A Commodity, a Security, or a Scam? – Jackson Walker

Despite recent setbacks and scandals, cryptocurrency and other blockchain technologies are increasingly being utilized in the finance and corporate world. However, transitioning to legitimacy also means regulation, which raises new questions about how cryptocurrencies will be treated by government agencies such as the Commodity Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC). On this episode of FRB, we explore what cryptocurrency is, how various types differ from one another, and how they could potentially fit into our country’s regulatory framework.

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Erin Camp: Hi, I’m Erin Camp, a corporate finance lawyer with Jackson Walker.

Art Cavazos: And I’m Art Cavazos, corporate and finance lawyer with Jackson Walker. And this is Future Ready Business.

Erin Camp: As always, we’d like to remind our listeners, that the opinions expressed today are ours and do not necessarily reflect the views of Jackson Walker, its clients, or any of their respective affiliates.

Art Cavazos: This podcast is for informational and entertainment purposes only and does not constitute legal advice. Also, we’ll be talking about some financial topics today, but we’re not financial advisors and we’re not giving investment advice. Now, we have a great show lined up for you today. In the previously recorded episode that follows, we’ll be talking about cryptocurrency and blockchain, but I think we had a few, kind of, updates to that previously recorded episode first.

Erin Camp: Yeah, in the time since we recorded the episode that you’re about to hear, there have been a lot of changes in the economy and in the world, overall.

Art Cavazos: And definitely in the world of crypto.

Erin Camp: Oh, yeah. I think – I don’t know how to really accurately encompass how many changes there have been and in how many different ways. First, I don’t think our predictions were exactly correct in where, maybe, we are with our relationship to cryptocurrency. I don’t think we really — in terms of trends and how long lasting it is — I’m not sure we are at a point where it is going to be stable. Like, we were optimistically predicting back in I think early June or late May when we first recorded this.

Art Cavazos: Yeah, and, you know, we’re presenting the episode exactly as it was recorded back in May. So, you know, we’ll let the record speak for itself. But the way I remember it, I don’t know if we were unnecessarily optimistic that we were already there, but I think we weren’t questioning if we might be there. I do still think that, despite recent events and that there’s obviously been a bit of a bubble, and there’s been some scam artists, you know, large and small, participating in the market, you know, kind of in a rampant fashion. I still don’t think that means, you know, the end of cryptocurrency or blockchain assets. I think Bitcoin is actually still doing pretty well. I think a lot of the kind of more legitimate, or what some market participants have viewed as more legitimate, coins are still doing okay. So, you know, it’s kind of like, you know, Enron happened and the financial markets were shaken, but stocks didn’t disappear as an asset class because of that. This has definitely been kind of a big blow to crypto with FTX going down, and the market overall going down.

Erin Camp: I mean, I think it’s made things absolutely terrifying for a lot of different people. I don’t necessarily just mean like individual investors and the mainstream sort of people that we’ve started seeing participate that hadn’t been participating. But a lot of the long-time, long-term players that are really big, you know, they’re scared too. All of a sudden, it looks like they can be held liable for what they’ve been doing and for the risks they’ve been taking.

Art Cavazos: Yeah, and I think one thing we have been anticipating is more regulation in this space. So, what this may result in is more concrete steps by the SEC, by the CFTC.

Erin Camp: Yeah.

Art Cavazos: Well, I think that’s enough of a preview. We’ll go ahead and shut up now and let you all enjoy the episode.

Today, we’re going to be talking about cryptocurrency, which is something that we both been interested in for a long time, but only recently have we actually started doing deals in it. I think that’s really legitimized it a lot for both of us.

Erin Camp: Yeah. So, since we are such early adopters, whenever something new pops up, it isn’t necessarily something we’re going to see in the finance world or in the corporate world. And we keep seeing cryptocurrency lately. I mean, really, just the last couple of months have come across many new clients and current clients wanting to trade with cryptocurrency. That’s when we realized that something that we previously were just interested in as sort of natural early adopters was something that was increasingly legitimate, and something that we not only were interested in, but something we’re going to need to know about in our own practice.

