A taxonomy of digital assets: is it a security, a commodity, a banking product or something else? | Ballard Spahr LLP

Two competing bills, both introduced earlier this year, are pending in Congress and seek to settle the regulatory jurisdiction of digital assets between the SEC and the CFTC. How a digital asset is defined will determine which government agency will hold regulatory authority over it. It is unlikely that either bill will pass before the end of the year. Please contact us if you have any questions.

Jurisdictional boundaries between different types of digital assets remain blurred. While Congress weighs separate bills to establish a clear and functional regulatory framework, market players are subject to regulation by enforcement, with multiple agencies independent of the executive and other functional regulators, each independently asserting its jurisdiction.

Below, we outline the factors that government agencies will consider when determining which assets are “securities”, which are “commodities”, which are “banking products” and which may not be governed by the regulatory regime.

Securities: Following the stock market crash of 1929, Congress enacted two sets of securities laws, the Securities Act of 1933, as amended, which dealt with disclosure requirements for securities offerings, and the Securities Exchange Act of 1934, as amended, which dealt with the machinery of securities markets and business. To the extent digital assets qualify as securities, they would be subject to these laws as well as the rules of the Securities and Exchange Commission implementing the laws and rules of the Financial Industry Regulatory Authority (FINRA), a registered securities association, which is the designated regulatory body for securities trading. In short, this means that unless exempted, digital assets that are securities would be subject to initial and ongoing disclosures, would be traded on regulated exchanges, and would be traded through broker-dealers. They would also be subject to regulations regarding maximum leverage and States which also have securities regulatory authority.

The 1933 law defines a security very broadly to include almost all financial instruments. However, for the purposes of digital assets, the market has focused on a specific subcategory called “investment contracts”. These are characterized by the four parts “Howey“test established by the United States Supreme Court in 1946 (long before the advent of digital assets): (i) an investment of money; (ii) in a joint venture; (iii) with a reasonable expectation of profit (iv) The SEC has determined that Bitcoin is not a security under the Howey test because it does not believe that its “current buyers…rely on the essential managerial and entrepreneurial efforts of others to generate a profit”. thus failing parts (ii) and (iv) of the Howey test. Most digital asset cases today focus on the elements of the Howey test that distinguished Bitcoin from a security. (See SEC vs. Ripple Labs). In this ongoing case, the SEC argued that these elements were satisfied because investors in XRP (the token sold by Ripple Labs) believed that the price of their investment would increase based on marketing efforts and supply restrictions. from Ripple. If Ripple wins and XRP is deemed not to be a security, XRP could be considered a commodity by the Commodity Futures Trading Commission. Another alternative is for the case to be settled or for the SEC to walk away, in which case the broader question of whether virtual currencies are securities would remain open.

Goods: The Commodity Futures Trading Commission (CFTC) has been form in 1974 as a spin-off from the United States Department of Agriculture to regulate “listed” markets for specified agricultural products. under the current Commodity Exchange Act, a commodity includes the listed agricultural products and “all other goods and articles … and all services, rights and interests . . . in which contracts for future delivery are currently or in the future concluded. » Courts noted that “virtual currency is offered for payment of debts” but is not legal tender which must be accepted and argued that virtual currencies are commodities. Due to the wording of the Commodity Exchange Act, the CFTC has only regulatory jurisdiction (similar to the Securities Exchange Act of 1934 mentioned above for products traded in the future (that’s to say futures, swaps, futures and options). However, the CFTC has anti-fraud jurisdiction over any commodity, including virtual currency, in which there is a future market.

Currently, the CFTC’s regulatory authority extends to virtual currencies traded on a forward deliverable (leveraged retail) basis, as well as virtual currencies traded on a non-deliverable (swap) basis or on an exchange. (futures). The CFTC requires retail virtual currency futures transactions to be conducted on an exchange, through a futures commissioner, subject to clearing house rules and subject to anti-money laundering protocols . Future trading of virtual currencies would be regulated as a swap or forward. Several legislative efforts are underway that, if passed, would allow the CFTC to regulate spot digital currencies itself. Current and potential CFTC regulatory regimes do not require the same level of disclosure required by the SEC regime and the Securities Act of 1933. Also, unlike securities laws, the Federal Commodities Act prevails over state law, so virtual currencies classified as commodities would be excluded. state securities regulations.

Banking products: The regulatory landscape is anything but simple. In addition to the CFTC, SEC, and state securities agencies, banks and banking products are separately regulated by the Federal Reserve, the Office of the Comptroller of the Currency (OCC), the FDIC, and/or the respective states. The jurisdictional discussion between banking regulators, the CFTC and the SEC has been ongoing for over 100 years and is not expected to be resolved now.

As a result of ongoing jurisdictional discussion, in the Sarbanes Oxley Act and the Commodity Futures Modernization Act, Congress has excluded certain “banking products identifiedwithin the jurisdiction of the SEC and the CFTC. “Identified banking products” include any deposit account, savings account, certificate of deposit or other deposit instrument issued by a bank. To the extent that a digital asset, including virtual currency, is hosted in a bank account, it may not be subject to the regulatory jurisdiction of the CFTC or the SEC. The exclusion of identified banking products, however, does not apply to digital asset trading.

Additionally, the New York State Department of Financial Services (NYDFS), which co-regulates with the Federal Reserve in New York State, now requires registration as a “virtual currency business.” for any person who, among other things, holds virtual currencies on behalf of others, exchanges virtual currencies or administers or issues virtual currencies. The term, virtual currency means “any type of digital unit used as a medium of exchange or as a form of digitally stored value” and is intended to be read broadly. NYDFS lists entities registered as virtual currency companies.

none of these answers: Which digital assets do not perfectly fit the definition of a security, commodity, identified banking product or virtual currency? Non-fungible tokens (NFTs) are digital assets that possess a property that is distinct from other digital assets of the same class. NFTs can take the form of tokenized works of art or collectibles, or “access tokens” that represent a right of access to a specific event, property, or person. Certain types of NFTs may not meet the criteria of an identified security, commodity or banking product. Additionally, certain governance tokens that represent rights associated with the governance of the network of a particular Decentralized Autonomous Organization (DAO) might also not fit within the definitions of a security, commodity, or banking product. identified. However, according to published reports, the SEC is currently investigating Yuga Labs as possibly making an unregistered securities offering in connection with the creation and sale of its Bored Ape Yacht Club NFTs.