Current regulatory interpretations of law can cause digital assets to simultaneously fall under multiple legal classifications by different federal agencies (e.g., as both a commodity and a security). This can potentially make it difficult to develop compliance and operational requirements for individual crypto assets – and may complicate which federal regulators have oversight of the asset. 

In the inaugural Grayscale Legal Spotlight, we summarize how various classifications affect digital assets through a two-part series. Here, Part One discusses the various classifications and their implications for digital assets. In Part Two, we unpack a recent example of the MNGO token that demonstrates the nuances of regulating and classifying digital assets.Current regulatory interpretations of law can cause digital assets to simultaneously fall under multiple legal classifications by different federal agencies (e.g., as both a commodity and a security). This can potentially make it difficult to develop compliance and operational requirements for individual crypto assets – and may complicate which federal regulators have oversight of the asset. 

Whether a digital asset is a “security” or a “commodity” under US law can have far-reaching consequences for the health and viability of that asset, as well as its related project(s). A security—unless it is subject to an exception or an exemption—must be publicly registered, trade through regulated entities, undergo certain record-keeping and disclosure requirements, and become subject to other rules seemingly incompatible with digital assets as we know them. Currently, the process for determining whether a digital asset is a security requires interpreting statute, court precedent, and statements by government officials. Passionate discussions in crypto-legal circles often result, centering on whether a given digital asset is or is not a security. 

The Securities Act of 1933 and the Securities Exchange Act of 1934 provide the definition of “security” that we use when determining how securities laws apply to a particular asset or transaction. While the statutory definition of “security” is comprised of a laundry list of assets (including more traditionally-known securities like stocks, notes, and bonds); among those terms is “investment contract,” which is undefined by statute. To determine whether a digital asset is an investment contract, one must apply the Howey Test articulated by the Supreme Court in SEC v. W.J. Howey Co. In that case, the Supreme Court stated that something is an investment contract if all four of the following prongs are satisfied: 

If an asset fails just one of these prongs, then it is not considered an investment contract. Most digital assets are analyzed under the Howey Test when determining the applicability of the securities laws. Over time, the Securities Exchange Commission (SEC) has alleged that several digital assets are investment contracts under the Howey Test, including XRP, FTT, and the Telegram-issued GRAM token.

But what happens if a crypto-asset is not a security? What legal classification should it carry? In some cases, officials from the SEC have stated that certain crypto-assets are not securities, such as BTC and ETH. These assets are then largely considered to be commodities under the purview of the Commodities Exchange Act (CEA). Commodities “spot” transactions, or transactions for commodities for instant delivery, are largely unregulated—aside from some prohibitions on fraud and manipulation related to the spot transactions— they differ from securities transactions in that they do not carry significant rules on registration, disclosure, regulated exchange, or other requirements. It is commonly believed tThis reduced amount of regulation is due to the fact that commodities—unlike securities—do not have issuers, affiliates, control persons and insiders that may be privy to material information unknown to the rest of the market. As a result, it is generally considered less necessary to subject them to as many rules to protect investors and consumers. 

In general, commodities spot transactions are considered much simpler to perform than securities transactions. On the other hand, “commodity derivatives trading,” or the trading of futures, swaps, and options on commodities, are subject to much more stringent rules around their exchange, participation, and registration, among other factors. For example, derivatives may only be traded via licensed exchanges among qualified participants. This is due, in part to the additional complexities, and therefore risks, that come with trading derivatives of commodities.

The SEC is not the only regulator to comment on whether a crypto-asset is a security. A recent civil complaint from the Commodity Futures Trading Commission (CFTC)—the regulator charged with overseeing commodities and commodities derivative transactions—stated that they consider the stable token Tether (USDT), in addition to BTC and ETH, to be a commodity. But it is possible that the CFTC and SEC both claim jurisdiction over an asset in what others have colloquially referred to as a “turf war.” In fact, the CFTC has stated its belief that all digital assets are commodities, but such a classification does not foreclose the possibility that a digital asset is also a security. Some have claimed there is currently a “turf war” brewing between the two agencies over the classification of digital assets – and therefore each agency’s jurisdiction. Nonetheless, it is instructive to look at statements made by all government agencies when considering a digital asset’s classification as a security, commodity, or otherwise.

In part two of this Legal Spotlight series, we look forward to diving deeper into a specific instance where this played out in a real-life example with the case of the MNGO token.

Read more: https://grayscale.com/legal-spotlight-digital-asset-securities-commodities/

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