The risk of being a security rather than a commodity The risk of being a security rather than a commodity The risk of being a security rather than a commodity

The risk of being a security rather than a commodity

Mads Eberhardt

Cryptocurrency Analyst

Summary:  Following the collapse of crypto exchange FTX in November 2022, the call for crypto regulation is louder than ever, but the question that remains yet to be answered is in what manner the industry should be regulated. In the US, the SEC calls for jurisdiction over the market by classifying most cryptocurrencies as securities, whereas the market broadly calls for the classification as commodities, as the regulation would then be less strict. Next to Ripple, everyone’s focus is on Ethereum.


In our crypto note from earlier this week, we focused on the crackdown on crypto by the Securities and Exchange Commission (SEC) in the US, as the agency forced crypto exchange Kraken to shut down its staking service and plans a lawsuit against stablecoin issuer Paxos over its Binance-branded stablecoin. However, the last week is nothing from a regulatory frame of reference in case the majority of cryptocurrencies are deemed as securities, on which topic this note seeks to explain the potential consequences if various cryptocurrencies are classified as securities.

To set the scene, in the US and many other countries, stocks, bonds, options, and funds, among many other tradable instruments and contracts are largely deemed as securities. These are fungible assets with some sort of monetary value. In this article, we mainly focus on the legislation of securities in the US, as the US may impact the crypto market the most.

For an asset to be characterized as a security, it may qualify as an “investment contract” according to the Howey test, by which four joined criteria are specified. These four criteria suggest that 1) it must be an investment in a contract, transaction, or scheme 2) in a common enterprise 3) with an expectation of profit 4) thanks to the work of others. In case an asset is considered an “investment contract”, it is usually treated as a security. An asset may also be a security due to other tests, but the Howey test is arguably the most known test. Taking into account the arguably broad four criteria of the Howey test, an asset, including crypto, may be classified as a security by some and not by others, depending on the eye of the beholder.

The label of being a security

In most countries, it largely brings along strict regulation in case an asset is subject to the label of being a security. This includes the US in which such a label entails that the asset must be registered with the Securities and Exchange Commission (SEC), causing not only issuers but also exchanges to face much more regulatory scrutiny by the SEC, if most crypto-native exchanges are at all allowed to list cryptocurrencies classified as securities.

As to present US legislation, on the assumption that a cryptocurrency is not a security, it would likely qualify as a commodity. In this case, it is regulated by the Commodity Futures Trading Commission (CFTC). If an asset falls under the CFTC rather than the SEC, the regulation is much less strict. Due to this fact, the crypto market broadly advocates for the classification as commodities, as it would arguably provide a much-needed regulatory framework to restore trust in the crypto market but not overextend the regulation which is feared by many following the events in the last week.

The SEC considers most cryptocurrencies to be securities

The chair of the SEC by the name Gary Gensler stated in an interview last year that he believes that most cryptocurrencies are securities: “The law is clear. I believe based on the facts and circumstances most of these tokens are securities”. The only cryptocurrency that Gary Gensler has explicitly argued is a commodity rather than a security is Bitcoin.

To stress this view that most cryptocurrencies are securities, the SEC has most prominently launched a lawsuit against Ripple (XRP) in 2020 due to what they claim was an unregistered security offering. XRP has opposed this by arguing that XRP is not a security. At this point in time, the lawsuit has not reached a ruling, but Ripple CEO Brad Garlinghouse is optimistic that such a ruling will be reached this year. Yet, the lawsuit led major exchanges such as Coinbase and Kraken to suspend the trading of XRP, soon after the SEC initiated the lawsuit, largely because they may not have the necessary permissions and compliance in place to facilitate the trading of securities.

