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How the SEC Defines Digital Assets

Digital assets are based on blockchains, which are chains of transaction blocks. They include cryptocurrencies, which use their own blockchains, and “crypto tokens [that] are built on an existing blockchain.” Cryptopedia, Digital Assets: Cryptocurrencies vs. Tokens (Mar. 23, 2021) (“Digital Assets”).    

A “token” can be defined as an instrument (tool) that is (1) perceptible using one or more senses, (2) representative of a stored value and useful as a medium for exchange in a particular market or system of markets, and (3) exchangeable, at some fixed or changeable ratio, for other value, such as a good or service, within that market or system of markets.     

In the first part of the definition, (1) above, the token can be perceptible as a tangible object, such as a coin, stamp, ticket, coupon, gambling chip, or only visually, as on a computer monitor or in a company’s ledger.     

The second prong, (2) above, includes tokens that have stored value that is either “intrinsic” in that the value derives solely from the token’s acceptability in transactions in the system of markets or “extrinsic” insofar as the token’s value is pegged or linked to another specific asset. A token’s perishability and replicability obviously impact its value. A banana makes for a poor token because it will decompose over time. Although the weight of a cylindrical piece of metal will diminish through abrasion over time, coins are perhaps the optimum token. The ability to create more units of value creates a fear and possibility of inflation, which creates more units even though the inventory of items that can be purchased has not increased.     

Under the third part of the definition, (3) above, the number and types of transactions and markets within which the token’s value is recognized can be used to determine the scope and value of the token. The key difference between a token, as defined, and money is the scope of the transactions and markets—the micro-economy—in which each is accepted and used. This is a difference in degree, not in kind.      

A distinction can be made between currency tokens and utility tokens, based on the scope of the transactions and markets in which they can be used, and between cryptocurrencies and crypto-tokens, based on their relationship to a blockchain. The difference between a currency token and utility token can soon break down, as the latter can become the former; in some sense, they both constitute money. Some tokens have their own blockchains, and other tokens use others’ blockchains.     

All items of value are social constructs, including digital tokens, securities, and money, whether a cryptocurrency (private digital money) or fiat currency issued by governments. Although not tangible, each “unit” has its own origin and history. Hard collectibles, digital collectibles, and digital currency or digital assets are all investments in the sense that—if a secondary market exists—one may, upon resale, be able to recover one’s purchase price and a profit as part of the total resale price. Also, these items are all usable in the same way as any asset is usable. They may be flipped for a quick gain, held to increase in value, used to secure loans, or traded for other assets of the same class or otherwise.       

The SEC defines a financial product to include but not be limited to “stocks, bonds, derivatives, and currency,” and this definition includes both a unit of cryptocurrency and a security. As discussed above, digital currency functions as a currency, either as its sole function or in a limited capacity as a token within a micro-economy. The cryptocurrency producer may be formally organized (as a corporation, partnership, limited liability company) or organized informally. Often, the producer of cryptocurrency is also the seller of the digital tokens. Similarly, any entity whether a formally or informally organized enterprise, may issue a security, such as a unit of stock (a share) or a dollar-denominated bond, and the security will be sold by the issuer.  

Having compared the digital token to the concept of a “security,” some of the dangers inherent in the SEC’s ongoing campaign to regulate cryptocurrencies become apparent. Because there is so little to distinguish a cryptocurrency from other types of digital tokens and because the SEC has chosen to disregard the numerous differences between digital assets and securities, any form of digital token risks being swept into the SEC’s regulatory scheme and regulated as a security.

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