Art Cavazos: So far, we’ve done deals involving crypto mining hosting agreements, which is basically where you take specialized equipment and place it in a computer server farm. That can be millions of dollars of equipment, and there’s a lot of specialized considerations that go into that. Also, we’ve done formation of crypto funds. You have quite a bit of fund formation experience, but not necessarily with cryptocurrency—

Erin Camp: Right.

Art Cavazos: So, that’s kind of a new angle on it. And also, some of our colleagues have been working with energy companies using natural gas runoff and things like that to power crypto mining machines. So, there’s been a lot of activity in the space this year.

Erin Camp: And it’s really touched, you know, many facets of our lives and our practices as a firm and as individual attorneys.

First, we should probably clarify that, you know, we’re not really experts in the space, and that’s okay. Part of the point of this podcast is really just to talk about topics that come up and interest us. One big thing we have in common as attorneys is that we have to learn about things quickly. And so, we thought we could bring some of those topics, including cryptocurrency to light through this podcast.

Art Cavazos: We’re not giving legal advice. We’re lawyers. So, we’re definitely not giving investment advice. That’s not really the purpose of this podcast. It’s really just to explore interesting topics. And like you said, that is something we do a lot in our practice, you were doing deals in lots of different spaces. As deal lawyers, we’re not always the subject-matter experts, we might bring in subject-matter experts to talk about things in future episodes. And that’s one of the advantages of being at a large law firm like Jackson Walker is we have folks with deep experience in a lot of different arenas that we can tap in and call upon.

Erin Camp: Right. So, for example, when these transactions started coming up that concern cryptocurrency, particularly in relation to these like crypto funds, one of our colleagues has a lot of experience in this space. His name is Mike Lassaude. Because of him, we’ve been able to work with all these new clients who’ve been able to take them on as clients, but also, we’ve been able to learn a lot from working with him right and are probably able to have this podcast.

Art Cavazos: Diving into cryptocurrency—First, let’s talk about just a little bit what is cryptocurrency. Despite the fact that you and I have really gotten steeped in it over the past six months, that have been a little bit familiar with it before that, there’s probably still a lot of folks out there that have maybe heard the term but don’t really know what it is, why it matters. So, I think let’s start there.

Erin Camp: Yeah, let’s start with just a simple, clear, crisp definition first.

Art Cavazos: Sure. What cryptocurrency is — it essentially started as a cryptology problem. Cryptographers back in the ’80s, ’90s were trying to figure out is there a way you can create a digital asset on the internet that can’t just be easily copied or easily manipulated. Anybody who’s pressed copy and paste knows that that’s actually not an easy thing to do with a digital asset. That was a problem that stumped cryptographers for decades. Really, it was in 2008 when somebody under the name Satoshi Nakamoto released a white paper describing how Bitcoin — specifically Bitcoin was the first — would work. Cryptographers have looked at that and thought, ‘This works, this solves the problem,’ and it actually went live in January 2009. There was one computer mining Bitcoin — we’ll talk a little bit in a minute about what Bitcoin mining is exactly — but it was just one computer at first. It snowballed to be a few more computers, a few more, until really kind of culminating most recently in about 2017 with a huge price increase and started to get mainstream attention.

But essentially what cryptocurrency is, is a software program that, in the Bitcoin model, has a difficult mathematical puzzle that needs to be solved. When you solve that puzzle, you’re rewarded with more Bitcoin. It’s kind of like the proverbial pancake-eating contest where the prize is more pancakes. But in this case, they’re very valuable pancakes, so people really want them. As you solve these problems and get more Bitcoin and they become more valuable, more people get onto the network and try to solve problems to get more Bitcoin themselves. So, it’s this snowballing thing where it actually becomes more and more difficult to solve those problems as more and more computing power is put towards solving those problems. All of that’s by design, and it’s turned out to work pretty well. You know, here we are more than a decade later and Bitcoin is still the leader in this space.

