Is Crypto a Commodity or a Security?

The classification of digital assets, commonly known as cryptocurrencies, as either commodities or securities presents a complex challenge. This distinction carries substantial implications for regulation, market operations, and investor protections. Understanding how these digital assets are categorized is essential for market participants and regulators to navigate the digital economy. This article explores the defining characteristics that determine such classifications and their regulatory consequences.

Understanding Commodities

In financial markets, a commodity refers to a raw material or primary agricultural product that can be bought and sold. A fundamental characteristic of commodities is fungibility, meaning that individual units are interchangeable with others of the same type, quality, and quantity. For instance, one ounce of gold of a specified purity is considered equivalent to any other ounce of gold of the same purity.

Standardization plays a pivotal role in achieving this fungibility, ensuring consistent quality and specifications. This enables efficient trading in large volumes and contributes to price transparency. Commodities are typically traded on specialized exchanges, often through futures contracts and options, which derive their value from the underlying physical asset. These derivatives markets enable participants to manage price risk and facilitate price discovery, reflecting global supply and demand dynamics.

The physical deliverability of a commodity is another defining aspect, meaning the asset can be physically transferred from seller to buyer. Examples include barrels of crude oil or bushels of corn. Unlike financial instruments, commodities represent tangible goods, such as agricultural products, energy resources, and metals. Their prices are largely influenced by global supply and demand, geopolitical events, and economic conditions.

Regulatory Perspectives on Crypto as a Commodity

The Commodity Futures Trading Commission (CFTC) has consistently maintained that certain virtual currencies, including Bitcoin, are commodities under the Commodity Exchange Act. The CFTC’s jurisdiction is primarily implicated when a virtual currency is used in derivatives contracts, or when fraud or manipulation occurs involving a virtual currency traded in interstate commerce. This position was established in a 2015 enforcement action, where the CFTC defined “virtual currency” as a digital representation of value functioning as a medium of exchange, unit of account, and/or store of value.

The CFTC’s authority stems from the Commodity Exchange Act, granting it power over commodity futures and derivatives markets, including the ability to pursue enforcement actions against entities operating without proper registration or engaging in fraudulent practices. While the CFTC does not directly regulate spot markets for digital assets, its authority extends to addressing fraud and manipulation in these markets if such activities impact derivatives trading.

The CFTC also recognizes Ethereum as a commodity, similar to Bitcoin. This aligns with the CFTC’s broader view that many digital assets, particularly those that function as native tokens of blockchain networks, should be classified as commodities. The CFTC applies its existing regulatory framework for commodities to these digital assets, especially concerning futures contracts based on them. This includes oversight of exchanges like the Chicago Mercantile Exchange (CME) that offer Bitcoin and Ethereum futures.

The Securities and Exchange Commission (SEC) generally views many cryptocurrencies as securities, but its stance on Bitcoin and Ethereum aligns with the CFTC’s commodity classification. SEC Chairman Paul Atkins recently affirmed that Ethereum should not be considered a security, informally placing it in the same category as Bitcoin. He noted that securities laws do not currently apply to Ethereum, citing its use case and technological infrastructure. The SEC’s current perspective emphasizes that the classification depends on how a token is presented and marketed to investors, rather than the token itself being inherently a security.

Distinguishing Commodities from Securities

The distinction between a commodity and a security in the context of digital assets is crucial for determining regulatory oversight. Securities represent an investment in an enterprise with an expectation of profit from the efforts of others. The primary framework used by the Securities and Exchange Commission (SEC) to determine if a digital asset constitutes a security is the “Howey Test,” derived from the 1946 Supreme Court case, SEC v. W.J. Howey Co.

The Howey Test establishes four criteria that, if met, classify a transaction as an “investment contract,” and thus a security subject to federal securities laws:
An investment of money
In a common enterprise
With a reasonable expectation of profits
Profits derived solely from the efforts of others

The “investment of money” criterion is broadly interpreted to include cash or other forms of consideration. The “common enterprise” element refers to horizontal commonality, where the fortunes of individual investors are linked to the success or failure of the promoter’s efforts.

If all four prongs are satisfied, the digital asset is considered a security, necessitating compliance with rigorous disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934. For instance, if a digital asset is sold to fund a development team’s efforts, and investors expect financial gains based on that team’s work, it strongly suggests the “efforts of others” criterion is met. This indicates a passive investment where the investor relies on the managerial or entrepreneurial efforts of a central group.

The presence of a centralized issuer or promoter who retains a significant stake and whose managerial efforts are central to the asset’s development and potential increase in value often points towards a security classification. In contrast, assets like Bitcoin, due to their highly decentralized nature and the absence of a single identifiable central issuing authority or ongoing managerial efforts driving its value, generally fail to meet the “efforts of others” prong of the Howey Test.

Regulatory Oversight Based on Classification

The classification of a digital asset as either a commodity or a security significantly determines which federal regulatory body has primary oversight and the specific rules that apply. This distinction directly impacts the legal obligations for issuers, exchanges, and other market participants, as well as the level of investor protection provided.

The Commodity Futures Trading Commission (CFTC) is the independent agency responsible for regulating the U.S. derivatives markets, which include futures contracts, swaps, and certain options based on commodities. Its mission involves protecting market participants from fraud, manipulation, and abusive practices. For digital assets deemed commodities, the CFTC exercises jurisdiction over their derivatives trading and has enforcement authority over fraud and manipulation in both the derivatives and underlying spot markets that impact derivatives. Companies dealing in commodity derivatives must register with the CFTC and adhere to its regulations regarding market transparency, position limits, and trading practices.

Conversely, the Securities and Exchange Commission (SEC) is the federal agency tasked with overseeing investment offerings and financial markets, with a primary goal of protecting investors. For digital assets classified as securities, the SEC’s jurisdiction covers their initial offerings, trading on exchanges, and ongoing disclosure requirements. Issuers of securities must generally register with the SEC and provide extensive financial and operational information to the public, ensuring transparency for potential investors. The SEC also regulates brokerage firms, investment advisors, and exchanges involved in securities transactions.

The divergent regulatory approaches mean that a digital asset classified as a security faces more stringent disclosure and registration requirements compared to one classified as a commodity. This difference affects everything from how these assets are issued and traded to the specific legal recourse available to investors.