ANZ Finance blog | Bitcoin and Ethereum: Commodities or Securities?

Bitcoin and Ethereum: Commodities or Securities?

Published 16 September 2022

By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland

Bitcoin and Ethereum: Commodities or Securities? -- McGraw Hill ANZ Finance Blog

People who have extra time on their hands like to debate the finer points of definitions. Often, they don’t get very far. There is no denying, however, that definitions have a certain power. If you can control the meaning of a word, that’s a powerful thing. And that is why some people are willing to spend decades trying to do just that.

"There is an important debate going on in the cryptocurrency industry right now. The debate is about the difference between a “financial security” and a “commodity”."

Because it can get rather tiresome, it is fortunate that purely academic debates about definitions are not as common in financial economics as they are in other parts of the social sciences. But there is an important debate going on in the cryptocurrency industry right now. The debate is about the difference between a “financial security” and a “commodity”. It concerns not so much the definitions of “security” and “commodity” but whether certain cryptocurrencies fit one definition or another.

In the United States, the Securities and Exchange Act (1934) defines a “security” as:

“…any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.”

This essentially says that a security is a tradeable financial asset. It’s a broad definition. In different jurisdictions, there might be tighter or looser definitions. A share in a company is the type of security that most people are familiar with. In the U.S., the regulator of securities and securities markets is the Securities and Exchange Commission (SEC).

A “commodity” is different from a security. In the U.S., commodities are regulated by the Commodities Futures Trading Commission (CFTC), which was established in 1975. According the CFTC website:

(1) A commodity, as defined in the Commodity Exchange Act, includes the agricultural commodities enumerated in Section 1a(4) of the Commodity Exchange Act, 7 USC 1a(4), and all other goods and articles, except onions as provided in Public Law 85-839 (7 USC 13-1), a 1958 law that banned futures trading in onions, and all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in; (2) A physical commodity such as an agricultural product or a natural resource as opposed to a financial instrument such as a currency or interest rate.

Corn, for example, is a commodity. So is gold. The question that is attracting a lot of attention now is whether cryptocurrency is a security or a commodity. And, if some cryptocurrencies are securities and some are commodities, which ones are which? The answer to this question matters. It matters because it will determine the shape of the regulatory framework around cryptocurrencies in general (and who the regulator is). More importantly, the answer to this question in each case will determine the future of the cryptocurrency concerned. Some might be deemed to be commodities while others are deemed to be securities.

"There is mixed opinion within the crypto community itself regarding which cryptocurrencies should be classed as commodities and those that should be classed as securities. In some cases, battle lines have been drawn and the debate can get feisty."

The significant implications arise if a cryptocurrency is deemed to be a security. Most existing cryptocurrencies (tokens, really) have not been issued according to the usual rules and regulations that govern the issuance of securities (e.g., shares). Anyone who has purchased shares at an initial public offering (IPO) knows that there is a whole bunch of paperwork made available to new investors (the prospectus etc.) to explain the nature of the investment and the underlying financial details and prospects for the company. There is also a tremendous ongoing burden placed on the officers of a public company to comply with corporations and securities regulations.

A consensus is beginning to form in a once anarchistic cryptocurrency environment that regulation is the next logical step in the development of crypto and its associated tech. Most of the big banks, investment funds, and major corporations are only dabbling, if that, until the regulatory environment is clear.

There is mixed opinion within the crypto community itself regarding which cryptocurrencies should be classed as commodities and those that should be classed as securities. In some cases, battle lines have been drawn and the debate can get feisty. The best example revolves around the two biggest cryptos: bitcoin and ether, the tokens for the Bitcoin and Ethereum networks. Prominent Bitcoin advocate Michael Saylor, co-founder of the firm MicroStrategy, which holds 129,000 bitcoins, has argued that bitcoin fits the definition of a commodity. He calls Bitcoin “digital energy”, which he designates as a resource. He also says that bitcoin is property, like real estate. We recently tried to explain, in way that economists might better understand, what we think he means by “digital energy” in our paper, Bitcoin is Digital Energy.

Some of those who think bitcoin is a commodity, to the extent they enter the debate at all, take issue with the non-Bitcoin networks that are primarily controlled by a group of developers/founders. The implication is that such outfits are like tech companies. While these outfits might be super and have great innovative ideas and potential and while they might be run impeccably, their tokens should be designated as securities and regulated as such. In an interview with YouTube channel, Altcoin Daily, Michael Saylor said that Ethereum is “obviously a security”. The co-founder of Ethereum, Vitaly Dmitriyevich "Vitalik" Buterin, has criticised Saylor’s comments.

The debate remains unsettled and is evolving into something of a regulatory turf war between the CFTC and the SEC.

Since 2014, the CFTC has treated bitcoin as a commodity. In 2015, the CFTC declared that all digital currencies were commodities for the purposes of trading. The CFTC chairman and its ex-chairman have stated repeatedly that they believe that bitcoin and ether are both commodities. The SEC has been less clear. In June 2022, the SEC chairman Gary Gensler argued that many cryptocurrencies are unregistered securities. While Gensler has said explicitly that he believes bitcoin to be a commodity and should be regulated by the CFTC, he was not explicit about ether. Some people interpreted this as a signal that Gensler believes ether to be a security (and therefore falls under the SEC’s jurisdiction, not the CFTC’s jurisdiction).

Clarity might be on the way in the form of the Responsible Financial Innovation Act, which is being introduced to the U.S. Congress in a bipartisan way by one Democrat Senator (Kirsten Gillibrand D-NY) and one Republican Senator (Cynthia Lummis R-WY). This might settle the dispute between the CFTC and the SEC but anyone familiar with the competition that exists between American government agencies will have the popcorn ready.

Discussion Question

How does the designation of something as a commodity or property or security change the nature of its regulatory framework? In Australia, what connection do such designations have to the regulations around the giving of financial advice?