As an individual or institution, the ability to differentiate between a cryptocurrency and a security is an essential skill in financial markets. In this article, Benzinga examines the defining characteristics of securities and cryptocurrencies.
What is Classified as a Cryptocurrency?
What is a Cryptocurrency?
Cryptocurrency refers to the native asset on a blockchain network such as Bitcoin BTC/USD or Ether ETH/USD. It is issued by the blockchain it operates on and can be traded or used as a medium of exchange and acts as a store of value.
Cryptocurrencies typically exhibit the following characteristics:
- Built on a blockchain or other distributed ledger technology (DLT), allowing participants to enforce rules of the system in a trustless and automated manner
- Uses cryptography to secure the cryptocurrency’s underlying network system and structure
- Decentralized, or at least not dependent on a central issuing authority — cryptocurrencies rely on code to manage issuance and verify transactions
Why Is It Called Cryptocurrency?
The term cryptocurrency is a blend of the words of cryptography and currency. Cryptography is used extensively to secure transactions between users.
Distinguishing Cryptocurrencies From Tokens And Digital Assets
When deciding what a cryptocurrency is, it’s critical to understand the difference between digital assets, tokens and cryptocurrencies. While many people use these terms interchangeably, they are different in a variety of ways.
Generally speaking, a digital asset is a nontangible asset that is traded, created and stored in a digital format. Cryptocurrency and tokens are a specific subclass of digital assets that use cryptography, a complex encryption technique that ensures authenticity and eliminates the possibility of double-spending and counterfeiting. As a result, digital assets are considered an umbrella term that encompasses both tokens and cryptocurrencies.
Next, it is important to distinguish between tokens and cryptocurrency. The fundamental difference between tokens and cryptocurrencies is that tokens are built on top of an existing blockchain, whereas cryptocurrencies are built into the underlying blockchain. Unlike cryptocurrencies, tokens are not built into the blockchain itself; instead, their behavior comes about by the implementation of smart contracts that operate on top of an existing blockchain.
If you are familiar with the Ethereum blockchain, you most likely would have come across ETH and ERC-20 tokens. Ether refers to the native asset on the Ethereum blockchain and is classified as a cryptocurrency. Conversely, ERC-20 tokens are classified as utility tokens — one of the different types of tokens — because ERC-20 tokens were created by platforms that are built on top of the Ethereum blockchain.
Takeaway
Overall, the easiest way to determine whether a digital asset is a cryptocurrency is by identifying if it functions as the native asset on a particular blockchain network. If you desire further confirmation, a reliable way to verify your findings is by reading the project’s official whitepaper.
What Is Classified As A Security?
What Is A Security?
A security is a financial instrument used to raise funds for the issuer. The term security implies that these types of investments are tradable, negotiable and fungible, such as bonds, stocks and exchange-traded funds (ETFs). The buyer of a security is called an investor, while the seller of the security is called the issuer. Generally speaking, the nature of what can and can’t be classified as a security depends on the jurisdiction in which the assets are being traded.
Types Of Securities
In the United States, securities are broadly classified into four primary categories. A straightforward way to determine whether an asset is a security is by attempting to classify it into one of these categories.
Equity securities:An equity security is a share of ownership in a company, partnership or trust. Equity securities are realized in the form shares of capital stock, which includes shares of both preferred and common stock. The value of equity securities can increase or decrease over time depending on the performance of the company and the broader financial market. You can trade cryptocurrencies and digital securities with INX.
Debt securities:Debt securities enable corporations and governments to raise money through publicly traded loans in exchange for the repayment of the principal loan and regular payments of interest. In this regard, the investor refers to the borrower and the issuer refers to the lender. Examples of debt securities include corporate bonds and treasury bonds.
Hybrid securities:Hybrid securities, as implied by the name, combine some characteristics of both equity and debt securities. Examples of hybrid securities include convertible bonds and equity warrants.
Derivatives:Derivatives are valued based on the value of another underlying asset. They are purchased and repaid, with the interest, price and maturity date all specified at the time of the initial transaction. Both parties involved in the contract are essentially betting on the underlying asset’s value changing in opposite ways. Examples of derivative securities include futures, swaps and options.
In summary, cryptocurrencies are a type of digital asset, and securities refer to financial instruments. True cryptocurrencies, those that act as replacements for traditional fiat currency, are commodities rather than securities. However, some types of cryptocurrencies such as security tokens are classified as securities.
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