Erin Camp: Yep. The leader and arguably the only cryptocurrency that’s been able to achieve the ultimate objective of a lot of these cryptocurrencies, which is decentralization. Another good point I think to bring up here is the term cryptocurrency actually includes a lot of different types of crypto currencies, which that’s the word currency may or may not be accurately used there. The two leading coins are Bitcoin and Ethereum. We’ll talk a little bit more about what makes those different in a little bit. But then there are also all these other sorts of alternative, or alt, coins.

Art Cavazos: And also, just to say that Ethereum technically, for technical folks out there, is the blockchain technology platform, and ether is the actual coin on the Ethereum platform. And that’s just for Ethereum people, because all of this is also very tribal. There’s like the Bitcoin team and the Ethereum team, and everybody has their favorite altcoin. But one of the big distinguishing factors for Ethereum is that they claim their blockchain technology platform can be used for a wide range of applications, not just coins.

Erin Camp: Another big difference is that we know who started Ethereum, and it is run by a company. There is a group of people that are essentially in charge of that coin. That’s not the case for Bitcoin. Truly, Bitcoin is the decentralized, original, sort of, explore in the cryptocurrency space – broke through.

Art Cavazos: Definitely the pioneer — definitely broke through. I think, really, the most important point is that we don’t know who Satoshi Nakamoto is or if it was a group of individuals or any of that, but it almost doesn’t matter because, like you said, the distinguishing factor about Bitcoin is that it’s been out in the wild for over a decade now with no centralized authority or company to go in and release software updates or anything like that. It has completely been running itself in a commons type way, somewhat similar to like a Wikipedia, but even Wikipedia has a Wikimedia Foundation that runs things on the back end. Bitcoin doesn’t have that. It’s simply a decentralized piece of software that is run by the community.

Erin Camp: This might be a good time to segue into more about Ethereum’s proof of work and proof of stake model.

Art Cavazos: Sure. Ethereum right now, I think, still is proof of work, which is very similar to what Bitcoin is what we talked about earlier. And I think ether is still done in the same way, but they have been marketing or whatever you want to call it, that they’re going to be moving towards proof of stake. The idea behind that, it’s much less energy-intensive than proof of work because one of the criticisms of proof of work in Bitcoin is that, as you have more and more people getting onto the network trying to solve these problems and they’re getting harder and harder to solve, it’s a revolving door where you always need more computing power to solve those problems. It’s a recipe for more and more energy use, kind of limitless increase in energy use. So, there’s environmental concerns with that.

The proof of stake model is supposed to cut off that vicious cycle and make it, instead, you have folks put up a stake once they own some Ether, they stake that, and then the system randomly or — we haven’t looked under the hoods, we don’t know exactly how it works — but somehow, someone who has put up a stake is chosen to validate transactions and then collects a fee for that service that they’re providing to the community.

Erin Camp: All of this is to say the environmental concerns are a huge concern when it comes to mining, and they’re a huge negative for Bitcoin and there’s something that these, another aspect of these other coins are trying to address as new cryptocurrencies come out, and the model that Bitcoin sort of pioneered gets tweaked. There are a lot of drawbacks with this new technology. When it first came out on the scene, it seemed like it was really just going to take over and change a lot of things. Whoever it was that brought Bitcoin to be really had these likely grandiose ideas that this was going to take place of the U.S. dollar eventually and what we think of as, you know, money and change things and how they’re backed by the government and no longer require that. But over time, it has seemed like it was going to have less and less of an effect, maybe it was going to die out, and then something happened with COVID, and interest has just peaked. The regulatory agencies are trying to decide what to do with it. We’re all trying to decide what is cryptocurrency, how does it fit into business and the finance space today. As we said at the beginning of this podcast, just continues to become increasingly and increasingly legitimized.

Art Cavazos: Yeah. And I think that’s a good point to make, you know, for folks out there who are still skeptical about it right now as we’re recording this. Bitcoin is way down along with the entire stock market. That’s not a reason to be skeptical, that it’s here to stay.

