Does cryptocurrency qualify as security? In this paper we discuss and consider applicable financial regulation currently in place and under consideration across the United Kingdom related to cryptocurrencies. Firstly, before we delve deeper into this simple yet challenging question, we address the topics related to definition of money and currency as related to cryptocurrencies. Secondly, we narrow down our discussion and expand the definitions to cover a definition of a security. Given our outline and understanding of the distinction between currency, cryptocurrency, and security definitions, thirdly, we proceed to discuss the issues related to relevant financial regulations encompassing recent events related to cryptocurrencies, specifically focusing on Financial Conduct Authority (FCA) regulatory framework. We conclude in the last section, discussing recent case studies and failures relevant to cryptocurrencies and note the critical importance and need for global approach and cooperation in financial regulations. We conclude that cryptocurrency can qualify as security or a currency as it depends on what cryptocurrency or token we are dealing with and the given level of decentralisation.
Money versus Currency and Cryptocurrency
Currency is a system of money that is used as a medium of exchange in a particular country or region[1]. It represents a specific value that is universally accepted within the defined geographical boundary. Different types of currencies are used in different countries, such as the dollar in the United States, the pound sterling in the United Kingdom, the euro in the European Union, and the yen in Japan. These currencies form an integral part of a country's economy as they enable economic transactions to occur. Currency is issued by a central authority of a given country, usually its Central Bank.
Money, on the other hand, is a broader concept than currency and represents anything that can be used as a medium of exchange for goods and services. In other words, money defined as coins or notes in circulation is a tool that allows people to trade goods and services indirectly[2]. It serves as a standard of value, a store of wealth, and a unit of account. Currency is one type of money, but other types can include commodities like gold or digital forms like cryptocurrencies.
The use of money simplifies trade and commerce by providing a common measure of value that can be easily exchanged. Without money, economies would have to rely on barter systems, which are inefficient because they require a double coincidence of wants. Money also provides a convenient way to store wealth. It's more practical to hold wealth in the form of currency than in physical goods like cattle or grain, which can degrade over time.
In addition, money serves as a standard measure for pricing goods and services and assets which makes it easier for consumers to compare prices and make informed decisions. It also acts as an economic lubricant, facilitating the flow of goods and services within an economy and across international borders. This role of money is especially critical in today's globalized economy where cross-border transactions are common.
Cryptocurrency, conversely, can be defined as a type of digital or virtual “currency” that uses cryptography for protection within blockchain driven database[3]. Unlike traditional forms of money issued by government authorities, such as banknotes and coins, cryptocurrency operates on decentralized platforms, usually, and these digital tokens are issued by an issuing central authority[4]. This digital asset, or token, is designed to work as a medium of exchange, where individual coin ownership records are stored in a digital crypto-protected ledger, which exists in a form of a computerized database using strong cryptography to secure transaction records, control the creation of additional coins, and verify the transfer of coin ownership [1].
The use of cryptocurrency is manifold. Its primary use is to serve as a medium of exchange within a peer-to-peer economy. In other words, it is used in a limited way to buy goods and services online with added security and potentially lower transaction costs. Moreover, many people invest or rather speculate in cryptocurrencies as they would in other assets, like stocks or precious metals. It is seen as a high-risk investment, with the hopes that it will gain value over time as cryptocurrencies do not pay or return dividends or any other cashflows.
One of the main attractions of cryptocurrency is its high-level security. Each transaction is permanently recorded on a public ledger known as the blockchain, which ensures transparency and traceability. Additionally, cryptocurrency transactions are pseudonymous, while transaction flow is transparent, the identities of the parties involved are not disclosed, providing privacy to users. This is considered as a potential issue as the use of cryptocurrencies can lead to illegal activities [2].
Cryptocurrency versus Security
From a legal perspective, the distinction between cryptocurrency and security is significant and has far-reaching implications. Cryptocurrency, like Bitcoin or Ethereum, is a digital or virtual form of currency that uses cryptography for security[5]. This type of currency operates independently of a central bank and is often decentralized, meaning it's distributed across a large network of computers. On the other hand, security is a broad term that refers to any tradable financial asset. In the legal context, it often refers to an equity security (like stocks), a debt security (like bonds), or derivative contracts (options or futures).
