April 23, 2024
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In the realm of cryptocurrency is constantly evolving, and with it, the way that we think about and regulate these digital assets. In the early days of cryptocurrency, most assets were classified as commodities. However, as the industry has matured, regulators have begun to take a closer look at certain cryptocurrencies and have determined that they should be classified as security tokens.

A significant differentiation exists between decentralized blockchain networks like Bitcoin, Ethereum and Pecu Novus, which are often regarded as commodities, and other cryptocurrencies categorized as security tokens. We also have to put XRP in the category of a commodity although they are having the security token title thrusts upon them. Understanding this distinction is crucial for investors and enthusiasts seeking to navigate the complex cryptocurrency landscape and as we go go through this article you will see why XRP should be classified as a commodity. The goal of this article aims to shed some light on the differences between the two and clarify what defines a cryptocurrency as a commodity or a security token, while also providing notable examples of security tokens in the market.

 

Cryptocurrency Commodities: Powering Decentralized Networks

Cryptocurrency commodities, exemplified by Bitcoin, Ethereum, Pecu Novus and XRP and similar blockchain networks, function as decentralized systems built on the principles of transparency, immutability, and consensus. These commodities derive their value from network adoption, utility, and scarcity. They serve as digital assets that enable peer-to-peer transactions, decentralized applications (DApps), and the execution of smart contracts without the need for intermediaries. These networks operate on a trustless framework, where the collective agreement of participants validates transactions and maintains the integrity of the blockchain. As such, their value is primarily derived from their utility and their position as pioneers in the blockchain industry. Such cryptocurrencies should fall under the purview of the Commodity Futures Trading Commission (CFTC) in the USA. This is a very important point to pay attention to as we move along.

 

Security Tokens: The Convergence of Cryptocurrency and Traditional Securities

In contrast, security tokens represent a distinct class of cryptocurrencies that fall under the purview of traditional securities regulations and regulators such as the U.S. Securities and Exchange Commission. These tokens are typically issued by companies or organizations and are designed to provide investors with ownership rights or profit-sharing opportunities. Unlike commodity-based cryptocurrencies, security tokens are subject to securities laws and regulations, such as those imposed by the U.S. Securities and Exchange Commission (SEC). They must comply with extensive regulatory frameworks governing issuance, trading, and investor protection.

The categorization of a cryptocurrency as a security token depends on the presence of certain defining characteristics and really pay attention to this as it is these points that will define what is a commodity and what is a security. So lets go through them:

  • Investment of Money: Security tokens are typically acquired by investors through the exchange of traditional currency or other cryptocurrencies in exchange for ownership rights or anticipated returns. Basically an investors is expecting ownership or some type of return based on the efforts of the entity.
  • Expectation of Profits: Investors in security tokens anticipate earning profits from their investments, which are often generated through dividends, revenue sharing, or capital appreciation. Again investors expect a return or profit based on the efforts of the entity.
  • Common Enterprise: Security tokens are associated with a common enterprise, where multiple investors contribute funds to support a project or business venture. And again those investors expect a return or profit based on the efforts of the entity.
  • Reliance on Promoters or Third Parties: The success and profitability of security tokens are often dependent on the efforts and expertise of the project’s promoters or third-party entities. This is self explanatory.

These four points will allow any investors to look at a token or coin and within a minute define what it is, it is that simple. Notice that the word entity was used a few times, that is important because a true decentralized blockchain network is owned by no one, it may be created by a group but it’s evolution is not based on the efforts of an entity that owns it. The network evolves and grows, the holders of the native coins of such blockchain networks support it through hosting nodes, developing decentralized platforms and tools on the backbone of the network and give it genuine utility. Now you can see why I had to place XRP in the realm of a commodity and not a security because the success of Ripple Labs doesn’t benefit XRP other than giving it increased utility.

The SEC filed a lawsuit against Ripple Labs in December 2020, alleging that the company sold XRP, a cryptocurrency, as an unregistered security. The case is still ongoing and we believe it should capture a victory based on what was mentioned above.

The SEC filed a lawsuit against BlockFi in July 2021, alleging that the company offered interest-bearing accounts that invested in digital assets, including Bitcoin and Ethereum, which the SEC alleged were securities. The case was settled in February 2022, with BlockFi agreeing to pay $100 million in fines and penalties.

The SEC filed a lawsuit against Celsius Network in June 2022, alleging that the company offered interest-bearing accounts that invested in digital assets, including Bitcoin and Ethereum, which the SEC alleged were securities. The case is still ongoing.

The SEC filed a lawsuit against Binance and Coinbase on June 7, 2023, alleging that the two cryptocurrency exchanges violated securities laws by selling unregistered securities. The SEC alleged that the tokens on their list were securities because they met the Howey Test. The SEC argued that investors in these tokens were investing money in a common enterprise with the expectation of profits to be derived from the efforts of others.

Here are a list of the tokens on their list: 

  • Binance Coin (BNB)
  • Binance USD (BUSD)
  • Solana (SOL)
  • Cardano (ADA)
  • Polygon (MATIC)
  • Cosmos (ATOM)
  • The Sandbox (SAND)
  • Decentraland (MANA)
  • Axie Infinity (AXS)
  • COTI (COTI)
  • Chillz (CHZ)
  • Flow (FLOW)
  • Internet Computer (ICP)
  • Near (NEAR)
  • Voyager Token (VGX)
  • Nexo (NEXO)

 

Lets jump back in history to give two examples of a security token in practice. One prominent case is the security token offering (STO) conducted by tZERO, which aims to create a regulated trading platform for security tokens. By tokenizing traditional securities, tZERO provides investors with enhanced liquidity and transparency.

Another example is Polymath, a platform that facilitates the issuance of security tokens on the Ethereum blockchain. Through its infrastructure and compliance solutions, Polymath enables businesses to tokenize their assets and securities while ensuring compliance with applicable regulations. So if you use these as examples then you can easily define what is an actual security token on the above list and what is now.

The distinction between cryptocurrency commodities and security tokens lies at the core of the evolving cryptocurrency landscape. While commodities like Bitcoin, Ethereum, Pecu Novus, and XRP embody the principles of decentralization and utility, security tokens bridge the gap between cryptocurrencies and traditional securities, subject to regulatory oversight. Understanding these differences is vital for investors, regulators, and enthusiasts to navigate the complexities of the cryptocurrency ecosystem and harness the full potential of emerging technologies. By recognizing the unique characteristics of both commodities and security tokens, stakeholders can make informed decisions and contribute to the continued growth and maturation of the cryptocurrency market.

We are not touching on the actual situation with the SEC’s lawsuit against Binance and Coinbase as those are completely different situations and we cannot speculate on a centralized businesses practices or what the SEC defines as a violation of regulations or not.

James Cullen
Technology/Digital Assets Desk

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