Is Bitcoin a security, currency or asset?

How do we define and label cryptocurrencies like Bitcoin?

21 June 2019 - 11:08
Existing financial terms may not be ideal to categorise Bitcoin.
Existing financial terms may not be ideal to categorise Bitcoin.
Image: Supplied/Luno/Unsplash

Labels are important in the financial world because they help regulators know how to fit something into the existing framework  - or if they should create a new category.

Sensible regulation has the potential to strengthen entire industries, offering greater clarity for law enforcement and protection for investors. It’s essential for governments to put adequate controls in place for any disruptive new technology, so it’s not used for crime.

Ultimately, regulators dictate the future of the industry. But to regulate something, you need to know which box to put it in.

Putting something in one category implicitly excludes it from other categories. By declaring cryptocurrencies to be a commodity regulators can assert that they’re not a currency, investment vehicle, or anything else. While regulators try to navigate these uncharted waters it’s clear the debate is far from over.

Cryptocurrencies are complex because different people use and regard them in different ways, and regulatory rulings don’t change that, in the same way calling a platypus a mammal doesn’t stop it laying eggs. Let’s go into the definition-debate to understand why the boundaries between each can blur at times.

A commodity is a commercial good

This means all units are treated as interchangeable. Although commodities vary in quality, they each tend to be regarded as a market in themselves. This category includes raw materials such as precious metals like gold and silver, agricultural products (like coffee and sugar), and other resources.

Thousands of years ago, people used commodities like salt as money. They have value because they can be used for practical purposes. Commodities can be traded on exchanges, where supply and demand set the price.

Cryptocurrencies can be defined as a commodity because the individual units are interchangeable and have the same core properties for anyone who uses them. If you regard Bitcoin as ‘digital gold’, this makes sense.

A currency is a medium of exchange, store of value, and unit of account

On paper, this would seem like the most appropriate category to classify cryptocurrencies.

Bitcoin, after all, is designed to be a currency and can be used to make purchases from merchants that accept them.

It’s sometimes said that cryptocurrencies are not currencies because they’re not backed by governments. But that’s confusing currency with legal tender. Anything can act as a currency if it has the right properties, and people use it as such. Furthermore, although volatility is impractical for a currency, price stability isn’t a requirement.

Currencies, like the dollar and euro, can also function as commodities  -  traders buy and sell them to profit from price changes in exchanges. So if you use a euro to buy a sandwich it’s a currency, but if a trader sells that same euro on an exchange it’s a commodity. Commodities can, as we’ve seen, act as currencies too. There’s a clear overlap between these two categories.

A security offers the possibility of profit in exchange for the risk of loss

Ownership of a security can pass between people, with the owner always receiving the profit or loss. Financial products that don’t represent tangible assets, including stocks, bonds, and mutual funds fall into this category.

For example, when you buy a stock you make money if it rises in value, and lose if it drops. Although it represents a piece of a company, it’s not a physical piece.

So, why doesn’t Bitcoin count as a security, in the eyes of regulators?

The key distinction is that it’s decentralised and no one controls it, whereas securities are released by a central authority. Regulating cryptocurrencies as securities would be problematic because there’s no one to comply with the rules usually imposed on issuers. Cryptocurrencies are not backed by anything other than trust.

Or something else entirely?

It’s been suggested that cryptocurrencies are simply a whole new category because they’re not quite like anything else. If that’s the case, regulators will need to treat them as unique instead of looking for a home in the existing frameworks. Seeing as each new cryptocurrency has slightly different intentions and technical details, they may need to be considered on a case-by-case basis and slotted into a few categories.

There’s no single answer to the question of what cryptocurrencies are  -  not yet anyway. Yet it’s this versatility that offers such great opportunities for a diverse range of people.

For a migrant worker sending money to their family without heavy transfer fees, it acts as a currency.

For an investor looking to diversify their portfolio, it acts as a commodity or security.

For a developer working to improve the Bitcoin network as a hobby, it might be seen merely as software.

These groups of people and numerous others stand to benefit in their own ways.

The most important thing to note is that it’s never too late to get started. Whether you’re interested in buying Bitcoin as a currency, commodity or security you can do it safely and securely with the Luno App.  

Want to learn more? Read Luno's Bitcoin education series here.

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This article was paid for by Luno.