The legal difference between cryptocurrency and security primarily rests on their regulation. Cryptocurrency, given its decentralization and lack of central authority, is currently less regulated than securities. This notion of decentralization, however, is the main contention for our purposes. We argue that in case of central authority, cryptocurrency can be viewed as security from legal perspective. While some countries have embraced cryptocurrencies and provided legal frameworks for their use, others have banned them outright due to their potential for facilitating illegal activities and the lack of control by financial institutions[6].
Securities, conversely, are highly regulated. They are subject to stringent laws and regulations designed to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Securities must comply with registration requirements and their issuers are required to disclose certain information to provide transparency for investors[7].
A critical distinction between cryptocurrency and security lies in their legal recognition as money or as an asset. Traditionally, money has three key attributes: it functions as a medium of exchange, a unit of account, and a store of value. Most cryptocurrencies, while they can function as a medium of exchange, are not widely accepted and their value can be rather highly volatile. Therefore, they do not fully meet the legal definition of money however given the decentralization component of the protocols can be deemed to perform the core function of money. On the other hand, securities are regarded as assets because they represent an ownership position in a publicly-traded corporation (in the case of stocks), a creditor relationship with governmental or corporate entities (in the case of bonds), or rights to assets issued by other unique entities and not being decentralized in nature. Therefore, while both cryptocurrencies and securities may be used as forms of investment, they differ significantly from a legal perspective in terms of regulation and recognition as either money or an asset.
In a recent ruling by a court in the U.S. District Court for the Southern District of New York on the Securities Exchange Commission SEC’s claims against Ripple Labs has been generally hailed as a victory for the token issuers and exchanges delivering a win indicating that cryptocurrency is not a security [4].
“The SEC’s claims against Ripple hinged on whether Ripple’s distribution of its cryptocurrency, XRP, was a “security” for the purposes of the Securities Act. More specifically, the question was whether these transactions satisfied a three-pronged test for an “investment-contract” security devised by the Supreme Court over seven decades ago in SEC v. W.J. Howey Co [5]. Under the Howey test, transactions involving the (1) investment of money in (2) a common enterprise with (3) an expectation of profit from the efforts of others, are securities.“ [6]
The court concluded that only certain negotiated sales of large blocks of XPR (Ripple Digital Token) by institutional investors satisfied Howey’s test, however any anonymous sales by Ripple on cryptocurrency exchanges did not likewise any other transfers defined as other distributions.
The application of expectation element is the unexpected part of the ruling. “Howey test focuses on whether a person with knowledge of all public information about the role of the people offering an investment in the future success of the investment would expect that the promoters’ ongoing efforts are key to profits. Instead, the court focused on the actual information available to different sets of purchasers. The court reasoned that since the institutional purchasers knew they were buying XRP from Ripple, and were provided marketing materials from Ripple, they would expect the value of the XRP to be affected by Ripple’s efforts. By contrast, the programmatic buyers’ assumed relative ignorance of Ripple’s role in developing, marketing, and distributing XRP led the court to conclude that these buyers would not reasonably expect Ripple’s activities to affect XRP.” [7] In short, this can be interpreted as decentralization argument, stating that given the centralized nature of XRP, issued by Ripple, the cryptocurrency is security, however, given the lack of knowledge by investors regarding centralized authority behind XRP, the cryptocurrency is defined as currency. Hence the dilemma. However, given the economic reality that XRP depends on the prospects of Ripple, crypto enthusiasts should not consider this a win either[8].
Financial Conduct Authority (FCA) Approach to Financial Regulation
FCA has been proactive in its approach towards cryptocurrency regulation. Recognising the increasing prominence of this digital form of currency, the FCA has sought to create a regulatory environment that protects consumers, enhances market integrity, and promotes competition, while encouraging innovation in the financial sector.
The FCA has been particularly focused on the security aspects associated with cryptocurrency. Given the digital nature of cryptocurrency, it is inherently susceptible to cyber threats. Therefore, the FCA has imposed stringent security measures for firms involved in crypto-related activities. These measures include robust systems and controls to detect, prevent, and respond to cyber threats, as well as safeguards to protect consumers' assets. In recent news release, companies marketing cryptoassets to UK consumers will be required to introduce a cooling-off period for first time investors announced under new FCA advertising rules.