We talked about Amara’s Law, or what we’ve renamed Amara’s Observation. Basically, this happens with every new technology where there’s a hype cycle where folks get really excited about it, which I would say was probably back in like 2017, when you had that first pop in value and everybody was talking about blockchain technology and all of these applications that were going to change the world. And then there’s a disillusionment when that doesn’t happen immediately, and people are like, ‘Oh, well, this was a fad and it’s nothing.’ And it falls down into kind of a trough of disillusionment. Right? And we’ve probably been there for a while. But then, during COVID, I think we have seen that resurgence of interest. Maybe, you know, living in a virtual environment essentially for two years made people rethink the value of digital assets. So, maybe we are on that slope to where it’s going to eventually kind of plateau out as just part of our environment, kind of like the personal computer. You saw the exact same thing happened with the personal computer, and nowadays, everything is a personal computer. So, blockchain may end up being along that same vein. It’s just going to be something that we use and don’t even think about.

Erin Camp: We are seeing the finance industry and our economy and our government, you know, sort of starting to anticipate how it’s going to look when it does plateau and become a part of our everyday life. In doing that, there’s been a lot of discussions surrounding, you know, what is cryptocurrency and how does it fit into our regulatory scheme? Is it a commodity or is it a security? And is it really currency? Is it really money?

Art Cavazos: So, we’re lawyers, but this isn’t really meant to be a legal podcast. We’re not going to spend too much time talking about regulatory things, but I think it is just important to talk about how is this going to be regulated, how’s it going to be treated by the government and government agencies. And the two most relevant agencies would be the CFTC, Commodity Futures Trading Commission, and the SEC, the Securities Exchange Commission. Basically, the way that they divide up their turf for their jurisdictions is the CFTC handles commodities and the SEC handles securities. So, it becomes an important question as to is cryptocurrency a commodity or security.

Erin Camp: And just for the people who do not operate in this space, just to make this like as plain English as possible — please remember that I’m oversimplifying — an example of a commodity would be like a brick of gold; an example of a security would be a share of stock; and then an example of currency would be like a U.S. dollar.

Art Cavazos: Yep.

Erin Camp: Well, and traditionally, something could be either a commodity or a security. There was no such thing as being both. You couldn’t be both a share of stock and a block of gold. But a commodity could, depending on how it was traded, be considered a type of money.

Art Cavazos: You could have a piece of paper represent your ownership in a block of gold.

Erin Camp: Correct. In that way, you would have a security. That piece of paper would be attached to the security interest you have in that block of gold. So, the idea that something could be both a commodity and a security was not something that existed until cryptocurrency and now that possibility is there.

Art Cavazos: Because even in that example, if you have a block of gold and a piece of paper representing your ownership of the block of gold, there’s still two distinct assets.

Erin Camp: Correct.

Art Cavazos: One is a commodity; one is a security.

Erin Camp: Right. There’s still two separate mutually exclusive ideas. In 2015, the CFTC just broadly ruled right out of the gate that all cryptocurrencies, no matter what they are, they’re all commodities.

Art Cavazos: Just planted that flag right on the moon.

Erin Camp: Which, really, that is just like a hilarious overstatement to me, because (A) not all cryptocurrencies are the same. In fact, they can be drastically different. I mean, we’ve all heard of Dogecoin at this point.

Art Cavazos: Yeah. So, SEC Chairman Gary Gensler in April of this year (2022) made a statement on cryptocurrency to the University of Pennsylvania Law School.

Erin Camp: He called into question that 2015 CFTC ruling and said that the majority of cryptocurrencies should be regulated as a security and not a commodity. So, he not only said that they should be regulated as a security, he also brings up the differences that exist between cryptocurrencies and how some of them should be regulated as a security but maybe not all of them, maybe some of them are commodities. And that idea in and of itself was something that did not exist before Bitcoin or cryptocurrencies were created.

