The regulatory uncertainty surrounding crypto is one of its biggest hurdles to mass adoption.

The United States Securities and Exchange Commission’s insistence that any cryptocurrency besides Bitcoin should be classified as a security, and should therefore come under the purview of SEC regulations.

On the other hand, former SEC executives have already made public statements that cryptocurrencies can be classified as non-securities if they achieve a certain level of decentralization.

There’s plenty to unpack behind the question. The debate over whether cryptocurrencies should be classified as securities (like stocks and bonds) or commodities (like oil and wheat), after all, has SERIOUS implications and far-ranging consequences depending on if, how, and by what entity they are regulated.

Want to find out whether the crypto you’re invested in is a security or a commodity and why it matters? Read on to find out.

Securities and Commodities: Definitions

Securities and commodities are entirely different financial instruments. In the United States, securities and commodities are governed by entirely different government entities.

Within the context of crypto, the legal determination of whether a cryptocurrency is classified as a security or a commodity has far-ranging implications as to how it can be sold, where it can be listed, and what recourse exists if an issuer steps out of line.

The question is far from being settled. Given the constantly evolving pace of the crypto market, the reality is that there won’t be a black-and-white decision—instead, it will vary depending on the cryptocurrency in question.

Before anything else, let’s set the ground rules by quickly running down the definition of securities and commodities.

Securities are financial instruments representing a claim on the issuer. Based on United States law, securities are investment contracts where investors expect profits from the efforts of a third party or promoter. The profit can be made from sales of the security or from collecting dividends or interest. Stocks, bonds, and derivatives fall under this definition, as do any other financial instruments classified as securities. Securities fall under the jurisdiction of the SEC.
- The SEC relies on the Howey Test, borne out of a 1946 United States Supreme Court decision, to determine whether transactions are investment contracts, which would classify them as securities. The SEC has already used the Howey Test in cases to determine whether crypto projects are securities, such as XRP and The DAO hack of 2016. The interpretation and application of the Howey Test influences whether they are treated as securities, and therefore subject to SEC, legal, and regulatory requirements.

On the other hand, Commodities are physical goods traded on exchanges in wholesale amounts. These include products such as oil, wheat, corn, and gold, among others. Commodities are generally traded based on their current market value. In the United States, commodities are overseen by the Commodity Futures Trading Commission (CFTC).

What Is More Favorable from a Financial Standpoint?

Cryptocurrencies that would be classified as securities offer enhanced protections for investors. In theory, issuers would be compelled under SEC regulations to adhere to a standard of transparency, and be obliged to disclose the risks of investing in them as they would for regular securities. This could protect more investors, especially individuals who are new to crypto.

However, crypto businesses or companies involved with crypto may be against such a classification, since stricter regulations can be a burden for them as far as compliance and reporting requirements are concerned.

Cryptocurrencies that would be classified as commodities, on the other hand, are more favorable in terms of looser regulations that in theory could promote the freedom to innovate. This would appeal to investors more focused on seeking faster, bigger gains at the risk of shady business practices.

Likewise, businesses involved with crypto could favor classification as a commodity due to the less stringent compliance and reporting requirements under the CFTC, promoting faster growth without too much government intrusion. This is why crypto proponents push to be recognized as commodities rather than securities.

Alternative Viewpoints: What Makes the SEC Believe Your Crypto is a Security?

The United States Securities and Exchange Commission consider cryptocurrencies securities based on the following reasons:

Initial Coin Offerings (ICOs)

The overwhelming majority of cryptocurrencies—Ethereum and its ecosystem included—raised capital through funding rounds via initial coin offerings. ICOs are set up in a similar fashion as to initial public offerings (IPOs) for company stocks, both of which involve companies selling shares and tokens to the public for fiat currency.

The funds raised through ICOs lined the pockets of development teams, which suggests that investors depend on third parties to make a profit on the tokens they received—therefore passing the Howey Test as a security. Bitcoin, meanwhile, is one of the very few big-cap cryptocurrencies that never did an ICO, which gives it a strong case for being a commodity.

The sale of tokens to investors instead of users

Cryptocurrencies are marketed as digital assets that can be used as an alternative medium of exchange over the internet. But the truth is, most individuals buy cryptocurrencies with the sole purpose of expecting token prices to appreciate. The mere act of calling a cryptocurrency a “utility token” doesn’t magically prevent it from being a de facto security.

