Crypto classification 101: Explaining a commodity versus security in crypto

Cryptocurrencies face unique identity challenges. As a new asset class, their rapid emergence has left governments and legal experts struggling to define them. Disagreements among institutions – sometimes outright contradictions – have fueled debates over key questions, such as whether these digital assets should be classified as a commodity versus security.

The classification dispute has increased scrutiny of centralized exchanges (CEXs) like Kraken and Coinbase, as well as projects such as Ethereum’s Ether (ETH) and Ripple’s XRP (XRP). Accusations from the U.S. Securities and Exchange Commission (SEC) of trading unregistered securities have further intensified the controversy.

So, why does it matter if a cryptocurrency is labeled a commodity or a security? In this guide, we'll explore the meanings of these classifications and their role in shaping the future of crypto regulation.

Commodity vs. security: Why do these categories matter in crypto?

The classification of cryptocurrencies as either commodities or securities shapes their legal status and determines which entities regulate their movements. This distinction also has significant implications for innovation in web3, investor protections, and accessibility for various digital assets.

A "commodity" designation imposes fewer regulatory requirements on exchanges and crypto projects. While commodities are overseen by bodies like the U.S. Commodity Futures Trading Commission (CFTC), they are not subject to the stricter transparency standards enforced by securities regulators such as the SEC. Avoiding a security designation spares cryptocurrencies from additional expenses, potential fines, and heightened oversight, allowing them to function as more flexible financial instruments.

Let’s take a closer look at how the two compare:

What is a commodity?

Commodities are assets with intrinsic value, whether raw materials, agricultural products, or financial instruments. Their value stems from their inherent features, independent of trading on formal exchanges. For example, oil and natural gas are valuable because they produce energy, while goods like coffee and wheat derive value as essential food products. Fiat currencies like the U.S. dollar and precious metals such as gold and silver are also considered commodities with well-established exchange rates.

Commodities are often categorized into "hard" and "soft" types. Hard commodities are typically mined or extracted, like oil or gold, while soft commodities come from agriculture, such as wheat or coffee. Regardless of the category, a commodity’s defining characteristic is its intrinsic value.

How are commodities regulated? 

Government agencies like the CFTC play a key role in regulating commodity markets. Their primary objective is to promote transparency and prevent fraud or manipulation in markets that trade commodities. However, the CFTC does not directly regulate the spot (or "cash") market for commodities. Instead, its focus is on derivative markets, overseeing contracts that use commodities as underlying assets.  

Exchanges where commodities are traded, such as the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE), also enforce rules to ensure compliance. These include standardized position sizes and margin requirements to maintain orderly trading. 

What is a security?

Unlike commodities, securities do not have intrinsic worth. Instead, their value stems from a debt obligation, such as a bond, or an ownership stake in a company or fund, like stocks or ETFs. In the U.S., the Securities and Exchange Commission (SEC) closely monitors securities to ensure compliance with stringent reporting standards.  

The 1946 case of SEC v. W. J. Howey Co. established the "Howey test," which outlines four characteristics that define a security:

1. Investors provide an initial monetary investment.
2. The investment is part of a shared enterprise.
3. Participants in the enterprise expect to profit from their investment.
4. The expected profits depend on the efforts of others, such as a company managing the investment.

How are securities regulated?

Organizations such as the SEC and the Financial Conduct Authority (FCA) in the United Kingdom oversee securities trading to maintain market integrity. The primary goal of securities regulations is to protect investors by ensuring transparency and preventing fraud. Companies or institutions issuing securities are required to register their offerings and disclose essential financial and operational details. This level of transparency equips investors with the information needed to make informed decisions.

Along with national regulations, state laws like (e.g., "Blue Sky Laws") may impose additional requirements on securities issuers. International bodies, such as the International Organization of Securities Commissions (IOSCO), also provide frameworks and best practices to guide global securities regulation.

What are the key differences between a commodity and a security?

The key difference between securities and commodities lies in their source of value. While trading both types of assets on exchange platforms may seem similar, their properties and purposes are distinct. For investors, understanding these differences is vital to making more informed decisions about portfolio management.

Intrinsic vs. representational value

Commodities have inherent value due to their physical traits or utility. For example, gold is valuable for its rarity and use in manufacturing, while wheat has value as a staple food. In contrast, securities derive their value from the performance or promise of an underlying entity, such as a company or fund.

Investment purpose

The Howey test defines securities as financial products purchased with the expectation of returns, whether through price appreciation or interest payments. Commodities, while often subject to speculative trading, appeal to investors seeking stability, as their intrinsic value makes them effective tools for hedging against inflation or reducing volatility.

Regulatory requirements

Commodities are subject to fewer regulatory requirements compared to securities. Organizations like the CFTC monitor fraud in derivatives markets, but spot markets for commodities are less regulated. By contrast, securities must meet stringent standards for transparency, including registering with authorities like the SEC and providing detailed financial disclosures.

Trading mechanisms

While physical commodities like gold can be purchased and stored, most commodity trading occurs through futures exchanges like the CME, which deal in contracts representing a fixed quantity of the asset. Securities, on the other hand, trade on stock exchanges like the New York Stock Exchange (NYSE) or through over-the-counter (OTC) markets using brokerage platforms. Investors interested in both commodities and securities may need multiple trading platforms to access these different asset types.

Is crypto a commodity or security? 

There's no clear-cut answer to whether cryptocurrencies are commodities or securities, but regulatory bodies widely agree that Bitcoin qualifies as a commodity. Even though BTC is a digital asset, each coin must be "mined" into existence on its decentralized protocol. Also, because Bitcoin functions as a virtual currency on the network rather than an ownership stake in a shared enterprise, it fails to meet the criteria outlined by the Howey test. Organizations like the CFTC now explicitly classify Bitcoin as a commodity.

Altcoins and the securities debate

While the case for Bitcoin as a commodity appears settled, there are ongoing debates over whether different altcoins fit the SEC's Howey test. Not all cryptocurrencies share Bitcoin’s traits, even if they operate on decentralized networks. For example, crypto projects that pre-mine tokens and distribute them to insiders at launch are more likely to face scrutiny under securities laws than fair-launch coins, which are made available to the public without prior allocations to insiders. Cryptocurrencies closely tied to centralized entities are especially vulnerable, as it’s easier to argue that investors are buying into a shared enterprise with the expectation of profit.

This scrutiny has led the SEC to take action against several crypto projects and exchanges for allegedly offering unlicensed securities. Notable examples include Coinbase’s listing of crypto projects like Polygon (POL), Algorand (ALGO), and Solana (SOL). The SEC's ongoing lawsuit against Ripple over its XRP cryptocurrency remains among the most influential cases. In 2023, the Southern District of New York sided with the SEC, ruling that XRP sold to institutional investors qualified as unregistered securities. However, the court also determined that other XRP transactions did not meet the security designation.

The uncertain path forward

Even though the crypto market reacted positively to some aspects of the XRP ruling, the appeals process continues, leaving many questions unanswered about which cryptocurrencies meet the Howey test. Until clearer regulatory frameworks for classifying cryptocurrencies exist, determining whether a cryptocurrency qualifies as a security will likely be on a case-by-case basis. 

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.