Art Cavazos: And you and I had a conversation about this before his speech, or at least before we knew about his speech. I think this made intuitive sense to us that it would really be on a case-by-case basis, because all these blockchain technologies are so different. I think what we found kind of comical about the CFTC ruling is just that it was so overbroad, you know, that all cryptocurrency would be a commodity when they can be so different. My big takeaway from his speech was we’re going to need to look at these on a case-by-case basis. And from what he’s seen right now in the marketplace, most of them probably will end up being securities, not commodities, but it just depends on the specific crypto in question.

Erin Camp: Yeah, so let’s go ahead and talk about like some of the considerations that we discussed about what makes something a commodity versus what makes it a security — remembering that very overly simplistic example that I gave earlier of a commodity being a brick of gold and a security being a share of stock. We are also going to bring into that third component, currency, and that example being just a dollar bill.

Art Cavazos: Right. So, like, if you think about back to grade school, like Venn diagrams, I would say a commodity and a security are mutually exclusive, their circles don’t really touch or overlap, but a currency could overlap, really, with either of those. It’s just a different question as to are you using that specific piece of paper or specific commodity as a medium of exchange? So, there are two different questions, I think.

Erin Camp: And what he means by that is medium of exchange, it’s with, we think, based off our prior conversations that whether or not something is currency or money has to do with the context upon which it is traded and that individual trade. But the second question of whether or not something is a commodity or security has to do with the actual character and not the specific context of the trade.

Art Cavazos: When we’re talking about the difference between a commodity and a security, there’s a whole Howey Test under the law. But we said we’re not going to get into too deep legal jargon. So, we won’t go through the Howey Test.

Erin Camp: You’re welcome.

Art Cavazos: But I do think that one of the touchstones of a security can be summed up, essentially, as anything that is sold to people who anticipate a profit from the efforts of others. You could sell a piece of paper that represents an ownership in an orange grove. You think that the orange grove is going to become more valuable because of the people working the land, and that’s why you’re purchasing that piece of paper. That would be a security.

Erin Camp: Just to bring that back to our original example: That piece of paper that represents the equity in the orchard would be the same as a stock certificate for that share of stock.

Art Cavazos: Right. And a commodity, on the other hand, is something — you gave the example of a brick of gold, orange juice, oil, it’s something that is fungible. So, you know, one barrel of oil is the same as another barrel of oil of the same grade. One barrel of orange juice is the same as another barrel of orange juice. And you’re not — you can buy it thinking that the price of orange juice is going to go up, but it’s not the same as buying a share of stock in Tropicana or a specific company. That would be purchasing a security. If you’re simply purchasing orange juice and it doesn’t really matter what company that’s associated with, then that’s a commodity.

Erin Camp: In other words, purchasing something that in and of itself has a store of value. When we say some cryptocurrencies should be treated as a commodity and some should be treated as a security, one thing that we’re saying is some cryptocurrencies actually act as an independent store of value, whereas others — it’s arguable whether or not they actually do that.

Art Cavazos: It’s arguable that the only value they’re providing is the anticipation of future profits.

Erin Camp: Exactly.

Art Cavazos: Folks might ask what inherent value does something like Bitcoin have? Which that, of all the coins out there, I think Bitcoin is maybe the most likely to be considered a commodity. So, one reason is that there is, as we were talking about, there’s no group of individuals that’s out there selling Bitcoin in anticipation of making a profit in the same sense.

Erin Camp: Yeah, and what we’re saying right now, isn’t necessarily correct or incorrect. What we’re talking about now doesn’t really have a set answer. There is a professor at NYU who is out there saying Bitcoin is neither a currency and not even an asset at all. So, we don’t know, no one knows. But this is just what we think. And it seems to line up with the direction in which the government is moving, our economy is moving, and the finance industry is moving.

