WTF Is... A Security Vs. A Commodity

TLDR: Assets fall into one of two categories: securities or commodities. But because digital assets are new and evolving, it is often unclear which category they fall into. Understanding the difference between securities and commodities is important for any investor, but especially those investing in crypto given regulation and taxation implications. 

Starting with the basics, commodities are defined as “basic goods” that can be bought, traded or exchanged; for example: oil, grain, lumber or gold. Commodities are natural or agricultural resources and often finite. Securities, however, yield return from a common enterprise or company, like a share in a company that trades on the stock market, or a government bond. 

Commodities are considered “stores of value” because they hold value over time unlike a security; for example, shares of General Motors have fluctuated dramatically over time. 

Securities’ value is not intrinsic but rather a reflection of the changing performance and value of the entity or companies they represent. Without the existence of General Motors — the entity — the share itself has no value. Commodities are the opposite: lumber has intrinsic value in that it can be used to build shelter; oil can be converted into energy. 

For the purpose of diversification, Investors will typically hold both commodities and securities in their portfolios. When commodities prices rise, securities generally fall. It all has to do with inflation. 

Think about it in the context of today: commodity prices, like oil, are rising. It’s becoming a lot more expensive to fuel your car. This is inflationary. Interest rates have been raised to combat inflation, and bond and stock prices have dipped. This is typical of how commodities and securities interact. 

Securities can be bought on the stock market, but to invest in commodities, you can buy the commodity itself at its spot price: buy a stockpile of lumber and hope its value rises so you can sell it to someone at a higher price than you bought it. Or, you can buy commodity futures on an exchange through your investment account. This equates to essentially buying a contract that says you have the right to sell at a future predetermined price at a predetermined time. You can also indirectly invest in commodities by buying stock in companies that deal primarily in the commodity, like buying a share in a logging company. In this case, you’ve technically bought a security that gives you commodity exposure. 

In the U.S., commodities are regulated by the Commodities Futures Trading Commission (CFTC) and securities are regulated by the Securities and Exchange Commission (SEC). 

What does this have to do with crypto?

The classification of cryptocurrencies and digital assets as either commodities or securities is critical because it impacts how they are regulated. Generally, securities are more highly regulated than commodities. Commodities are taxed more favorably than securities. The SEC and financial regulators have been debating how to classify crypto since Bitcoin was introduced. Bitcoin’s native token, bitcoin (BTC), sometimes referred to as “digital gold” given its finite supply of 21 million, is largely considered a “store of value.” And since Ethereum’s native token, ether (ETH), fuels the Ethereum blockchain, regulators have argued time and time again that it holds implicit value like oil or gas, and is therefore a commodity, too.

As of 2018, the then-SEC chairman stipulated that cryptocurrencies like bitcoin and ether were categorically not securities. But even in the last five years as understanding of crypto has increased and tokenization has exploded, there is an increased appreciation that classification must be approached on an asset-by-asset basis. And as of October 2022, the SEC changed its tune for many tokens. 

So, is crypto considered a security?

The answer to that question evolves as crypto and digital assets evolve – often and with debate! 

In short, some are and some aren’t — and some still are unclear. It varies based on the digital asset, and regulators are getting closer to fit-for-purpose frameworks. Digital assets – upwards of 22,000 tokens that now exist – are not the same and cannot be treated as such. NFTs, initial coin offerings and native cryptocurrencies across different blockchains must all be evaluated uniquely to determine their security status.

The frameworks to determine what is a commodity or a security are much older than digital asset technology, which makes that deduction challenging. A framework known as The Howey Test from 1946 has long been the main checklist to assess whether something is a security. It has four requirements that an asset must meet to be considered a security: 

Due to blockchain’s decentralization, many cryptos fail to meet the common enterprise criteria. Likewise, the promise of profits by the issuer is hard to argue especially for native cryptos like blockchain and ether. On the other hand, tokens offered in an Initial Coin Offering (ICO) do fit the four criteria and are considered securities. 

In summary, The Howey Test cannot be expected to keep pace with and exhaust digital asset innovation given how far it predates them. That is what makes the Responsible Financial Innovation Act introduced in June 2022 so notable. 

The RFIA proposes frameworks for assessing digital assets that are more nuanced, encompassing and detailed. Some highlights, for example, are proposing Decentralized autonomous organizations (DAOs) as business entities; categorizing a number of cryptos including bitcoin and ether officially as commodities; and expanding requirements for security classification beyond the Howey Test. The proposed bill would establish that the SEC has jurisdiction over digital assets providing holders with financial interest in a business entity (e.g. ICO), while the CFTC has jurisdiction over digital assets that do not (e.g. bitcoin).

The RFIA is not expected to pass any time soon. It is the most comprehensive government attempt to regulate digital assets to date, and we expect Congress and regulatory bodies to debate it for a while. Investors should keep watch for future iterations and proposals on digital asset regulation. 

To sum it up

Further Resources:

Crunchbase News: Commodity or Security?

Crypto Regulation: Is Cryptocurrency A Security?

Responsible Financial Innovation Act

Investopedia: The Howey Test

I Also Want Money Podcast: Risk & Regulation in Crypto with Paige Berges

This is not financial advice. If you don't want to spend money investing in crypto or Web3 — you don’t have to. The intent of this article is to help others educate themselves and learn.

Nicole Kyle is a storyteller, podcaster and gender equity advocate exploring the intersection of money, equality, technology, and creativity with a focus on crypto & web3 education.  Nicole is a 2022 LinkedIn Top Voice in Gender Equity.

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