The Uncertain Future of Cryptocurrency Investing

 

An ongoing debate in cryptocurrency circles could soon be decided by a federal court. Three Coinbase users have initiated a class-action lawsuit against the crypto exchange because it hasn’t registered with the Securities and Exchange Commission (SEC). They claim that users should be reimbursed for trading losses up to $5 million. Coinbase has filed a motion to have the lawsuit dismissed.

 

Are Coinbase Listings Securities or Commodities?

At the heart of the issue is whether cryptocurrencies listed on Coinbase should be considered securities or commodities.

 

Last September, SEC Chairman Gary Gensler told the Senate Banking Committee that Coinbase has not registered with the regulatory agency “even though they have dozens of tokens that may be securities.” In March, President Joe Biden signed an executive order to initiate a study on cryptocurrencies to determine how they should be regulated. Until that is settled, there will remain some regulatory uncertainty regarding how crypto exchanges like Coinbase should be regulated.

 

To complicate matters, the SEC has already initiated action on some blockchains regarding unregistered securities.

 

In 2019, the SEC settled a dispute with Block.One over its cryptocurrency EOS when the blockchain company agreed to pay a $24 million civil penalty for raising capital through an initial coin offering (ICO) in 2017 and 2018. The SEC’s position is that ICOs are unregistered securities and Block.One is just one of several blockchain companies the SEC has pursued regarding violations of securities laws. EOS is still listed on Coinbase.

The SEC has also taken action against Ripple, creator of XRP. The outcome of that lawsuit has yet to be determined. Ripple and its executives continue to maintain that XRP is not a security.

 

What Determines Whether a Cryptocurrency is a Security or a Commodity?

Since 1946, the law applied a four-part analysis to investments in various classes to determine whether they are securities and subject to regulatory constraints outlined in The Securities Act of 1933 and the Securities and Exchange Act of 1934. That analysis is called the Howey Test.

 

The four criteria that determines whether an investment is a security or not are:

  • It involves an investment of money
  • In a “common enterprise”
  • With profit expectations
  • Derived from the efforts of others.

 

A major contention with many tokens, including XRP, is whether the investment of money with profit expectations are derived from the efforts of others. Since XRP is independent of its creator, Ripple Labs, XRP would continue to operate, and investors could profit even if the company were to go away. Unlike traditional stocks, which represent shares in a company that disappear should the company dissolve, decentralized blockchains and decentralized apps on blockchains continue to operate even if the company’s that found them go away.

 

While securities are financial instruments, commodities are goods that serve a utilitarian purpose. They are interchangeable with other goods of the same type. Common commodities include precious metals, agricultural products, crude oil, and livestock.

 

While people can invest in both commodities and securities, they are not interchangeable. Buying $100 worth of shares in Exxon Mobile, for instance, is not the same as investing $100 in crude oil. And this is the sticking point with whether crypto exchanges like Coinbase are dealing with securities, commodities, or neither.

 

Earlier this year, Coinbase CEO Brian Armstrong commented on the SEC’s case against Ripple saying that not all cryptocurrencies are securities. In fact, he pointed out that some are also commodities while others are currencies.

 

When the classifications are sorted out, Coinbase could be subject to regulatory oversight from either the SEC, the Commodity Futures Trading Commission (CFTC), or both. Until then, investors and exchanges are navigating a path of uncertainty.

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