Commodity vs. Security: An Overview
A commodity is a basic good that can be interchanged with other goods of the same type, often a raw material used in producing other goods or services. Meanwhile, a security describes a tradable financial instrument with monetary value.
While they are both assets that traders can buy and sell, securities receive stricter regulatory oversight than commodities. Companies that issue securities like stocks and bonds must provide investors with detailed, transparent information, while commodities are subject to less stringent reporting requirements.
The distinction between trading basic goods and trading financial instruments seems clear enough. However, when it comes to digital assets like cryptocurrency, the classification becomes murkier. Depending on your perspective, cryptocurrencies could be considered commodities or securities. How this debate is resolved could have a big impact on the future of crypto.
Key Takeaways
- A commodity is a basic good that can be exchanged with other goods of the same type, while a security is a financial instrument representing an investment in a common enterprise.
- Commodities are subject to less stringent regulations, while securities involve strict reporting requirements designed to ensure transparency for all investors.
- The classification of cryptocurrencies remains a subject of debate, and the determination of whether digital assets are commodities or securities could have widespread implications.
What Is a Commodity?
A commodity is a tangible product, often a raw material that can be used to make other products. Hard commodities include energy goods like oil and gas as well as metals like gold and silver, while soft commodities are generally agricultural goods like grains, livestock, and cotton. Traders can buy and sell commodities on the spot market or by using derivatives such as futures and options.
A lot of commodities trading takes place between companies that use the goods, like food producers that depend on agricultural products, and industrial companies that use metals. However, it is generally recommended that all investors have some exposure to commodities as part of a diversified portfolio. That’s because commodities tend to have a low or negative correlation with other assets like stocks and bonds, often performing well when other areas of the financial market are struggling. Commodities may also be a useful tool for investors aiming to hedge against inflation.
Fast Fact
The Commodity Futures Trading Commission (CFTC) regulates the trading of derivatives in the U.S. When the commission was established in 1974, agricultural products dominated futures trading. Since then, the markets overseen by the CFTC have become more complex, with fintech and digital currencies underpinning more intricate commodities transactions.
What Is a Security?
A security is a fungible and tradable financial instrument issued by corporations and governments to raise capital. In general, securities represent equity (the rights to an ownership share in an enterprise), debt (loans that are repaid in periodic installments), or a hybrid of equity and debt.
Securities typically refer to stocks and bonds along with related products like mutual funds and exchange-traded funds (ETFs). However, the legal interpretation of what constitutes a financial security is quite broad. In the case of Howey vs. SEC in 1946, the Supreme Court determined that a contract involving the sale of agricultural land and services represented a security.
This case resulted in a list of criteria—known as the Howey Test—to determine whether instruments should be regulated as a security. According to federal laws, a financial contract meets the threshold of a security if there is an investment of money made in a common enterprise in anticipation of a profit driven by the efforts of others.
Fast Fact
In the U.S., the Securities and Exchange Commission (SEC) regulates the buying and selling of instruments that meet the criteria to be classified as securities. Self-regulatory organizations (SROs) such as the National Association of Securities Dealers (NASD) and the Financial Industry Regulatory Authority (FINRA) also play a role in regulating securities.
When a corporation or government entity wants to raise capital from the public by issuing securities, it must follow strict reporting requirements set out by the SEC. These rules are designed to ensure transparency in the securities market, ensuring that investors have access to all the information they need to make informed decisions.
Key Differences Between Commodities and Securities
The fundamental difference between a commodity and a security hinges on what is being bought and sold. There’s also regulatory issues to consider. Here are the main differences between the two.
Definition and Nature
Commodities are raw materials or primary goods that are interchangeable with other goods of the same type, such as oil, gold, or agricultural products. They are primarily used for consumption or industrial production. Securities, on the other hand, represent financial ownership or a claim on an entity. They can’t really be used in manufacturing, as they usually just represent an intangible ownership stake.
Regulation and Oversight
The regulation of commodities and securities falls under different government agencies. In the United States, commodities are primarily regulated by the CFTC. Securities are regulated by the SEC.
Trading Markets
Commodities are mainly traded on specialized exchanges such as the CME or ICE. These exchanges facilitate futures contracts, which allow traders to buy and sell commodities at a predetermined price for future delivery. Securities are, instead, traded on stock exchanges like the NYSE or NASDAQ.
Price Determination
The price of commodities is primarily influenced by supply and demand dynamics. Factors like weather conditions, geopolitical events, and production levels can cause price fluctuations. For example, a drought can drive up the price of wheat, while increased oil production can lower fuel costs. Securities derive their prices from the financial performance and future prospects of the issuing company or government. Stock prices, in theory, are based on the future cash flow of a firm and not necessarily based on the supply and demand of the specific shares.
