Can cryptocurrencies be classified as securities? A legal perspective

The Cryptocurrency & Regulation of Official Digital Currency Bill 2021 prima facie seeks to ban all ‘private’ cryptocurrencies in India and create a framework for regulation of official digital currency issued by the Reserve Bank of India (RBI).

Can cryptocurrencies be classified as securities? A legal perspective

By Trisha Shreyashi

The striking growth of the global blockchain based crypto-market has struck a strong chord with the governments, financial institutions, and investors alike. In light of the chain of events transpiring in India and globally, the policy makers are propelled to regulate virtual assets like crypto. The crypto regulation is being discussed extensively in the 2021 parliamentary winter session.

The Cryptocurrency & Regulation of Official Digital Currency Bill 2021 prima facie seeks to ban all ‘private’ cryptocurrencies in India and create a framework for regulation of official digital currency issued by the Reserve Bank of India (RBI). RBI’s digital currency; viz:- the Central Bank Digital Currency (CBDC) is proposed to operate as legal tender on the lines of Inter-ministerial Committee, Ministry of Finance (GoI) report 2019. Present plans propose the launch of two forms of CBDC –

(i) Retail CBDC, a digital equivalent of fiat currency, would enable the public to perform payment and settlement functions, via existing retail payments and core banking systems.

(ii) Wholesale CBDCs would perform as a merger of payment and trading processes in the form of tokens to enable interbank large value payments and settlements by permitted entities.

The Securities & Exchange Board of India (SEBI), the market regulator of Indian Financial Markets, has been proposed to regulate the crypto-market. In face of this development, it is imperative to discuss the nuances of whether cryptocurrency falls under the definition of “securities” or not. Section 2 (h) of Securities Contract Regulation Act (SCRA), 1956 entails all negotiable, marketable and fungible financial instruments representing financial value or ownership rights as “securities”. These include shares, scrips, bonds, stocks, debentures, derivatives, hybrids, government securities etc., purchase and sale of which is enabled by investment contracts.

It is pertinent to scrutinize whether digital assets like crypto fall under the definition of securities enabled by investment contracts. The landmark judgment of SEC V Howey pronounced by the US Supreme Court establishes “Howey test” for the same. It entails that the investment’s profits accrued largely or completely outside the control of the investor are securities. The Howey test considerably emphasizes on the substance and value rather than the form of investment. Therefore, virtual currencies(VCs) like- Bitcoin(BTC) & Ethereum(ETH) don’t qualify as securities, according to the Howey test.

While the Howey test has not yet been expressly explored in the Indian regime, the concepts of “securities” and “investment contracts” are similar as in the case of Sahara V SEBI (2012). Further, the International Monetary Fund explains how aforementioned VCs derive their value from demand and supply instead of underlying assets. Once can thus infer that such VCs are beyond the purview of non-exhaustive definition of “securities”, under the SCRA. Moreover, such decentralized assets with a non-identifiable issuer are not considered securities under Indian laws.

Radical crypto positivists could argue that classifying cryptocurrencies as securities goes fundamentally against everything it stands for. There is a very strong case for crypto-regulation and crypto-ban but it must not be forgotten that cryptocurrencies were originally designed to be autonomous and decentralized.

(The author is a legal professional and a part of the National Institute of Securities Markets (NISM) academia. Views expressed are personal and not necessarily that of Financial Express Online.)

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