Understanding Security vs. Commodity and Crypto’s Position

Financial terms can be tricky, whether we like them or not. Since we encounter them daily, financial education is more important than ever. Even basic terms can be confusing, and security vs. commodity is no exception, especially for the average person.

Most people know the essential difference. It comes down to what you own. However, the financial world is getting more complex. And with the rise of cryptocurrency, another key question arises: where does crypto fit in?

This article explains the key differences between securities and commodities and examines how these differences impact the regulation and classification of cryptocurrencies today.

Commodity vs. Security: At-a-Glance

Disclaimer: This table offers a quick overview. Please read the article further for a deeper understanding of these differences and where cryptocurrencies fit.

What are Securities?

Securities are financial instruments that denote ownership or debt and are traded on financial markets. They are essentially tradable assets that can be bought and sold, and their value is derived from the financial interest they represent.

How Securities Are Regulated?

Given that the U.S. market is one of the most prominent globally and its highly influential regulatory institutions, we’ll focus on U.S. securities regulations. However, many other countries have similar regulatory bodies.

The Securities and Exchange Commission (SEC) regulates the securities market in the U.S. Its core purpose is to protect investors, ensure transparent and orderly markets, and foster efficient capital formation. 

Several self-regulatory organizations (SROs), such as the National Association of Securities Dealers (NASD) and the Financial Industry Regulatory Authority (FINRA), also help regulate securities.

The SEC derives its authority from key securities laws that define the regulatory framework:

• The Securities Act of 1933 governs the initial sale of securities to the public.
• The Securities Exchange Act of 1934 established the SEC and regulated the secondary trading of securities.
• The Investment Advisers Act of 1940 regulates investment advisors.
• The Sarbanes-Oxley Act of 2002 enhances corporate responsibility and improves financial disclosures.
• The Dodd-Frank Act of 2010 strengthens financial industry oversight and safeguards consumers.

The SEC is led by five commissioners appointed by the president and confirmed by the Senate, serving staggered five-year terms. One commissioner is designated as the chair, and no more than three commissioners may be from the same political party, maintaining balance.

This regulatory role is important when a company or government wants to raise money from the public. They must follow strict SEC reporting rules. This gives investors the information they need to make smart choices.

SEC originally regulated traditional securities like stocks and bonds. As financial markets have changed, the SEC’s oversight has grown. It now includes complex financial products and some cryptocurrency assets. The SEC checks whether these meet the security criteria under U.S. law.

What are Commodities?

Commodities are basic goods or raw materials traded on financial markets. These physical commodities are typically interchangeable and often used to produce other goods and services. 

Types of Commodities

1. Agricultural Commodities include goods produced from farming and agriculture, primarily food and fiber products. Agricultural commodities are often seasonal, sensitive to weather, and subject to price fluctuations based on global demand and supply conditions.
2. Energy Commodities are fuel sources for powering industries, transportation, and residential areas. Global economic conditions, political events, and production levels from key producers influence their prices.
3. Metals are split into two main groups: precious metals, often valued for their scarcity and use as a store of value, and industrial metals, widely used in manufacturing, construction, and technology. Their market prices vary based on industrial demand and economic cycles.
4. Livestock and Meat include animals raised for meat production. These commodities are affected by factors like feed costs, consumer demand, and health regulations. They play a vital role in food industries worldwide.
5. Environmental Commodities are associated with sustainable practices and environmental goals. They are part of regulatory efforts to reduce environmental impact, particularly related to greenhouse gas emissions and renewable energy usage.

What Federal Agency Regulates Commodities?

Considering that the U.S. market is one of the most well-known and its regulatory agencies are among the most vocal, we’ll focus on the U.S. regulatory setup. However, remember that most countries have similar institutions for commodity regulation.

In the U.S., the Commodity Futures Trading Commission (CFTC) oversees the commodity markets and related financial products, such as futures and options. Established in 1974, its mission is to ensure these markets remain competitive, efficient, and free from manipulation and fraud. Thus, creating a fair environment for investors.

The Commodity Exchange Act, originally passed in 1936, lays out the foundational rules for trading commodity futures. It has been updated over time to match market developments, and it grants the CFTC the authority to establish detailed regulations published in the Code of Federal Regulations.

Like the SEC for securities, the CFTC is led by five commissioners appointed by the president and confirmed by the Senate. Each serves staggered five-year terms. The president designates one commissioner as chair, and no more than three commissioners can simultaneously belong to the same political party.

