How a cryptocurrency or digital token is classified under law determines which regulations apply and which agencies have jurisdiction. The same asset might be treated as a security by the SEC, a commodity by the CFTC, property by the IRS, and currency for certain state money transmitter laws. This regulatory patchwork creates significant complexity for businesses and investors. Understanding token classification is essential for compliance, investment decisions, and structuring digital asset projects.
The Securities Classification
The SEC uses the Howey test to determine whether a digital asset constitutes a security. Under this analysis, an investment contract exists when there is an investment of money in a common enterprise with a reasonable expectation of profits derived from the efforts of others. Most token offerings during initial coin offerings have been found to satisfy this test, particularly when purchasers expected the token to increase in value based on the promoters' development efforts.
Securities classification triggers registration requirements under the Securities Act of 1933, ongoing disclosure obligations under the Securities Exchange Act of 1934, and restrictions on trading venues and intermediaries. Failure to comply with securities laws can result in SEC enforcement actions, rescission rights for purchasers, and potential criminal liability. Structuring token sales to avoid securities classification requires careful legal analysis.
The Commodity Classification
The CFTC has asserted that Bitcoin, Ethereum, and certain other cryptocurrencies are commodities under the Commodity Exchange Act. This classification gives the CFTC jurisdiction over fraud and manipulation in crypto spot markets and exclusive jurisdiction over crypto derivatives including futures and options. Unlike securities, commodities do not require registration for spot market trading, creating a less burdensome regulatory framework.
The commodity classification provides certain advantages for digital assets that qualify. Spot market trading can occur without registration as securities exchanges, and intermediaries may avoid broker-dealer registration requirements. However, derivatives trading requires registration with the CFTC, and fraud and manipulation remain subject to CFTC enforcement regardless of whether derivatives are involved.
The Currency Classification
For purposes of money transmission laws, cryptocurrencies used as payment mechanisms may be treated as currency or its equivalent. This classification triggers state money transmitter licensing requirements and federal Bank Secrecy Act compliance obligations. Businesses that exchange, transmit, or hold cryptocurrency for customers often must register as money services businesses and obtain state licenses.
The currency classification focuses on how the crypto asset is used rather than its inherent characteristics. An asset might be a commodity for CFTC purposes while simultaneously being treated as currency for money transmission purposes. This overlap creates compliance obligations under multiple regulatory frameworks simultaneously for many crypto businesses.
Tax Treatment as Property
The IRS treats cryptocurrency as property rather than currency for federal tax purposes. This means that transactions involving crypto can trigger taxable events, including sales, exchanges, and uses to purchase goods or services. Capital gains and losses must be calculated based on the difference between the amount realized and the taxpayer's basis in the crypto.
The property classification creates significant record-keeping requirements for crypto users and businesses. Every transaction potentially requires tracking of cost basis, holding period, and gain or loss. Businesses may have information reporting obligations for certain transactions. Tax compliance represents a distinct regulatory consideration separate from securities, commodities, and money transmission requirements.
Utility Tokens and Functional Classification
Tokens designed primarily to provide access to a network, service, or application are often called utility tokens. Project promoters frequently argue that such tokens should not be classified as securities because purchasers acquire them for use rather than investment. However, the SEC has rejected this argument in many cases, finding that utility tokens can still be securities if purchasers have investment intent.
The timing of utility matters for classification analysis. Tokens sold before a network is operational are more likely to be securities because purchasers necessarily rely on promoters' future efforts. Once a network is fully developed and tokens function primarily as consumptive goods, the securities analysis may change. Some projects structure offerings to sell tokens only after achieving sufficient decentralization and functionality.
NFTs and Unique Digital Assets
Non-fungible tokens present additional classification questions due to their unique characteristics. NFTs that represent ownership of artwork, collectibles, or other unique items may not satisfy the Howey test if purchasers acquire them for personal enjoyment rather than investment. However, NFT projects with investment-oriented marketing or features like royalty sharing may cross into securities territory.
Fractionalized NFTs that divide ownership among multiple holders raise particular concerns, as the shared ownership structure resembles traditional investment contracts. The specific characteristics of each NFT project determine its classification, making generalization difficult. Legal analysis should focus on how the project is structured and marketed rather than simply the NFT label.
Stablecoins and Payment Tokens
Stablecoins designed to maintain stable value relative to fiat currency present their own classification challenges. Depending on their structure, stablecoins might be treated as securities, money market funds, bank deposits, or payment instruments. Regulatory approaches to stablecoins continue to evolve as lawmakers and regulators consider the systemic implications of widely adopted payment stablecoins.
Algorithmic stablecoins that maintain value through market mechanisms rather than reserves face additional scrutiny after notable failures. Reserve-backed stablecoins must address questions about reserve composition, attestation, and customer claims in insolvency. The regulatory treatment of stablecoins remains particularly unsettled compared to other token categories.
Practical Implications
Token classification affects nearly every aspect of a crypto project or business. Incorrect classification can result in enforcement actions, litigation, and inability to operate in desired markets. Getting classification right from the beginning is far less costly than correcting course after problems arise.
Obtaining legal analysis of classification before launching projects or business lines helps identify compliance requirements and structure activities appropriately. Multiple regulatory frameworks may apply simultaneously, requiring compliance with securities, commodities, money transmission, and tax laws. Working with counsel experienced in digital asset regulation provides the analysis needed to navigate this complex landscape.