The U.S. Securities Exchange Commission (SEC) defines a security as a financial instrument representing ownership, debt (liability), or a right to ownership, encompassing a wide range of financial instruments. The SEC considers various factors to determine if an investment is a security - The Howey Test - and if so, it must register and comply with federal securities laws for the protection of investors and preservation of market integrity.
This week, the SEC made a significant move targeting the cryptocurrency industry. American-based cryptocurrency exchange, Kraken, was forced to shut down its crypto staking services and pay a $30 million penalty. This action sets a precedent for other American-based exchanges that offer ‘Staking as a Service” to their clients. The SEC found that Kraken was in violation of securities laws for not registering the program with the SEC.
Kraken's lending platform allowed customers to deposit cryptocurrencies and earn interest in those cryptocurrencies. They would then seek a yield on these deposits through an undisclosed process. When Kraken’s reddit moderator was asked how yields were generated, they simply replied “For operation reasons we cannot publicly divulge any more specific information on this subject…”. The most likely case, Kraken was lending client deposits to borrowers and not disclosing this. Kraken was offering the sale of an unregistered security, as customers had an expectation of returns. This type of transaction is considered a security and must follow all securities laws, including proper registration and disclosure.
From this precedence, cryptocurrencies that are not registered as securities are considered unregistered securities and are in violation of federal securities laws. As a result, U.S. investors cannot purchase these unregistered cryptocurrencies. This could potentially include Ethereum, which weakened its case by switching from a proof of work (POW) to a proof of stake (POS) mining protocol, now allowing those who lock up their ETH tokens to earn a yield with an expectation that the developers will expand and innovate the project, which would in turn drive up the value of the native tokens.
Think of this as how a corporation would issue corporate bonds which are classified as… say it with me…. SECURITIES!!!!
Bitcoin is not considered a security. It has no liabilities and is not "owed" to anyone person on the network. It is truly decentralised. Therefore, it is to be considered a bearer asset and is most comparable to gold – a commodity – which is regulated by the Commodity Futures Trading Commission (CFTC) and not the SEC.
SEC Chairman Gary Gensler in an interview with CNBC stated “Some, like Bitcoin, and that’s the only one I’m gonna say… They’re a commodity.” Bitcoin's classification as a commodity is beneficial for its investors as it will be subject to less stringent regulation, allowing the Bitcoin network to innovate and grow without being hindered by extensive oversight and regulation. The owner of Bitcoin will never have to fill out a balance sheet in their life! This classification also provides peace of mind to investors. Their investment will not be shut down by the regulatory agency and become worthless. Bitcoin exchanges may be regulated by the SEC, but the Bitcoin protocol itself cannot.
The question arises: who should be the person to regulate cryptocurrency? While some advocates of cryptography argue that regulation undermines the purpose of cryptocurrencies and stifles innovation, it must be recognised that we live in a world ruled by powerful governments who govern.
He gets a lot of slack from the community, but I will stand by my beliefs that Gary Gensler – the current chairman - is the absolute best candidate for the job, and I’m unsure why this isn’t a widely held opinion. Anyone who disagrees with me, sit through the 30 hours of lecture material, where Gensler is the lecturer for MIT’s Blockchain and Money, Fall 2018 class. From these lectures, it is quite clear that he has a deeper understanding of cryptocurrency than any other government official. He truly stands out from the pack and a candidate I am willing to put my minute amount of trust in.
To all those who are allocating more than a quarter of their cryptocurrency portfolio towards anything other than Bitcoin, be cautious. Regulation could potentially end your investment and have you holding the bag.
I’ll leave you with one last word from my favourite SEC Chairman, “When I see a bird that walks like a duck and swims like a duck and quacks like a duck, I call that bird a duck.”
If you have to ask if __________ is a security, it’s probably a security 😉
^ not financial advice btw ^