* Regulators grapple with how to classify cryptocurrencies
* Bitcoin behaviour mirrors commodities in lending market
* But digital coins akin to securities in initial offerings
* How virtual money is defined could determine fate of
market
By Tom Wilson
LONDON, March 3 (Reuters) - So bitcoin's a currency, right?
Well, yes, it can be used to buy, sell and price goods much like
dollars and euros.
A commodity? Come to think of it, it does behave a lot like
oil and gold - it can be bought and sold in cash markets or via
derivatives such as futures.
What about a security? Many cryptocurrencies are, in a way.
They're issued like stocks in "initial coin offerings" and used
to represent shares in online projects.
The debate may appear abstract, with little bearing on the
hard-boiled world of finance, but it is attracting increasing
interest from economists and lawyers who say it could have major
implications for the future of cryptocurrencies.
How bitcoin and other digital coins are defined could shape
how they are regulated around the world. In turn, the rules they
are subject to could determine whether they make the leap from a
niche to a mainstream asset.
So how will regulators treat them?
In the United States, federal watchdogs say they see
elements of both securities and commodities, but like most major
economies have not come up with a set of rules. The European
Union, however, will outline a framework this year, which could
see crypto wedged into existing regulations, or a whole new set
of rules created.
For market players, how bitcoin and its kin are regulated
will have serious ramifications.
Commodity markets operate with relatively little regulatory
oversight. Securities, on the other hand, are typically subject
to more onerous rules on price transparency, trade reporting and
market abuse.
"When we're going through the security process, we spend a
lot of fees and lawyers to make sure we're in compliance," said
Benjamin Tsai, president of Wave Financial, an investment
manager in Los Angeles overseeing $40 million in crypto.
"It's a lot more of a pain in the butt."
CHARACTER CLUES
Some of the cryptocurrency identity crisis lies in the fact
that bitcoin was originally conceived as a means of payment, but
now rarely bears the hallmarks of dollars, euros or pounds.
It's of little use as a store of value because of its
volatility, and is hampered as a means of exchange by its slow
network and high transfer costs.
A booming bitcoin lending market is offering clues to its
character.
Bitcoin lending offers lines of credit to crypto firms
earning money in cryptocurrencies, such as payment processors or
miners, looking to secure traditional money for covering
expenses. Also, traders who don't want to sell their bitcoin
holdings use them as collateral to borrow cash for use in
algorithmic or high-frequency trading.
For those lending money, relatively high yields are an
attractive proposition in an era of rock-bottom rates.
Key characteristics of this market, such as market-led price
discovery and the motivation to seek liquidity, mirror that of
commodities leasing, according to market players and economists.
"The commodities markets (analogy) is very fitting," said
Deeksha Gupta, an assistant professor of finance at the Carnegie
Mellon University in Pittsburgh who has researched crypto.
"One of the biggest similarities is that they are also
driven by people wanting to be able to get liquidity."
The bitcoin lending market has grown quietly as an opaque
corner of the cryptocurrency sector, which itself is notorious
for its lack of transparency. While there's little data with
which to gauge the size of the lending market, it is widely seen
to have expanded rapidly over the past year.
New York-based Genesis Capital, one of the biggest lenders
in the market, said its outstanding loans soared late last year
to around $545 million compared with $100 million a year
earlier.
Implied interest rates in these markets - the price of
borrowing bitcoin - stand at around 4-5%, Genesis CEO Michael
Moro said. On platforms for people to lend cash against bitcoin,
rates are as high as 8%.
FINANCIAL INSTRUMENTS
Cryptocurrencies' kinship to securities arises largely from
their issuance and function in initial coin offerings, or ICOs,
where they are used to raise traditional money.
ICOs are often held by companies seeking to raise funds for
blockchain-related or other online projects. They raise capital
by issuing digital coins, which grant holders access to the new
system or software or a share in profits generated.
For instance, Switzerland-based Aragon - a management
platform for decentralised organisations - raised about $25
million in 2017 issuing tokens that gave voting rights on how
the system is developed.
Regulators may choose to treat different cryptocurrencies
differently, depending on their specific characteristics, an
approach taken by Britain last year.
Some players say any designation of cryptocurrencies as
financial instruments akin to securities may be positive, with
burdensome oversight balanced by the potential to allow funds to
market cryptocurrencies to a wider pool of investors.
"If they were somehow classified as a financial instrument,
then that would have the knock-on effect that they would be
eligible for retail funds," said Nic Niedermowwe, CEO of crypto
fund Prime Factor Capital in London.
(Reporting by Tom Wilson; Editing by Pravin Char)