Dependence on third-party development teams

Issuers may not directly manage a cryptocurrency, but it may have individual marketers and promoters with a large proportion of the circulating token supply. Such promoters may be motivated to pump the value of their crypto holdings, making the success of the project solely dependent on these actors.

Is SEC Regulation Really Bad for Cryptocurrencies?

Here’s a bitter pill to swallow: the regulation of cryptocurrencies under the SEC isn’t as much of a tragedy as crypto advocates make it out to be. Hundreds of billions of dollars have been lost to scams, rug pulls, and insolvency due to cavalier investment practices of certain firms involved with the technology. One need only look at the sensational collapse of Terra Labs and FTX as an example of why some form of regulation is needed.

Cryptocurrency advocates will obviously be averse to this opinion because of their belief that cryptocurrencies present a legitimate chance to create a decentralized financial system, with full transparency, greater access, and pseudonymity for all who participate.

The United States Securities and Exchange Commission, meanwhile, wants to bring crypto under its oversight to help investors make informed investment decisions. Under the SEC, cryptocurrency projects will be obliged to disclose risks, identities of development teams, and make timely financial disclosures to the public just as other entities that issue securities such as stocks do.

What Happens If Your Crypto is Classified as a Security?

If any particular cryptocurrency is deemed as a security by the SEC, crypto issuers and exchanges will be compelled to obtain the necessary licenses from securities regulators, which is notoriously tricky. That’s why the crypto industry as a whole directs their efforts in ensuring that token sales and developments skirt existing securities laws.

Decentralization is a major aspect of this strategy. If, for example, a cryptocurrency is developed in a way that the SEC could not identify a centralized entity responsible for developing and increasing the value of the token, then it is less likely that it will be classified as a security. It is for this reason why many projects in the DeFi space attempt to decentralize their governance using decentralized autonomous organizations and employ a proof-of-stake consensus mechanism. The main idea behind this is that if individuals are both investors and play an active role in the development of the project as stakers, validators, and/or participants in DAO governance, they no longer depend on a “third party” to generate profits under the Howey test.

On the other hand, cryptocurrencies being tagged as securities could run the risk of exchanges refusing to list them due to the risk of being fined by the SEC for selling unregistered securities. Moreover, cryptocurrencies can run afoul of regulations that could vary depending on varying interpretations by state regulators.

How can you protect your privacy?

Privacy has become a major talking point in the face of looming government regulations that could change how individuals interact with cryptocurrencies—especially for crypto users who wish to protect their financial activities and keep their identities private.

There is a need for a privacy solution that is fully compliant with tightening regulations—and that solution has arrived with Houdini Swap.

Houdini Swap enables users to perform private direct crypto-to-crypto swaps. The protocol is a liquidity aggregator that uses a random Layer-1 protocol and works with fully compliant exchanges that prevent the disclosure of the ultimate source and target addresses.

This reduces the likelihood of a wallet being linked to a particular user to virtually nil. Houdini Swap offers the best-in-class privacy available on the market today, while remaining fully compliant with existing anti-money laundering and anti-terrorist financing regulations.

Future Trends

The constantly evolving discussion surrounding the nature of cryptocurrencies in terms of their treatment as a financial instrument remains one of the major obstacles to mass adoption. The United States Securities and Exchange Commission showed its teeth by suing the world’s largest centralized crypto exchanges in Binance and Coinbase late in 2023 for selling cryptocurrencies, which it deemed as unregistered securities.

On the other hand, while purists may scoff at the notion of coming under government regulation, this can be seen as a positive for the crypto industry.

The mere fact that the US SEC is angling to regulate crypto assets posits a future where mass adoption could be just around the corner. Cryptocurrencies are now being formalized as a permanent asset class. Nevertheless, as regulatory frameworks continue to evolve in the US and around the world, investors should take an active role in understanding how their interactions with the technology will be treated under the current regulatory framework.

Ultimately, regardless of whether your crypto is deemed a security or commodity, one thing that will never change is the importance of privacy and the role it plays in maintaining the pseudonymity and privacy of individuals.

And in that regard, few solutions come close to Houdini Swap. Want to experience the best possible privacy available in the market today? Try Houdini Swap and see the difference.