Financial law is complicated on the best of days. You could fill several volumes with information on securities in this country. But when you get into something as new as crypto, things get even more complicated.
Crypto represents the cutting edge of currency and as such, it’s not easy to pin down everything about it. It has to be handled on a much more case-by-case basis. Discussions about when a crypto asset is considered a security is very much an ongoing process rather than something that has been pinned down and clearly defined.
That’s why we’re going to walk through everything you need to know to understand where the discussion currently rests. To do that, we’ll have to first talk about what a crypto asset is since they may be broader than you think. We’ll then see what experts are saying about the questions and then learn about the Howey test and how it can help us determine the answer.
What is a Crypto Asset?
If you only have a loose understanding of crypto then you may think that the term refers exclusively to Bitcoin. But crypto is much more than Bitcoin. Using Bitcoin as a random example, we can say that it is a cryptocurrency and that cryptocurrency is a crypto asset. But not all crypto assets are cryptocurrency.
Cryptocurrencies are certainly the most talked-about crypto. Another type of crypto is tokens. You’ve probably heard the term NFT thrown around a lot lately. Those are tokens, you trade money to receive a token on the blockchain to signify your ownership of a digital asset like a jpeg.
Yet another type of crypto, and of the most important to our discussion today, is traditionally equity or debt securities that have been digitized. Digitized, also often called tokenized, securities of this type function like securities except that they’ve been included on the blockchain.
The blockchain, in case you didn’t know, is basically a digital ledger that keeps track of all the transactions that have occurred. So for cryptocurrency, this serves the function of sorting out who has how much of a given currency and keeps track of when it trades hands. However, the blockchain doesn’t have to be used for cryptocurrency. It could be used to keep track of securities or, in the case of NFTs, a jpeg of a kid getting hit in the face with a pie.
When Is a Crypto Asset a Security?
Here’s where it gets both simple and extremely complicated.
For the simple part of this equation, we can say that any traditional equity or debt securities you have that have been digitized would still remain as securities. Just because they have been digitized that does not mean that they have changed in any real, tangible way. They are simply being kept as records on a blockchain. So they’re in a distributed ledger instead of a paper one.
As for the complicated part, let’s just get into it. The Securities and Exchange Commission has not yet concluded on whether cryptocurrencies are securities as it regards the legal side of federal securities. This may be an American organization but a ruling on their part would make it easier for us to answer the core question.
But some officials that are very high in the Securities and Exchange Commission have come to the conclusion that neither Bitcoin or Ether, which is another highly popular cryptocurrency, would count as securities.
So there is not an official ruling but there are officials who have come to a conclusion that sounds like a ruling. However, to add to the confusion, this is only talking about Bitcoin and Ether and it doesn’t extend to other cryptocurrencies yet and so those are in an even more confusing gray zone.
We’re going to have to use the Howey Test.
What is the Howey Test?
The Howey test is named after a famous U.S Supreme Court case from 1946 and it provides us with a blueprint from which we can determine whether a crypto asset could be considered a security. Of course, they didn’t have anything remotely similar to crypto yet in 1946 but that part is irrelevant.
The question we have to answer is not whether or not crypto assets are securities but rather whether a particular crypto asset is a security. The Howey test allows us to define whether an asset is an investment contract, and thereby a security. You can apply this to any asset, so it doesn’t matter whether it is crypto or your pet cat, though that’s just an example to show how broad this test can be.
The Howey test takes three steps to determine whether an asset is a security:
- When there has been an investment of money. Traditionally, this was done in fiat currency but it can also be done in cryptocurrency.
- There is a common enterprise.
- There is the expectation that there will be a profit gained from the efforts that others put into the enterprise.
This helps us to get a better understanding of why high-level officials have taken the stance that Bitcoin and Ether are not securities. Consider these the same way that you would a $20 bill. You have this money but that doesn’t mean you have a security. There is nothing attached to that money, it is simply the currency that you possess.
However, if you invest that money into a new startup that uses NFTs to create a unique video game experience then you’ve gained a security. It doesn’t matter if it was done with a $20 bill or the equivalent in Bitcoin.
Keep in mind that the Howey test is not a legal standard in Canada but rather a useful tool for determining if an asset is a security.
What Should I Do If I’m Not Sure If a Crypto Asset is a Security or Not?
Your best bet is to speak to an attorney with an understanding of what’s happening with crypto these days. Additionally, you’ll want that attorney to also have a detailed understanding of financial laws and how to best manage your assets.
Working with an attorney with this skillset can help you to get a better understanding of your assets, what you can do with them, and how to use them to your advantage.