In recent years, the cryptocurrency industry has experienced significant growth, resulting in the creation of various digital assets that serve different purposes.
Given the fast-paced nature of these developments, it’s possible that frictionless peer-to-peer transactions without the need for a centralized authority have already surpassed the adoption threshold. However, a major challenge for this industry is the classification of digital assets, particularly in determining whether they should be considered securities or assets with utility.
This article will explore the classification of digital assets, the implications of conflicting definitions, and the need for clearer regulations.
Types of Digital Assets
Digital assets refer to cryptocurrencies or tokens that use cryptography to secure transactions and control new unit creation.
Two categories of digital assets are security tokens and utility tokens. Security tokens represent ownership of an underlying asset and are subject to securities laws and regulations, while utility tokens provide access to a product or service within a particular ecosystem. However, the distinction between security and utility tokens can be blurry, leading to conflicting classifications and regulatory uncertainty.
Understanding the characteristics of security tokens can help clarify the differences between security and utility tokens and why utility tokens may not fall under the same definitions and regulations.
Understanding Security Tokens
Compared to other digital assets where the value is derived from the blockchain technology itself, security token’s value is typically derived from using the technology to represent an underlying asset or company.
As such, security tokens are specifically designed to function like a traditional security that uses blockchain technology.
Despite the ongoing lack of comprehensive regulatory guidelines, security tokens have been developed to comply with existing laws and regulations. Similar to stocks, bonds, and REITs, security tokens function as digital shares of a corporation that exist on the blockchain.
While this use case may work well for tokenized securities, challenges arise when applying old regulations to less traditional types of digital assets.
Conflicting Classifications of Digital Assets
Regulating new technology has always been a challenge.
However, with the development of blockchain technology, something that may be used as a financial instrument also has other use cases far beyond a financial exchange. If you break it down and only take the underlying innovation of distributed ledger technology (DLT), a blockchain can be used for a multitude of functions such as data storage, identity verification, gaming software, running DeFi applications, and much more.
With the growing number of use cases of digital assets, the lack of regulatory clarity has become increasingly detrimental to the growth of the industry. For instance, the SEC’s strict approach to regulation by enforcement actions only showcases what not to do, which has done little to provide guidance.
This ambiguity has been especially damaging for startups, which often find it overly burdensome to balance innovation, competition, and compliance.
Implications on Current and Future Regulations
The conflicting classifications of digital assets have significant implications on current and future development in the cryptocurrency industry.
Since blockchain technology enables a global network that operates without a centralized authority, developers and entrepreneurs have had no choice but to tip toe over the gaps in regulation, which stifles creativity.
Furthermore, regulatory agencies use different criteria to determine whether a token is a security or not. This has led to legal disputes and increased regulatory costs for companies, ultimately reducing democratic access to capital and community participation, which are key advantages of this new technology.
Final Thoughts…
The classification of digital assets as securities or utility assets presents a significant challenge in the cryptocurrency industry.
Competition is a key driver of progress in a capitalist market, and innovation typically leads to modernized regulation. However, the decentralized nature of this new ecosystem presents unique complexities, and regulators must carefully consider the implications of strict enforcement actions. As there is a fine line between protecting participants and limiting access to capital.
Therefore, a balance between protecting investors and promoting innovation is necessary to ensure the long-term success and sustainability of the emerging crypto space.
