Prerequisites and conditions, when cryptocurrency is deemed a security

25 April 2018

Trading cryptocurrencies may be related to some regulatory perplex as in a number of cases authorities across the globe view it as trading securities, which means that such activity may be subject to taxation and other legislative actions. In this post we will try to make a brief outlook of circumstance, when cryptocurrency is viewed by governments as a stock instrument.

United States and Howey Test

The cryptocurrency market is a question of specific attitude in the United States, where a digital currency may become a security under circumstances, when an investor allocates some money, including in Bitcoin and other cryptocurrencies, into a company with a view to derive a profit from the future operations. Such a definition was made by the Securities and Exchange Commission (SEC) last year, when the regulator was investigating the case of the DAO cryptocurrency.

United States and Howey Test

Separately, the U.S. Supreme Court uses the Howey Test for making it clear, if a certain deal may be treated as an ‘investment contract’. So did the SEC in its investigation into the DAO case. The commission applied the Howey Test to the process and established that the DAO should be qualified as a security. In the follow-up report the SEC explicitly stated that cryptocurrencies may be viewed as a security based on the circumstances, and the underlying technology and organization may be neglected as immaterial facts.

The decision on the essence of the DAO currency was taken based on the three key facts: 1) investors brought their money and invested in DAO, and Ether used to purchase the tokens from DAO should also be treated as ‘exchange of value’ according to the SEC; 2) token holders expected to derive the profit on their invested money; 3) the profits expected by the token holders were to come from the management activity of other parties involved. On the top of that, the existence of a centralized enterprise, where people invested their money, also subjects the cryptocurrency within the interpretation of a security.

Cryptocurrencies beyond the definition

Investors wishing to evade risks associated with the stock regulation applicable to some transactions involving cryptocurrencies, are highly recommended to deal with the cryptocurrencies meeting the criteria below:

Decentralization: Cryptocurrencies without centralized entity, performing management for the whole network and, thus, making investors rely on it, feature less risk. Some of these include Bitcoin, Bitcoin Cash, Litecoin and others.

No promise of profit: Cryptocurrencies, where participants expect no profit or the profit is dependent on the activity of coin holders, are not considered a security, because no third parties are involved in managing assets on behalf of investors. Such currencies include IOTA, Monero, Dogecoin and others.

App-coins: Ethereum is not considered a security, because the use-value of the token is more important for the holders than the future profit.

Legal position on cryptocurrencies by countries

Given the lack of proper regulatory and legal framework in many countries, trading cryptocurrencies is either deemed illegal or questionable there. In some jurisdictions authorities warn against dealing with the digital assets.

Bitcoin use is legalized in Argentina, Bulgaria, South Korea, Croatia and Japan. The most favorable nations for dealing with cryptocurrencies are Singapore, Hong Kong, Taiwan, Ireland, Portugal, Slovenia, Denmark. United States, Australia, Canada, Luxembourg, Spain and Belgium have favorable legal conditions.

Bitcoin and other cryptocurrencies are explicitly banned in Iceland, Vietnam, Kyrgyzstan, Ecuador, Bolivia, China and Bangladesh. Countries with the most unfavorable legal framework for using cryptocurrencies include Italy, Slovak, Brazil, Chile, Thailand, Cyprus and Estonia.

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