to fall squarely within the scope of SEC oversight, it would have to be viewed as tantamount to an investment contract. This specifically means it must meet a three-pronged test (defined by case law), wherein it is (1) the investment of money (2) in a common enterprise (3) with a reasonable expectation of profits to be derived from the efforts of others.
Cryptocurrencies also use Initial Coin Offerings to raise capital - similar in process to an IPO. Additionally, tokens, like stocks that are regulated by the SEC, are generally issued by a centralized party.
The future of cryptocurrency regulation in the US depends on its classification. But why should you care if digital assets are regulated by the SEC or the CFTC? Government regulation is government regulation, right? Well, not quite.
The tension over classifying cryptocurrency as a security or a commodity has a significant impact on the extent to which investor protection (and, of course, government scrutiny) should exist in what is yet a new and volatile market.
If digital assets are declared to be commodities, then the restrictions and regulations will generally be less stringent, giving investors more freedom (as well as greater risk exposure) and allowing entrepreneurs to define the system through more innovation.
On the other hand, if digital assets are defined as securities, then the SEC will demand greater price transparency and reporting demands, as well as market abuse oversight. Although this provides investors more protection, it also limits the freedom of the market. Securities — as opposed to commodities — are strictly regulated and require detailed disclosures to inform investors of potential risks.
The truth is that cryptocurrencies are more of a hybrid of securities and commodities - likely deserving of definition as a new asset class, rather than being forced into the strictures of other asset classes, with which they do not hold parity. However, from the government’s perspective, it will be more expedient to slot crypto into an existing asset class to benefit from settled rules and regulations that can be immediately applied.
However this plays out, the impact will help determine how wildly (or not) cryptocurrencies will be allowed to grow. It will also dictate their level of regulation (and possibly taxation), in addition to just how much information the government demands to know about participants in the market.
