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Define crypto assets and characterise them, including the classes that financial regulators around the world commonly use to sort them.

FRM® Part II · Current Issues in Financial Markets · Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets · FRM2.CI.6.a

The idea

A crypto asset is a private digital asset that relies on cryptography and a distributed ledger or similar technology to record and transfer value without a central intermediary. Central bank digital currencies are excluded because they are an official liability of the central bank. Regulators sort crypto assets by backing and by function. Unbacked crypto assets, such as Bitcoin and Ether, have no issuer liability and no reference asset, so their price rests on supply, demand and sentiment. Stablecoins aim to hold a stable value against a reference asset. Tokens are commonly split into payment or exchange tokens, utility tokens that give access to a service, and security or investment tokens that carry profit or ownership rights. The usual mistake is to accept the label an issuer chooses. Regulators look at substance. Exam point: the class decides which existing rulebook applies.

A practice question

From the question bank, with the reason each wrong option is wrong.

Which statement best defines a crypto asset as the term is used by financial regulators?

  1. A private digital asset that relies on cryptography and ledger technology to record value. - correct
  2. A digital form of a country's currency issued directly by its central bank as a liability.Why not: Describes a central bank digital currency, which regulators exclude from crypto assets because it is an official claim on the central bank.
  3. Any bank deposit that can be moved between accounts through a smartphone application.Why not: Confuses digital payment channels with crypto assets; a bank deposit is a claim on a bank and uses no distributed ledger.
  4. A traditional share or bond whose ownership register is kept in electronic form at a central securities depository.Why not: Dematerialised securities are ordinary regulated securities held on a conventional register, not private assets built on cryptography and ledgers.

Regulators define crypto assets by their private nature and their reliance on cryptography and distributed ledger technology. Central bank money and ordinary deposits or securities in electronic form are not crypto assets.

A harder one

A token gives holders discounted access to a software platform's services. It carries no right to dividends, profits or the platform's assets and is also traded on exchanges. Under the functional classes regulators commonly use, this token is best described as a:

  1. payment or exchange token.Why not: Treats any traded token as a means of payment; this token's main function is access to a service, not general exchange.
  2. security or investment token.Why not: Would apply only if the token carried profit, ownership or other investment-type rights, which are expressly absent here.
  3. utility token. - correct
  4. stablecoin.Why not: Stablecoins are defined by a stabilisation mechanism against a reference asset; nothing in the facts mentions one.

A token whose main function is access to a product or service, with no profit or ownership rights, is a utility token. Being traded on exchanges does not change its function.

The hardest tier

An issuer sells a token it calls a utility token because it unlocks access to a lending platform. The terms also entitle holders to 40 percent of the platform's net fees, paid pro rata. Following the substance-over-form approach most regulators use, how would the token be treated?

  1. As a utility token, because the issuer's description is accepted unless it is challenged in court.Why not: Takes the issuer's label at face value; regulators test the economic substance of the rights.
  2. A security token, because the right to a share of fees is an investment-type feature. - correct
  3. As a payment token, because any token that can be transferred between holders is a means of payment.Why not: Transferability does not make a token a payment token; the profit entitlement points to an investment instrument.
  4. As an unbacked crypto asset outside all existing regimes, because it has no reference asset.Why not: Confuses the absence of a reference asset with the absence of regulation; profit rights can bring it within securities rules.

Regulators sort tokens by the rights they carry. A claim on 40 percent of net fees is a profit-sharing feature typical of an investment instrument, so securities rules would normally apply despite the utility label.

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