Tangibility
Commodities are physical goods that can be delivered and stored, making them tangible assets. Investors can purchase and take possession of commodities like gold bars or barrels of oil, though most trading occurs through contracts rather than direct ownership. Securities, meanwhile, are intangible financial instruments that represent ownership or a claim. Though you can physically hold a piece of paper that might represent a security, you can’t touch the actual security in the same way you can a commodity.
Role in the Economy
Commodities are used in the global supply chain since they are used in manufacturing, energy production, and consumer goods. Their availability and prices affect industries ranging from agriculture to technology, and they play an important part as an input into the global economy. Securities, instead, are mainly used by companies to raise capital. They’re also used by investors to generate wealth.
Fast Fact
Whether cryptocurrency is classified as a commodity or a security depends on the specific digital asset and how it is used.
Is Cryptocurrency a Commodity or a Security?
The differentiation between commodities and securities may seem relatively straightforward when it comes to traditional assets like gold and oil or stocks and bonds. However, digital assets like cryptocurrencies have stretched the delineation between the two types of assets.
The debate over whether cryptocurrencies constitute commodities or securities remains unresolved. In fact, the intricacies of the question may make it impractical to come up with a one-size-fits-all solution, with some cryptocurrency tokens presenting characteristics more like commodities, while there are valid arguments for considering some cryptocurrencies as securities.
The ultimate determination of how to classify crypto will likely have a significant impact on how digital assets are regulated and determine the future of the cryptocurrency industry.
Cryptocurrencies As Commodities
Since securities are subject to tighter regulations, it may come as no surprise that crypto industry executives and proponents argue that cryptocurrencies should be considered commodities. According to their perspective, cryptocurrencies are used as a store of value, similar to commodities like gold. Traders and investors may purchase crypto assets for speculative purposes—hoping to profit from price swings—which is another way that cryptocurrencies mirror commodities.
Another key argument that cryptocurrencies should not be considered securities revolves around their decentralized nature. The Howey test specifies that a security involves investing in a common enterprise and profiting from the efforts of a third party. The lack of a centralized entity underlying cryptocurrencies supports the idea that they should be classified as commodities rather than securities.
Cryptocurrencies As Securities
Although crypto advocates generally argue against the more stringent regulations that would come from classifying digital assets as securities, subjecting crypto to securities rules could make the assets more attractive to a wider range of investors.
In addition, there are some elements of the cryptocurrency markets that seem to fall closer in line with the definition of a security. For instance, when blockchain or crypto-related companies raise capital through initial coin offerings (ICOs), they issue digital coins that allow investors to participate in the crypto project and earn a share of its profits. Therefore, ICOs resemble the initial public offerings (IPOs) that companies use to bring their stock onto the public markets, lending credence to the idea that they should be similarly regulated as securities.
Other areas of the crypto markets are reminiscent of debt securities. For example, crypto lenders may provide credit in the form of cryptocurrency in exchange for interest or fees—a structure that closely resembles bonds.
Is Bitcoin a Security or a Commodity?
There is an ongoing debate about whether Bitcoin and other cryptocurrencies should be classified as a security or a commodity. The decentralized nature of Bitcoin raises questions about whether the asset meets the criteria of the Howey Test that would classify it as a security. The Commodity Futures Trading Commission (CFTC) considers Bitcoin to be a commodity and asserts that it holds regulatory authority over BTC under the Commodity Exchange Act.
Is Ethereum a Commodity or Security?
Much like Bitcoin, Ethereum remains in a regulatory grey area and is subject to differences in opinion about its classification. When it filed its lawsuit against Binance, the CFTC explicitly declared that Ethereum, along with Bitcoin and Litecoin, are considered commodities. However, the SEC has applied the Howey Test and argued that other crypto tokens such as Ripple’s XRP are securities and should be subject to the associated regulations.
Why Is a Commodity Not a Security?
Commodities—such as energy assets like oil, metals like gold, and agriculture products like corn—are not considered securities because they do not involve investing in a common enterprise and profiting from the efforts of others.
Can a Commodity Become a Security?
Commodities can serve as the underlying asset for derivatives such as futures and options. Futures establish an obligation to buy or sell a commodity at a set price and date in the future, while options provide holders with the right (but not the obligation) to buy or sell the commodity.
The Bottom Line
Assets are traditionally classified as either commodities, which are basic goods used in making other products, or securities, which are financial instruments designed to generate profits from a shared enterprise. Digital assets like cryptocurrencies have stretched the limits of these categorizations, with different perspectives on how to classify digital assets. A concrete determination on whether crypto counts as a commodity or a security could have broad implications for the regulatory framework and the future of cryptocurrencies.