While the CFTC initially focused on agricultural products, it now oversees a wider array of commodities, including digital assets, as these markets have expanded and evolved over the years.

Commodity vs. Security Examples

Commodity Examples

1. Energy Resources: crude oil, natural gas, gasoline, and coal;
2. Metals: gold, silver, copper, and platinum;
3. Agricultural Products: wheat, corn, soybeans, coffee, and sugar;
4. Livestock and Meat: cattle (beef), hogs (pork), and poultry;
5. Environmental: carbon credits, renewable energy certificates (RECs).

Each of these commodities is traded around the world. They are important for many industries and vital to the global economy.

Security Examples

1. Stocks (Equity Securities): common stock and preferred stock;
2. Bonds (Debt Securities): government, corporate, and municipal bonds;
3. Mutual Funds: equity mutual funds, bond mutual funds, and index funds;
4. Exchange-Traded Funds (ETFs): equity, commodity, and sector ETFs;
5. Options: call options and put options;
6. Futures Contracts: commodity futures and financial futures contracts;
7. Real Estate Investment Trusts (REITs): equity and mortgage REITs;
8. Certificates of Deposit (CDs): bank-issued CDs.

These securities serve different investment purposes. They are important instruments in financial markets, used for everything from building long-term wealth to generating income or hedging risks.

Is Cryptocurrency a Commodity or Security?

Cryptocurrencies are especially interesting when discussing whether something is a security or a commodity.

Recent market events make answering this question about digital assets difficult. These events include the SEC vs. Ripple lawsuit, Ethereum’s Merger, and concerns about its staking model. Coinbase is facing regulatory challenges, including the CFTC vs. Binance case. There are also debates about how to classify stablecoins.

Simply put, there’s still no clear answer, so the best we can say right now is that it depends.

Classifying traditional assets like gold, oil, stocks, or bonds as commodities or securities is usually straightforward. But the line isn’t so clear with digital assets like cryptocurrencies. Some cryptocurrencies share traits with commodities, while others could be treated more like securities. Each has unique qualities that make a one-size-fits-all approach tough to apply.

So, the classification of each crypto asset could depend on its specific features and how it’s used in the market. But why is it important, you may ask?

Cryptocurrencies as Commodities

In the future, if cryptocurrencies were recognized as commodities, they would be treated similarly to assets like gold, oil, or agricultural goods. This framework would focus on the asset’s use as a store of value and trade based on market demand and supply dynamics rather than regulatory oversight tied to investor protection.

In this regard, the CFTC, which oversees commodities in the U.S., has historically argued that cryptocurrencies such as Bitcoin and Ether are more like commodities. This is because these digital assets are fungible, meaning each unit is interchangeable with any other unit, much like other commodities that hold inherent value. While one Bitcoin is fungible with another, its market value can fluctuate based on supply, demand, and market conditions. This interchangeability, or ‘fungibility,’ is central to how the CFTC views commodities.

The CFTC’s role remains limited because its authority primarily extends to derivative products based on commodities, like futures contracts. This means it doesn’t have direct oversight over the spot (direct purchase) trading of cryptocurrencies. 

However, if cryptocurrencies are designated fully as commodities, this could grant the CFTC broader regulatory powers, helping them oversee markets for fraud or manipulation while allowing a less restrictive trading environment.

The ongoing debate has seen the CFTC push for more clarity and authority in crypto. Proposals in Congress aim to expand the CFTC’s role, granting it increased jurisdiction over non-security digital assets like Bitcoin. This could create a simpler, more predictable regulatory environment for those cryptocurrencies that meet the “commodity” profile.

Cryptocurrencies as Securities

If cryptocurrencies are considered securities, they would follow the Securities and Exchange Commission (SEC) rules. The SEC relies on the Howey Test, a legal framework dating back to the 1940s, to determine whether an asset qualifies as a security.

The Howey Test defines an investment contract as one in which:

1. An investor purchases the asset to invest,
2. providing money or something of value,
3. which is pooled into a common enterprise,
4. with the expectation of profits,
5. derived from the essential managerial efforts of others.

The ongoing debate about cryptocurrencies’ classification centers on the fourth criterion—whether profits come primarily from a central, coordinated effort or a decentralized network. Many cryptocurrencies, particularly those rooted in decentralized finance (DeFi), are structured so that no single entity is responsible for the project’s value or success. 

