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Lately, a lot of FUD has been created in crypto market due to the news that SEC is claiming various cryptocurrencies as securities. Today we will explore that what is a security, why SEC is declaring crypto currencies as securities, is crypto a security and what impact it will have on cryptocurrencies in the long run.

What is a security?

Any investment, debt, stock, bond, share, treasury stock and collateral trust certificate that can be sold to make profit is considered a security by SEC. Securities can be bought and sold in exchanges or in over the counter (OTC) trades. Stocks are the most common type of securities traded in exchanges.

Who can issue a security?

Any entity that needs to raise capital can issue one or more type of securities. Some issue stocks, while some offer bonds and others offer future contracts.

Type of securities:

Securities can be classified into three categories i.e., Equity, Debt and Derivatives.

Equity securities represent investment in a company or an entity. Stocks are the most common type of equity securities. They offer higher return than other type of securities as greater level of risk is associated with them. The risk associated with Equity securities is twofold, e.g., investors can lose money if the price of shares drop or the company they are invested in, files for bankruptcy.

Debt securities represents a loan that can be in form of government bonds, corporate bonds or certificate of deposit (CDs). Debt securities features a loan amount, maturity date of loan and interest on loan. The investors loan money to companies or entities and debtors must pay back the loan with interest in a specified time.

Derivative securities consist of an agreement to buy or sell an asset at a specific price on an agreed date. Derivative securities can consist of any type of assets e.g., property, stocks, bond or other securities. Future contracts, Options, Swaps and forward contracts are most common types of derivative securities.

What is the role of Securities and Exchange Commission (SEC)?

SEC was established in 1933, after the Great Depression of 1929. In October 1929, majority of securities issued by various companies became worthless as many have provided false or misleading information to the public. To combat this, SEC was established to restore public confidence in securities.

SEC’s main responsibility is to ensure that entities provide authentic information about their business. Moreover, regulate exchanges, brokers and dealers so that they treat investors in a fair manner. Any type of security must be registered with SEC, before it can be sold to investors in US. Brokers, Dealers and Asset Managers must also be registered with SEC to conduct business.

Is crypto a security?

SEC has defined security in a very broad term. SEC is now seeking to regulate crypto as it does the traditional financial markets. As things stands right now crypto will be classified as a security by SEC in US.

How does it affect Cryptocurrencies?

Any crypto exchange offering services in US must be registered with SEC, along with all the cryptocurrencies that are being offered must also be registered as securities. Currently, no crypto exchange and cryptocurrencies that are being offered are registered with SEC.

In March 2023, SEC issued an investor alert, listing all the apprehensions they have regarding crypto exchanges and cryptocurrencies. Full detail is available here.

One of the main apprehension SEC has with crypto exchanges is related to financial audit. Any registration with SEC requires that the security issuer must include a financial statement audited by an independent public account firm registered with PCAOB.

What happens if crypto is a security?

SEC has already started litigation against leading crypto exchanges i.e., Binance and Coinbase for dealing in unregistered securities. It is going to be a long battle in court of law. For short term it created some FUD in crypto world and prices have been impacted significantly, but it will not last long. It seems highly improbable that crypto exchanges will be outright banned in US. Some amicable solution will be found in the longer run, but in short term uncertainty may prevail.

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