Moreover, the FCA has taken steps to mitigate the risks associated with the volatile nature of cryptocurrency. It has issued warnings about the high risks associated with investing in cryptocurrencies and has banned the sale of derivatives and exchange-traded notes that reference certain types of cryptoassets to retail consumers. “The new rules mean crypto firms must ensure that people have the appropriate knowledge and experience to invest in crypto. Those promoting crypto must also put in place clear risk warnings and ensure adverts are clear, fair and not misleading [8].”
The FCA’s approach to cryptocurrency regulation also extends to combatting financial crimes such as money laundering and terrorist financing. The agency has implemented regulations that require businesses involved in the transfer of cryptocurrencies to comply with Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) rules [9].
In essence, the FCA's approach to cryptocurrency regulation is a balanced one. While it recognises the potential benefits that cryptocurrencies can bring to the financial sector, it also acknowledges their potential risks. Therefore, it seeks to ensure that any firm dealing with cryptocurrency operates within a secure regulatory framework that mitigates risks while maximising benefits [10].
Overall, most cryptoassets are not regulated by FCA as these assets do not fall under the definition of “specified investment” under the Financial Services and Markets Act 2000 (FSMA). In recent amendments to FSMA the UK government is increasing regulatory reach and effort to provide stability to consumers aiming to be the leading jurisdiction safeguarding clear passage to support crypto innovation in financial industry [11]. However, at the same time, the UK government acknowledges the complexity of cryptoasset regulatory frameworks and provides for additional level of protection [12]:
“We recommend that the Government takes a balanced approach to supporting the development of cryptoasset technologies. It should seek to avoid expending public resources on supporting cryptoasset activities without a clear, beneficial use case, as appears to have been the case with the Royal Mint NFT. It is not the Government’s role to promote particular technological innovations for their own sake. (Paragraph 37)”
Furthermore, and more importantly:
“We strongly recommend that the Government regulates retail trading and investment activity in unbacked cryptoassets as gambling rather than as a financial service, consistent with its stated principle of ‘same risk, same regulatory outcome’. (Paragraph 52)”
Global Perspective
The global approach to cryptocurrency financial regulation is a complex and evolving landscape, reflecting the rapidly changing nature of digital currency markets. This approach varies considerably across different jurisdictions. In the United States, for instance, SEC treats certain types of cryptocurrencies as securities and subject them to relevant regulations. On the other hand, the European Union and UK is also actively exploring regulations that can provide a balance between enabling the benefits of cryptocurrencies and mitigating risks. The risks can be extensive for all market participants as recent developments in FTX bankruptcy provide a glimpse into the intricate world of tokenisation, risk trading and alleged exchange driven price and issuance manipulation inclusive of legal jurisdiction arbitrage[9].
Looking ahead, the future possibilities for cryptocurrency regulation are numerous. We may see an increasing number of countries developing comprehensive regulatory frameworks for cryptocurrencies to ensure stability, security, and consumer protection. International cooperation could also intensify to address cross-border issues related to cryptocurrency regulation. Ultimately, the goal will be to create a regulatory environment that fosters innovation while simultaneously ensuring the safety and integrity of global financial markets. In conclusion, does cryptocurrency qualify as security? The answer, at the moment is, it depends! Further questions can be postulated such as do we need different state based currencies? Do we create one decentralized token, a.k.a Bitcoin to be used globally? Is Twitter/X going to issue its own global currency or a security?
References
[1] FCA Invest Smart, Crypto: The Basic, Blog: https://www.fca.org.uk/investsmart/crypto-basics
[2] UK Government Policy Paper, Jun 2023, Factsheet: Cryptoassets Technical,
[3] FCA Handbook, Definition of Security:
[4] Order at 26, SEC v. Ripple Labs, Inc., No. 20-CV-10832 (S.D.N.Y. July 13, 2023) (ECF No. 874).
[5] S.E.C. v. W.J. Howey Co., 328 U.S. 293, 301 (1946).
