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Security

A security is a tradable financial asset. The legal definition of a security varies by countries. In some countries, a security includes equities and fixed income instruments. In some other countries, hybrid instruments such as convertibles, equity warrants, and so on are included in the definition of a security. In the US, commonly known securities include debt securities such as commercial papers; bonds and debentures; equity securities such as stocks; or a more exotic type, derivatives, such as forwards, futures, options, and swaps. We will explain the definition of security and how to determine whether a coin is a security under the US securities law in the next chapter. In the UK, securities, as outlined by FCA, include equities, debentures, alternative debentures, and units, along with stakeholder or personal pension schemes.

Securities are different from commodities. For example, equity securities represent ownership of a company, while commodities are items of useful value, but are not considered as a right to ownership. Securities can only be traded at registered trading platforms and participants that trade securities are required to be registered broker and dealers under the applicable securities laws. Commodity or currencies trading platforms for spot markets don't need to be licensed. For instance, cryptocurrency exchanges are not regulated and do not need to be licensed. In the US, the Commodity Futures Trading Commission (CFTC) defines bitcoin to be a commodity and the Internal Revenue Service (IRS) defines cryptocurrency as property. SEC views many ICO issued tokens to be securities, which the blockchain community has a different view. For example, in July 2017, SEC declared the DAO token to be a security.

In the real word, the definition of a security is far more complicated. For instance, an e-money or payment service can be considered a security. Normally, a country's security regulatory agency publishes guidelines to define what qualifies as a security.

In the US, the Supreme Court has created the Howey Test to determine whether a transaction is an investment contract. Under the Howey test, you have to ask the following four questions:

Whether it is an investment of money
Whether it is expecting profits from the investment
Whether it is an investment of money in a common enterprise
Whether there is any profit from the efforts of a promoter or third party

If the answer is yes, a token sale is considered to be a security that's subject to securities laws.

Any business that's involved in tradable financial assets (securities) is required to comply with laws for financial services and consumer protection. Two well-known laws are the Bank Secrecy Act (BSA) and the USA Patriot Act.

BSA, which was signed into law on October 26, 1970 by President Richard Nixon, requires businesses to do the following:

Maintain records of cash transactions of negotiable instruments
File reports if the total transactions in a day exceed $10,000
Report suspicious activities, which may imply money laundering, tax evasion, or other criminal activities

BSA is also referred to as the Currency and Foreign Transactions Reporting Act and is more often called an AML law.

The USA Patriot Act, which was signed into law on October 26, 2001 by President George W. Bush, is passed by congress to strengthen national security in response to the September 11 terrorist attacks in 2001. The act has ten titles. The third title is called anti-money-laundering to prevent terrorism, modifying parts of BSA and the Money Laundering Control Act (MLCA) of 1986 to prevent terrorism.

Pursuant to the USA Patriot Act, the US government issued regulations, making KYC mandatory for US financial institutions. Any businesses that conduct security transactions need to follow regulations on KYC as well. KYC stands for know your customer or know your client. KYC is the process in which businesses collect and verify information about the identity and address of their customers. Companies use this information to ensure that their services are not misused for illegal activities such as money laundering, criminal activities, or bribery. The KYC procedure is required to be completed by companies while opening customer accounts. Post an account opening, the process also needs to be followed periodically.