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Categories of Crypto Assets, Part 1

Posted by Bulldog Law | Nov 17, 2022 | 0 Comments

There is a large variety of cryptocurrency assets. Virtual coins or tokens, “virtual” currencies, and “conventional” equity or debt instruments that have been “digitized” or “tokenized” are just a few examples of the wide variety of crypto assets available.

Making distinctions between various categories of crypto asset is very crucial since how a given crypto asset is regulated greatly depends on whether or not it qualifies as a security.

For instance, whether the crypto assets that any investment adviser manages are securities or cash or cash equivalents may affect how the adviser calculates the regulatory assets under its management.

Further, whether the requirements of Investment Advisers Act 1940 will be applicable to crypto assets also depends on whether such crypto assets are securities or not. For instance, if crypto assets are considered as securities, such assets will be subject to the requirement of Rule 204A-1 of the Advisers Act which requires reporting and clearance of such assets.

Moreover, where crypto assets are treated as securities, the investment adviser will have to make sure that it complies with Rule 206 (4)-2 of the Act. This section is applicable where the investment adviser has a custody over such crypto assets.

The question that arises here is in which circumstances will a crypto asset be termed as a security for the purposes of the federal laws on securities?

Debt securities or traditional equities which have simply been digitized falls under the category of securities. It has been seen that where a debt security or traditional equity has been represented by record on a blockchain or even on a ledger, the status of the same will not be changed. Such assets will still be considered as securities.

Another point to note here is that according to the officials from the SEC, the Securities and Exchange Commission two of the most known crypto currencies namely Ethereum and Bitcoin are not considered as securities for the purposes of securities laws. This stance from the SEC has further raised questions as to what type of crypto currency will then be considered as securities? Unfortunately, there is not a lot of guidance in this regard.

Another question that arises is regarding the status of the virtual currencies other than the Ethereum or Bitcoin? It is to be noted that for now SEC officials have left it upon the market participants to decide whether a particular type of crypto assets can be treated as security or not.

The point here rises that how can the market participants determine the status of a particular crypto assets by themselves?

At the very outset is has been made clear by the regulators that merely terming something as virtual currency or crypto assets will not mean that it is to be treated as a security. In fact, what matters is the substance and the way to determine whether a crypto asset is security in substance is by applying the Howey Test.

The Howey Test was laid down in the case titled SEC v. W.J. Howey Co., 328 U.S. 293 1946. The Howey test consists of three-fold test which shall be discussed in our Second Article.

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