Last year, the SEC filed securities fraud charges against a former Coinbase employee for the misuse of confidential information. It involved nine crypto assets believed by the SEC to be securities, of which seven were tradable on Coinbase. The Chief Legal Officer of Coinbase named Paul Grewal responded by publishing an article by the title: “Coinbase does not list securities. End of story.”, in which he argues that Coinbase has a rigorous process to analyze and review each cryptocurrency, including whether it may be a security. He argues that this process has led Coinbase to not list any securities. The Department of Justice (DOJ) did not file securities fraud charges against the individuals, arguably as it did not consider them securities, contrary to the SEC.

Based on the statements by Gensler, Bitcoin is considered to be out of the scope of security laws, but the second-largest Ethereum is still yet to be out of the woods. In fact, next to XRP, all eyes are on Ethereum on whether it is a security or not, following its transition from proof-of-work to proof-of-stake in September 2022 known as the merge. Around the time of the merge, Gensler stated that cryptocurrencies based on proof-of-stake may then pass the Howey test. The crypto market was fast to conclude that it was a hint to Ethereum, although Gensler stated that he was not referring to any specific cryptocurrency. Talking of staking, on Thursday last week, Kraken agreed to pay $30mn to settle an SEC allegation that Kraken’s staking service was an illegal sale of securities and end its staking service to US clients, stressing the view that proof-of-stake cryptocurrencies might be securities.

The CFTC may consider Ethereum a commodity

If a cryptocurrency is not a security but a commodity in the US, it is largely regulated by the Commodity Futures Trading Commission (CFTC). The latter, however, does not appear to provide much clarity on whether certain cryptocurrencies, including Ethereum, are securities or not.

On November 30, 2022, CFTC chairman Rostin Behnam suggested that Bitcoin is the sole cryptocurrency to be viewed as a commodity. Yet, barely two weeks later, on December 13, 2022, the CFTC proclaimed Ethereum, alongside Bitcoin and Tether, as commodities in a court filing in a lawsuit against co-founder and former CEO of FTX and Alameda Research, Sam Bankman-Fried. So, the CFTC also has doubts about how to categorize Ethereum or is perhaps at this moment not much interested in tying itself down to a certain stance. It is not only the CFTC, the SEC, and crypto companies that appear to not have a common ground, as other market participants seem to have contradictory opinions as well. This disagreement and somewhat indecisiveness convey the impression that these stakeholders await the ongoing lawsuit against XRP before taking a thorough stance.

XRP serves as an example

The case of XRP serves as a fairly worst-case scenario when battling the SEC on security legislation. The lawsuit has been ongoing since late-2020 without a ruling, but with severe consequences for XRP, due to delisting across major exchanges servicing US clients fearing the outcome of the lawsuit. By retaining less exchange presence, a cryptocurrency loses its main gateway for not only end-users but developers as well. This has immense implications since both groups bring about value for the cryptocurrency by facilitating transfers on the blockchain and developing new applications. If an asset barely has exchange presence, it is rarely considered among end-users and developers.

Next to XRP, everyone’s focus is on Ethereum, as it might be the next target for the SEC, particularly if the XRP ruling is in the agency’s favor. Similar to the case of XRP, in the event that Ethereum is a security, the likely outcome is that exchanges must delist it and cease staking operations of Ether unless they obtain licenses to deal in securities. Relative to XRP, Ethereum has a much larger market capitalization and a lot greater ecosystem, so in case the SEC targets Ethereum, not only Ethereum might be severely negatively impacted, but perchance there will be a negative spillover effect to the whole crypto market, as it will be tougher for companies and decentralized protocols to survive in such a regulatory environment.

The above is surely an assumption based on present legislation, since the US may at some point fully adopt regulation tailored to the decentralized nature of cryptocurrencies to achieve a regulatory framework fitted for crypto, rather than regulate crypto based on frameworks intended for other asset classes. However, there are no guarantees that this will happen at all, so the present security legislation is a looming risk for crypto, while everyone awaits the XRP lawsuit.

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Trading in financial instruments carries risk, and may not be suitable for you. Past performance is not indicative of future performance. Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.