Crypto Coins, Tokens, And Securities: A Guide To Digital Asset Classification

In the world of cryptocurrency, one of the most pressing questions facing investors and executives is how regulatory authorities will treat various digital assets. As blockchain technology takes the 21st century by storm, everybody is trying to claim a piece of the money pie. Traders eagerly ride the waves of volatility, turning astronomical profits in a matter of months or even days. Realizing the groundbreaking potential of blockchain technology, institutional investors have increasingly financed moonshot ventures. Now, of course, governments across the globe have begun considering how to approach these nascent instruments.

At the 1986 White House Conference on Small Business, President Ronald Regan humorously paraphrased the government’s approach to industry.

“Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.”

Over the last 30 years, the world has become more technologically advanced, more globalized, and significantly faster. Today, we’re faced with a financial future that doesn’t fit neatly into the regulatory structures our nation has created. In the cryptocurrency world, digital assets frequently overlap the boundaries of traditional classifications. ETHNews will attempt to explain the distinctions between coins, tokens, and securities. Please note that many digital assets fit into more than one category and sometimes, an asset even fits into all three.

Coins

Humans have been using coins as a medium of exchange since the dawn of civilization. Thus, it was fitting that Satoshi Nakamoto gave bitcoin a name rooted in ancient history. While “bit” hints at the currency’s digital nature, “coin” appropriately captures how the computational instrument is actually used by society – as a currency.

Traditionally, currency has been issued by a government. The political apparatus of a nation also governs its economic operation – the amount of money in circulation, the inflation rate, and the unemployment rate. Historically, currency was tied to the value of a commodity (often gold). However, this is no longer the norm. In the 1970s, when the Bretton Woods System ended under the Nixon administration, fiat money became standard in the United States and, later, globally.

Fiat money is government-issued currency that is declared legal tender but is not backed by a physical commodity. Fiat money is not dependent – literally or psychologically – on gold reserves or any other tangible product. Instead, it has value based on the strength of government decree.

As demonstrated by the crypto world, currency can also be issued privately – in other words, not by a government. For example, bitcoin can be earned through mining on the bitcoin blockchain. Supporting the cryptographic protection of the network gives miners a small chance of earning a reward, commensurate with the hashing power that they contribute to the effort.

A central bank does not influence the issuance of bitcoin or guide its monetary policy. Regardless, millions of people around the world have adopted bitcoin as a medium of exchange. Bitcoin functions first and foremost as a currency and could possibly even become a global reserve currency.

Since bitcoin is the world’s largest cryptocurrency and because it employs the suffix “coin,” I will define a coin as a digital asset that functions as a currency.

It is also possible for a coin to fit under other classifications that I have not listed. For example, the Internal Revenue Service regards bitcoin as property for federal tax purposes. Classification as a coin does not preclude a digital asset from also being a token or a security – which I will get to later. Ether, the digital asset used on the Ethereum blockchain, functions as a medium of exchange, or “coin,” but also qualifies as a token and even a security.

Tokens

A token is a digital asset that allows a user to interact with, or gain utility from, a platform. In the physical world, a token is similar to buying tickets at a carnival. At the carnival grounds, tickets can be redeemed for hot dogs and cotton candy, or perhaps for a ride on the giant Ferris wheel. Within the carnival, tickets might seem priceless! But outside of the carnival, they are not worth much at all. That’s why there’s a specific kind of sadness when you get home, only to realize that you had a pocketful of tickets remaining.

In the cryptocurrency realm, a token might entitle a person to a specified amount of a good or a certain service. A number of companies have sprouted to offer tokens that represent ownership of tangible goods like precious metals, but service-based tokens also abound.

For instance, a person may have purchased Golem Network Tokens (GNT) to access Golem, an Ethereum-based network for idle computing power. The founders claim, “Anyone will be able to use Golem to compute (almost) any program you can think of, from rendering to research to running websites, in a completely decentralized & inexpensive way.”

The actual price of GNT does not matter at all. One GNT could be worth $1 million or 1 cent and the token would still provide the same service. Essentially, GNT tokens provide utility as long as they can be used on the Golem network. Accordingly, a secondary market for GNT arose after the company’s token offering. Today, GNT has the 26th largest market capitalization of the assets listed on CoinMarketCap. GNT trades for approximately 39 cents per token at the time of publication.

Like GNT, Ether allows a person to access a network. Ether is the only way to submit transactions or record to the Ethereum blockchain. As decentralized applications (Dapps) are built on the public Ethereum blockchain, Ether will be required in order to interact with each of these various platforms. By this logic, Ether is also a token.

Securities

In July 2017, the US Securities and Exchange Commission determined that tokens from The DAO were, in fact, securities. This guidance gave pause to many cryptocurrency executives and investors, as it became clear that the US government has begun exploring digital asset regulation. The question at hand is when a digital asset qualifies as a security. In many cases, it appears that digital assets transcend the boundaries between tokens and securities. Ether may fall into this category.

There are people who will use Ether as a currency and there are people who will use it as a token. There are also folks who will use Ether as an investment opportunity. People who believe in the long-term value of the Ethereum blockchain might actually approach the digital asset as a security – though they don’t possess any voting rights or a formal investment contract.

Nonetheless, Ether fulfills many of standards that the SEC applied to The DAO using the Howey Test.

Many investors have:

  1. invested money in Ether
  2. with a reasonable expectation of profits
  3. derived from the managerial efforts of others.

As developers create Dapps for Ethereum, many believe that the value of Ether will increase dramatically. Perhaps, the greatest obstacle to classification as a security is that there are no shareholder’s rights or dividends through ownership of Ether. It’s worth noting that these attributes are not even required of securities that trade on stock exchanges.

So, it’s not totally clear whether Ether is a security, but with people pouring record amounts of money into the digital asset, there’s good reason to believe that it’s been regarded as an investment. On its face, Ether appears to qualify as a security.

Closing Thoughts

As FinTech evolves, the boundaries between currencies, stocks, and utilities have become blurred. The nomenclature and regulatory structures we have today are imperfect because they don’t address the multiple uses of digital assets. When considering the cryptocurrency world, it will be vital to distinguish between digital assets that function as coins (currency), tokens (which provide utility), and securities (that enable investment opportunities). Frequently, a digital asset can fall into two or more of these categories – and additional categories may not have been invented yet. Ongoing discussion of the properties of emerging asset classes will be crucial to ensure regulatory compliance, investor education, and appropriate governance.