Art Cavazos: And I’m glad you brought that up, because it is such a new area. This isn’t gold or oil or paper money that’s been around for hundreds or thousands of years or forever, this is a brand-new asset that literally didn’t exist about 12 years ago. And so, all of these definitional questions and things are still completely wide open. That economist was Nouriel Roubini at NYU. He’s also known apparently as Dr. Doom because he predicted the financial recession, I believe. But he said that it’s not an asset, it’s not a currency, it’s simply a bubble that’s going to pop. So…

Erin Camp: Yeah, so we really don’t know.

Art Cavazos: We really don’t know at this point.

Erin Camp: But I do think one important thing to end this little discussion with is just what we mean in terms of, like, whether or not a cryptocurrency is currency and is money — when we say it’s in the context or in the medium of exchange, in order for something to be currency or money in colloquial terms, it has to really be traded in exchange for something else. It has to be a currency that has a value in and of itself. It has to be used as money to purchase something else. It has to be readily used; it can’t be taken and converted into something else, and then that something else be used. In other words, you can’t take your bitcoin out of your wallet, convert it to U.S. dollars, and then spend it, and in that context Bitcoin is money, because it’s not. In that context, it looks more like a share of stock. So, there’s only a limited amount of instances in society today where any cryptocurrency really is a currency.

Art Cavazos: Right. If you have to convert it into something else before you can spend it, it’s not a currency.

Erin Camp: There’s only been a few instances where, definitionally, a cryptocurrency has been used as currency or money.

Art Cavazos: Yeah. I think somebody bought two pizzas for like $50 million dollars’ worth of bitcoin, worth $50 million today.

Erin Camp: Yeah, that’s insane. Or you know, El Salvador has switched to have Bitcoin be its official currency. But other than those limited instances, cryptocurrency hasn’t actually been a currency or money. You have to take it out of your wallet and convert it into U.S. dollars or into another currency or something that actually is money and then you can spend it. Anytime you take it out of a crypto ATM, it gets converted into something that is currency or is money and then spent. In today’s world, even Bitcoin does look more like a security and is traded more like shares than it is currency or money, and I think that’s important to note here.

Art Cavazos: But if you have to convert something in order to spend it, it’s not currency. So, that might be a complete misnomer to even call it cryptocurrency. But I think we’ve talked quite a bit about cryptocurrency for one day, and we’re definitely going to have multiple episodes on cryptocurrency. We thought that might be the case at the outset. After diving in deeper, I think we’re definitely going to need more episodes to talk about everything related to cryptocurrency.

Thank you, everyone for joining us for this episode of Future Ready Business. We touched on a lot of things today regarding cryptocurrency and blockchain, but that’s not the only thing we’ll be talking about on this podcast.

Erin Camp: Exactly. We’ll be discussing more topics like fashion, the metaverse and its ups and downs, and much more.

Art Cavazos: If you liked the show, please rate and review us wherever you listen to your favorite podcasts, and please share feature at business with your friends and colleagues.

Erin Camp: Thank you to our producer, Greg, on the ones and twos. Our own personal Roz, you can call him. You can find us on Instagram at @futurereadybusiness all one word. You can find me on Twitter at @BusinessLawyerE. E for Erin.

Art Cavazos: For now, at least. And you can find me on Twitter for now at @FinanceLawyer. We may be switching away from that honestly soon.

Erin Camp: That also changed since May.

Art Cavazos: That’s also a recent development, as mentioned at the top of the show. The opinions expressed today are ours and those of our guests, if any, and do not necessarily reflect the views of Jackson Walker, its clients, or any of their respective affiliates.

Erin Camp: This podcast is for informational and entertainment purposes only and does not constitute legal or investment advice. We hope you enjoyed it. Thanks for listening.

Art Cavazos: Goodbye, everybody.

Visit JW.com/future-ready-business-podcast for more episodes. Follow Jackson Walker LLP on LinkedIn, Twitter, Facebook, and Instagram.

This podcast is made available by Jackson Walker for informational purposes only, does not constitute legal advice, and is not a substitute for legal advice from qualified counsel. Your use of this podcast does not create an attorney-client relationship between you and Jackson Walker. The facts and results of each case will vary, and no particular result can be guaranteed.


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