Instead, investors might actively participate by staking coins, validating transactions, or voting on governance decisions, complicating the Howey Test application. Proponents of classifying crypto as commodities argue that this decentralized structure means investors aren’t solely reliant on third-party efforts.

The SEC thinks that many crypto projects look like investment contracts. This is especially true when crypto tokens are sold through Initial Coin Offerings (ICOs). These methods are similar to traditional stock offerings. When investors buy tokens in ICOs, they often expect the project’s team to work to increase the token’s value—a similarity to stocks that fuels the SEC’s push for regulation.

In the past, the SEC has taken enforcement actions against ICOs, asserting they should be treated and regulated as securities.

Why the Classification Matters

The implications of being classified as securities vs. commodities are substantial for the crypto industry.

If deemed securities, crypto exchanges must register with the SEC, imposing more compliance requirements and costs. This could deter innovation and limit accessibility for U.S. investors. Exchanges may even avoid listing certain tokens to avoid potential fines for selling unregistered securities.

On the other hand, if classified as commodities, crypto assets would experience lighter regulatory scrutiny, allowing for more accessible innovation but with fewer protections for investors. The industry favors this path, encouraging development and avoiding the burden of intensive disclosure requirements.

In this regulatory gray area (regulatory uncertainty), some cryptocurrencies could likely be treated as securities and others as commodities. However, until a clear framework is established, digital asset classification remains a significant tension between the crypto industry and regulators.

Choosing Between Commodities vs. Securities

Deciding between commodities and securities largely depends on your goals, risk tolerance, and investment objectives. 

If You Prefer Stability and Physical Assets

Commodities may be better if you want tangible assets like metals, energy, or agricultural products. They are known for being somewhat resistant to inflation, as they’re often linked to essential goods. 

Investors in commodities often guess how much people will want these goods. They also protect themselves against price changes. This can be attractive if you want something different from regular stocks.

If You’re Drawn to Company Ownership and Growth

Securities, like stocks, give you partial ownership in companies and often come with the opportunity for dividends. 

Investing in securities can be rewarding. It allows you to support a company’s growth. You can earn returns based on its success, and you also get to join in the market’s long-term potential. 

However, securities are regulated with market participants’ protection in mind. So, there’s a level of transparency that helps you make informed choices.

Cryptocurrencies: A Middle Ground with Unique Rules

With digital assets like cryptocurrencies, the choice between commodity and security status is still debatable. however, understanding where a token falls can help guide your decisions. If crypto is treated like a commodity, you might see lighter regulations, more flexibility, and opportunities for quick innovation but less regulatory protection. 

On the other hand, if a token is classified as a security, you’d have stricter oversight. This could add a level of safety but may also slow innovation and increase compliance costs.

FAQs on Security vs. Commodity

Is Bitcoin a Security or a Commodity?

The classification of Bitcoin is still debated. Some argue that Bitcoin could be considered a security, but because it’s decentralized, it doesn’t fit neatly into that category. The CFTC treats Bitcoin as a commodity and regulates it under the Commodity Exchange Act.

Is Ethereum a Commodity or Security?

Ethereum is also involved in this debate. The CFTC treats it as a commodity, like Bitcoin and Litecoin. On the other hand, the Securities and Exchange Commission (SEC) has said that certain cryptocurrencies, like Ripple’s XRP, might be securities and should be regulated as such.

Can a Commodity Become a Security?

Yes, a commodity can become a security if it fits the “investment contract” criteria outlined by the Howey Test. This test was created by a Supreme Court decision in 1946. It says something is an investment contract if people invest money in a shared venture. They expect to earn profits from the work done by others. In cases where a commodity is being marketed or structured in a way that meets these conditions, it could be reclassified and regulated as a security.

Final Thoughts

Regarding security vs. commodity in finance, assets are typically divided into two main categories: commodities, basic goods used to make other products, and securities, which are financial instruments designed to generate profits from shared investments.

However, digital assets like cryptocurrencies don’t quite fit into either category. At least there isn’t a common sense about it. This creates a challenge, forcing us to rethink how we classify assets.

The debate over whether crypto should be treated as a commodity or a security is still ongoing, and how it’s ultimately classified could have a major impact on its regulation and shape its future development.

That’s why it’s important to watch how crypto evolves in the coming years. But until then, it’s useful to understand the general differences between securities and commodities. So be sure to keep them in mind.