Quick Answer
Digital assets exist and trade electronically. Bitcoin is generally classified as a commodity, not a security, but the Howey test can pull other tokens into SEC and state securities regulation regardless of what the issuer calls them. The IRS treats every digital asset as property, never as currency.
This unit was added to the Series 65 outline effective June 12, 2023, and it tests classification more than technical mechanics: what type of token it is, whether it is a security, and how it is taxed. Get comfortable applying the same four-prong test across cryptocurrency, stablecoins, NFTs, and utility tokens, because the exam swaps labels to see whether you follow the substance.
What Types of Digital Assets Does the Exam Test?
| Type | Description | Example | Key Feature |
|---|---|---|---|
| Cryptocurrency | Digital currency used as medium of exchange or store of value | Bitcoin, Ethereum | Fungible; recorded on a distributed ledger |
| Stablecoin | Cryptocurrency pegged to a fiat currency, asset, or commodity | USDT (Tether), USDC | Designed to maintain stable value |
| Non-fungible token (NFT) | Unique digital token representing ownership of a specific asset | Digital art, collectibles | Non-fungible; each token is unique |
| Utility token | Token providing access to a product or service within a platform | Various decentralized finance (DeFi) tokens | Function-based, not primarily investment |
| Security token | Token representing ownership in a traditional asset (equity, debt, real estate) | Tokenized securities | Subject to securities regulation |
Cryptocurrency:
- Bitcoin (BTC) - the first and largest cryptocurrency by market capitalization
- Created in 2009 by pseudonymous Satoshi Nakamoto
- Limited supply - capped at 21 million coins (deflationary by design)
- Generally classified as a commodity by the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), not a security
Stablecoins:
- Pegged to maintain a 1:1 value with a reference asset (typically the U.S. dollar)
- The Internal Revenue Service (IRS) does not consider any digital asset to be currency; only fiat currency backed by a government qualifies
- Used for trading, transfers, and as a bridge between crypto and fiat
- Once the GENIUS Act takes effect, federal banking regulators (the OCC, the Fed, the FDIC, and the NCUA) oversee payment stablecoins, a different regulatory lane than SEC- or CFTC-regulated tokens
Non-fungible tokens (NFTs):
- Each token is unique and cannot be exchanged on a 1:1 basis with another NFT
- Use smart contracts - self-executing contracts with terms written into code
- Central to the DeFi (decentralized finance) movement
How Does the Howey Test Decide Security or Not?
The regulatory treatment of digital assets depends on how they function and are marketed. The Howey Test determines whether a digital asset is an investment contract (security). All four prongs must be met:
- Investment of money
- Common enterprise
- Reasonable expectation of profits
- Derived from the efforts of others
If someone buys a token hoping the development team will build something that makes the token more valuable, that looks like a security. If someone buys a token just to use a service (like a subway token), it probably is not.
Exam Tip: Gotchas
- Labeling a token a "utility token" does not make it a non-security. The Securities and Exchange Commission (SEC) applies the Howey test to economic substance. If it was marketed with profit expectations driven by the team's efforts, it is a security.
- Bitcoin fails prong 4 (sufficiently decentralized, no central team), so it is classified as a commodity, not a security.
Who Regulates Digital Assets?
| Regulator | Jurisdiction | Classification |
|---|---|---|
| SEC | Securities | Digital assets that meet the Howey test are securities; subject to registration and disclosure requirements |
| CFTC | Commodities | Bitcoin and certain other cryptocurrencies classified as commodities; CFTC regulates crypto derivatives (futures, options) |
| IRS | Taxation | All digital assets are treated as property (not currency); taxable events include sales, exchanges, and payments for goods/services |
| Financial Crimes Enforcement Network (FinCEN) | Anti-money laundering | Crypto exchanges must comply with Bank Secrecy Act (BSA) and anti-money laundering/know your customer (AML/KYC) requirements |
Exam Tip: Gotchas
- Bitcoin is generally classified as a commodity (regulated by the CFTC), NOT a security. However, many other digital tokens that meet the Howey test ARE securities subject to SEC regulation. The classification depends on how the asset functions, not what it is called.
Does State Law Follow the Same Test?
The Uniform Securities Act's definition of "security" also includes an investment contract, so a digital asset that satisfies the Howey test is a security under state law, not just under federal law.
That classification puts the token inside the state Administrator's registration and antifraud jurisdiction, independent of whatever the SEC ultimately decides. A token can be a security for state purposes even before, or regardless of, a federal enforcement action.
How Does the IRS Tax Digital Assets?
The Internal Revenue Service (IRS) treats all digital assets as property (not currency). Key tax rules:
- Every sale, exchange, or use of digital assets to purchase goods/services is a taxable event
- Capital gains/losses apply based on the difference between purchase price (cost basis) and sale price
- Standard capital gains rates apply to most digital assets: short-term (held 1 year or less) at ordinary income rates; long-term (held over 1 year) at 15% or 20%. Some NFTs can instead receive the 28% collectibles rate under an IRS look-through analysis, depending on what the NFT represents
- Receiving digital assets as payment for services is taxed as ordinary income at fair market value
- Mining and staking rewards are taxed as ordinary income when received
- Like-kind exchange tax deferral does NOT apply to digital assets (limited to real property)
Exam Tip: Gotchas
- The IRS does not classify any cryptocurrency as currency, even stablecoins pegged to the dollar. All digital assets are property for tax purposes. Every crypto-to-crypto swap is a taxable event.
What Risks Come With Holding Digital Assets?
| Risk | Detail |
|---|---|
| Volatility risk | Extreme price swings; Bitcoin has experienced multiple deep, prolonged drawdowns from its highs |
| Regulatory risk | Evolving rules; assets classified as securities face registration requirements |
| Cybersecurity risk | Exchanges and wallets vulnerable to hacking, theft, and fraud |
| Liquidity risk | Smaller tokens may have thin markets; hard to sell at desired price |
| Technology risk | Smart contract bugs and protocol failures |
| Custody risk | "Not your keys, not your coins" - loss of private keys means permanent loss of assets |
| Fraud risk | Scams, Ponzi schemes, and unregulated offerings are prevalent |
| No Federal Deposit Insurance Corporation (FDIC) or Securities Investor Protection Corporation (SIPC) protection | Digital assets held on exchanges are NOT insured by any government agency |
| Valuation difficulty | No earnings, dividends, or cash flows to anchor fundamental valuation |
Exam Tip: Gotchas
- Digital assets held on exchanges have NO FDIC or SIPC protection. If the exchange fails or is hacked, investors may lose their entire investment with no recourse.
What Should You Check on Exam Day?
- Bitcoin is a commodity (CFTC); other tokens can be securities (SEC and, separately, under state law) if they meet the Howey test. Function decides, not the label the issuer picked.
- All four Howey prongs must be met for a token to be an investment contract.
- The IRS treats every digital asset as property, so even a crypto-to-crypto swap triggers a taxable event.
- No FDIC or SIPC protection exists for assets held on an exchange.