[6] Fortune, Fox P., Scoolidge P., Scott D., (Aug 20, 2023), Ripple v. SEC: Why the crypto industry may have celebrated too early, https://fortune.com/2023/08/10/ripple-v-sec-crypto-industry-may-have-celebrated-too-early-peter-fox/
[7] id. Sic
[8] FCA News, FCA introduces tough new rules for marketing cryptoassets
[9] FCA News, Pritchard S., (25 April 2023), Regulation of Digital Assets in the UK, Speech by Sarah Pritchard, Executive Director of Markets, and Executive Director of International, at City Week 2023,
[10] FCA News, (24 March 2023), Notice to all FCA regulated firms with exposure to cryptoassets
[11] House of Commons Library, (20 January 2023), Regulation of cryptocurrency:
[12] House of Commons Treasury Committee, (10 May 2023), Regulating Crypto:
Bibliography
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Lessons from FTX and the Crypto Winter of 2022-2023”, UNSW Law & Justice, ssrn:
Nakamoto S., (), “Bitcoin: A Peer-to-Peer Electronic Cash System”, www.bitcoing.org
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[1] Currency definition, Cambridge Dictionary, https://dictionary.cambridge.org/dictionary/english/currency [2] Money definition, Cambridge Dictionary, https://dictionary.cambridge.org/dictionary/english/money [3] Chapter 14 – Cryptography in Blockchain for further details, reference: https://www.sciencedirect.com/science/article/abs/pii/B9780323961462000115 [4] “Some cryptoassets have a finite total supply (such as Bitcoin); others are launched with infinite total supply. Bitcoin was the first and is the most popular cryptoasset, currently holding the highest market cap of any coin. Bitcoin’s design set a precedent for future cryptoassets, however each has their own unique specifications. Bitcoin is created through a process called mining, which involves using computing power to solve mathematical puzzles on the Bitcoin network. Every time a new block is added to the blockchain, new Bitcoins enter circulation. The participants (nodes) who solve the computational puzzle receive some Bitcoin as a reward for contributing their computing power to the Bitcoin network”. https://www.gov.uk/government/publications/economic-crime-and-corporate-transparency-bill-2022-factsheets/fact-sheet-cryptoassets-technical#how-are-new-cryptoassets-createddo-they-enter-circulation [5] Platform for trading Bitcoin, Ethereum and other cryptoassets, https://www.blockchain.com/, showing Bitcoin blockchain in actions: https://www.blockchain.com/explorer [6] China's central bank has announced that all transactions of crypto-currencies are illegal, effectively banning digital tokens such as Bitcoin. "Virtual currency-related business activities are illegal financial activities," the People's Bank of China said, warning it "seriously endangers the safety of people's assets". https://www.bbc.com/news/technology-58678907 [7] FCA Handbook, Security definition in accordance with article 3(1) of the Regulated Activities Order (Interpretation)) any of the following investments: https://www.handbook.fca.org.uk/handbook/glossary/G1061.html [8] “Under the Ripple decision, many types of transactions would seemingly make nearly all existing securities no longer securities, which would be a big loss for the SEC. Various schemes designed to evade scrutiny of initial coin offerings, such as Initial Decentralized Exchange offerings of security tokens, could arguably not be securities under this view. However, the obvious clash with existing securities laws should lead to a swift review and reversal. And even if this saga drags on, Judge Torres has helpfully made clear that XRP sales satisfy the Howey test. That could mean that any unhappy institutional buyers could seek a remedy of rescission, which would put Ripple on the hook for hundreds of millions of dollars.” https://clsbluesky.law.columbia.edu/2023/07/18/sec-v-ripple-everyone-loses/ Furthermore, this is not likely be a win for the industry https://www.bclplaw.com/en-US/events-insights-news/sec-v-ripple-labs-a-critical-industry-win.html [9] Crypto giant FTX collapses into bankruptcy, https://www.bbc.com/news/business-63601213 and recent events, FTX's Bankman-Fried headed for jail over alleged witness tampering, https://www.reuters.com/legal/ftxs-bankman-fried-seeking-avoid-jail-due-back-court-2023-08-11/