One of the most debated topics in the crypto space is the underlying value of cryptocurrencies.
Unlike stocks, most cryptocurrencies do not give any legal entitlements to holders.
Therefore, crypto-asset trading is mostly unregulated opposed to common stock trading on the majority of stock exchanges.
So what are the key differences between trading stocks and cryptocurrencies?
The main points I will discuss here are:
- Ownership and possession
- Legal rights
- The Howey test and why a great deal of cryptocurrencies are unregulated
Stocks vs cryptocurrencies: Ownership and possession
One of the main differences between traditional stocks and cryptocurrencies is ownership.
Even though a unit of stock grants its owner a piece of a company, cryptocurrency usually does not. I’ll discuss legal rights in depth in the next section.
For now, what matters is ownership. Remember the famous Andreas Antonopolous quote, “not your keys, not your coins”?
Well, that’s exactly my point. Cryptocurrencies are much easier to own than stock. Even though most investors and traders do purchase a derivative of stock, the stock itself is not with the user.
This means to properly own stock, you cannot just purchase the asset on an exchange. You must make sure you get the actual paper-stock.
With cryptocurrencies, the process is usually much easier. First, there are plenty of ways to trade crypto-assets peer-to-peer (P2P). Decentralised and non-custodial exchanges are becoming more common by the day.
Second, in less than 10 minutes, we’re able to transfer assets from exchanges to private wallets. The process is much faster and simpler with cryptocurrencies than with stock.
Exceptions are STOs, or Security Token Offerings, which grant the owner an equity share of a company. However, I’m ignoring those for the purpose of the article as they represent a very small share of the overall cryptocurrency pie.
Stocks vs cryptocurrencies: Legal rights
As mentioned above, stock usually entitles owners to legal rights, such as dividends (a share of the company profits).
However, imagine a cryptocurrency like Bitcoin or Ethereum. Ownership is quite easy to have, but that does not entitle users to legal rights.
Remember the DAO hack? Or the Mt Gox hack?
Even though people tried to get their funds back, the majority was lost. And there are much fewer legal recourses for cryptocurrency investors and traders.
The advantage is the insane amount of volatility in the cryptocurrency market, which helps traders get rich (or lose everything) much quicker.
Stocks vs cryptocurrencies: The Howey test
To conclude, I would like to draw attention to the Howey test. Even though it’s not essentially 100% accurate to use it for cryptocurrencies, it’s still the best we’ve got.
What the Howey test defines is whether or not an asset will be categorised as a security by financial regulators.
Put simply, the Howey test asks whether the value of a transaction for one of the participants is dependent upon the other’s work.
Specifically, the Howey test determines whether a transaction represents an investment contract if “a person invests their money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party”.
Essentially, if an asset, digital or not, falls into any of the below categories, it will be labeled a security:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
If any of these categories apply to the asset in question, the cryptocurrency will most likely be a security and should be treated as common stock.