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The Top 3 Factors That Will Determine What is a “Cryptocurrency”

Jun 25, 2018 7:00:00 AM / by Daniel D'Costa

what-is-cyptocurrency

What is a Cryptocurrency? Whether you’re one of the millions of investors who cashed out their savings to get into the Bitcoin buying frenzy with high hopes for exponential gains or a pessimistic spectator laughing as the price fluctuates thousands of dollars per day; it is unclear and speculative at best if anyone really knows what will happen to Bitcoin and cryptocurrencies in the near future.  The first step in forecasting any investment is to start with the basics and establish some type of foundational understanding. So, what is a cryptocurrency? Despite its name indicating an intention to operate as a form of currency, cryptocurrencies will probably operate more as a “security” than as a replacement to fiat currencies (e.g., U.S. Dollar).

The SEC Division of Investment Management acknowledged that cryptocurrencies can provide market benefits and that there is an overall interest to embrace technological innovation, however it[cryptocurrency] is not yet ready for mainstream exposure.  In order for cryptocurrencies to break through the brick and mortar walls of banking, it must first abolish its theoretical dreams of being an unregulated currency and accept being regulated by any or all regulatory bodies in a given jurisdiction. With respect to the United States laws and regulations, the clearest route to regulation is cryptocurrencies being defined as a “security” under the Securities Act of 1933. It will take some time before the Judiciary or Congress is able to clarify how a cryptocurrency operates as a as a security; however, let’s point out some issues we can expect will be points of discussions and forecast how they will probably be resolved:

  1. Price and Value: Actual valuation of digital assets is almost impossible to achieve. There is nothing underlying the cryptocurrencies themselves that the value can be based on.  Given the daily volatility, creation of forks at the creator’s whim, and a lack of any regulations, it will be difficult to distinguish the value. We can expect that a given cryptocurrency will be tied to some type of global pricing index that is free of any manipulation and has less fluctuations in value.  The concept of a global pricing index that is taken directly from the given cryptocurrencies ledger and then tied to an asset of value will be something the regulators and congress will probably explore.
  2. Tokens: If cryptocurrencies are considered securities, then what will tokens be considered? The token market has boomed in the past few years with companies releasing tokens that represent the value of the underlying currency.  Therefore, one can argue that tokens are by definition “securities” since it represents an ownership interest in the cryptocurrency. However, the value of tokens is based on the value of the underlying cryptocurrency or in some cases the value of several cryptocurrencies. As stated in point one above, the price and value of cryptocurrencies is almost impossible to determine so putting a price tag on tokens is without any solid foundation.  As a result, we have seen token sellers and distributors become subject to heft regulatory fines and outright banned from practice due to fraud, manipulation, and a whole allotment of other SEC and FINRA violations.
  3. Compliance with other Security Regulations: Even if cryptocurrencies are deemed “securities” under the Securities Act of 1933, compliance with all the other financial regulatory rules will be extremely cumbersome. For example, if cryptocurrencies were traded like any other stock they may be subject to the new margin rules and custody requirements where custodians would be required to hold a certain percentage of digital assets as custody for a given trade.  Although cryptocurrencies allow for specific private “keys” that differentiate from one cryptocurrency to the next, it would be interesting to see how easily transferable these keys will be in more large-scale (millions of different key combinations operating simultaneously) transactions.

Until these questions and many others are resolved, it’s difficult to determine when cryptocurrencies will finally break into the market.  Despite the skepticism and ambiguity, it is abundantly clear the regulators do not want to end this journey.

Topics: News

Daniel D'Costa

Written by Daniel D'Costa

Attorney in the Derivatives & Structured Products Practice Group of a Am Law 100 Firm in New York City. Advise investment banks, domestic and foreign commercial banks, asset managers, hedge funds, private equity funds and mutual funds on related transactional and trading regulatory issues. Negotiate trading agreements, including ISDA, repo, securities lending, prime brokerage, custody, futures, cleared swaps, asset-backed securities and related agreements. Represent corporate clients in commercial lending and project finance transactions. Address issues arising under the federal securities and commodities laws and regulations, including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940 and the Investment Advisers Act of 1940, and the Commodity Exchange Act and related rules and regulations. Develop and execute a wide variety of hedge fund structured products (and their OTC counterparts), such as principal-protected notes, warrants, and certificates. Advise on related hedge fund financing transactions such as credit facilities, secured loans, and collateralized financial obligations. Research and advise on regulatory developments in digital currency and blockchain technology.