Is crypto a commodity or a security?

This case goes beyond the survival of Ripple and XRP. It actually lays the predicate for the SEC to charge many of the other cryptos as securities.

The crypto industry waits anxiously for the decision of Judge Analisa Torres of the Southern District Court of New York on the Securities and Exchange Commission (SEC) versus Ripple Corporation case. Ripple owns the popular XRP crypto token, which is currently still in the Top 10 of Coinmarketcap.com, a popular token-tracking website.

The SEC charged in December 2020 that “Ripple raised funds, beginning in 2013, through the sale of digital assets known as XRP in an unregistered securities offering to investors in the U.S. and worldwide. Ripple also allegedly distributed billions of XRP in exchange for non-cash consideration, such as labor and market-making services.” 

In addition, the charge alleges that company executives Christian Larsen and Bradley Garlinghouse “also effected personal unregistered sales of XRP totaling approximately $600 million.” It further alleges that “the defendants failed to register their offers and sales of XRP or satisfy any exemption from registration, in violation of the registration provisions of the federal securities laws.”

This case goes beyond the survival of Ripple and XRP. It actually lays the predicate for the SEC to charge many of the other cryptos as securities. The trading of commodities like sugar, wheat, oil and gold are governed by the Commodity Futures Trading Commission (CFTC), and much of the crypto industry would prefer to see itself regulated under this regime. The price of crypto depends on buyer versus seller sentiment driven by a variety of factors such as individual token news, but also macro factors like inflation and employment which also influence other commodity prices. 

Generally, when the following happens, the price of crypto goes up. These events include excess liquidity, quantitative easing, money overprinting, high M2 supply and low-interest rates. Inversely, the price of crypto may tend to go down when you have high inflation with the quantitative tightening and higher interest rates that central banks (including the Fed) use to try and reduce inflation. 

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If crypto is declared a security, however, it could be subject to added reporting requirements such as annual reports, profit and loss statements, and environmental, social and governance (ESG) reports. There are some tokens that have decided to register with the SEC as a security. Clearly, this move is extremely unpopular with most token issuers in the industry.

The XRP case has been mired in controversy from the start because of well-reported public statements by the former SEC Chairman Jay Clayton stating that both Bitcoin and Ethereum are not securities and are instead more of commodities like sugar, oil, gold and the like.

When current SEC Chairman Gary Gensler — a former MIT professor in blockchain tech — took over, the mood changed. Gensler is more inclined now to consider many cryptocurrencies, with the exception of Bitcoin, as securities. 

In US jurisprudence, the way to determine if something is a security or not is something called the Howey Test. The SEC versus the WJ Howey Company was a case involving orange plantations in Florida that was decided by the Supreme Court in 1946. The Supreme Court basically gave four criteria for something to be deemed as a security. The four elements are as follows: [1] An investment of money [2] in a common enterprise [3] with expectations of a profit [4] to be derived from the efforts of others.

Crypto definitely involves the first three considerations. First, people use their money to buy crypto. Second, the tokens could be called a common enterprise because the token generally has a particular objective. Third, most people who buy crypto want to make a profit. So what’s the hold-up?

The tricky part is the fourth condition, which basically states that most investors of securities rely on a particular group of people such as the management of the company that owns the security to ensure that profit results from their common endeavor. 

Bitcoin for example was started by Satoshi Nakamoto, which is a pseudonym for possibly one or even a group of people. We don’t know who this person (or persons) is and where he/they are domiciled at. So how can he/they be held to account if we don’t even know who is in charge? 

In addition, a new type of organization called a Decentralized Autonomous Organization (DAO) has sprouted up. People with a particular token pool their resources in a DAO and decide collectively how to move forward to achieve objectives. But since the ownership is decentralized, condition four of the Howey Test becomes difficult to determine. This is exacerbated by the fact that many people in crypto also use aliases and pseudonyms.

Still, Gensler won’t back away. He has been condemned in various venues for “regulating by enforcement” instead of clearly laying down the policy for crypto that the various tokens can adhere to. That will most likely change when the US Congress decides on clear laws to regulate the growing crypto sector, but it is challenging because many do not understand what crypto and blockchain are. 

Elected officials in the US have very polarized positions on how it should be handled. Some want to ban it, while others want the U.S. to keep a global leadership role and only want to regulate it.

Whatever Judge Torres decides won’t necessarily derail the progress of crypto and blockchain into our everyday lives. In fact, clearly defining whether crypto is a commodity or security would clarify the way for tokens to proceed moving forward.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

Zain Jaffer is the CEO of Zain Ventures focused on investments in Web3 and real estate.

This article was published through Cointelegraph Innovation Circle, a vetted organization of senior executives and experts in the blockchain technology industry who are building the future through the power of connections, collaboration and thought leadership. Opinions expressed do not necessarily reflect those of Cointelegraph.

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