Crypto Investing #62 – Is A Cryptocurrency Token A Stock Or A Security?

Tai Zen: What’s up guys. This is Tai Zen. Today, we’re broadcasting from Ponce City market, which is located in downtown in the great city of Atlanta in the state of Georgia, the southern eastern part of the United States of America.

With me today, I have the honorable grandmaster legendary In this video today, we want to talk about

Leon Fu:…to explain to our audience what cryptocurrencies are. Right now, when you say: “I’m buying Ethereum. I’m buying Bitcoin”, immediately they think that is stock. No, it’s not a stock.

Tai Zen: Okay. This is a big misconception that people think that it’s a stock or it doesn’t have the value of a stock…

Leon Fu: Or people think that because it’s not a stock, it’s a Ponzi scheme or a fraud. Both are not correct. It’s not a stock.

Tai Zen: Don’t shake the table

Leon Fu: It does have value, but not in the way that we normally think of a stock.

Tai Zen: In case somebody is new to investing or maybe they’re in a place where they don’t have stocks. Let’s start off with what is a stock.

Leon Fu: I think most people don’t have an understanding about what a stock actually represents. People know that stock is ownership of a company or a business and we typically call stock shares.

However, there’s another name for stocks that many people actually heard we call them equities. Equity represents the profits of a company after all expenses are paid. For example, if you own a company, you have customers and they pay you money. You also have expenses and you pay off those expenses. What’s left over is the profits.

Tai Zen: That profits get divided among the shareholders who hold the shares of the business of the company.

Leon Fu: That’s all great.

Tai Zen: Let’s just do simple math. Let’s say at the end of the year, the company does $100 in profits and that company has $100 shareholders. As a result, each shareholder has one share of the company. They each get $1 of the profits.

Leon Fu: However, there’s something very unique about shares as an owner is that as an owner, you get paid last. It means all your suppliers, employees and everyone else you owe money to, even the bank if you take out debt gets paid first.

Tai Zen: So the shareholders are the last people to get paid.

Leon Fu: This is why shares are risky. That’s why stocks are considered risky because you’re at the back of the line. All these people in front of you get paid first. Therefore, the question is why we do that. Who would ever want to be in the back of the line?

Tai Zen: Plus, you have to put up money for it.

Leon Fu: You have to buy these shares, so what is the incentive?

Tai Zen: Basically, you’re saying that the disadvantage of owning stock is you’re at the back of the line

Leon Fu: or being a business owner because shares represent the ownership.

That sucks, right? I want to get paid first.

Tai Zen: However, the thing is, let’s say the employees, the vendors and the contractors get paid first, but the money they get is limited.

Leon Fu: That’s right.

Tai Zen: There’s a limit to how much they can get.

Leon Fu: That’s right.

Tai Zen: Let’s say that the employee makes $10 an hour and they’re never going to get any more than that.

Leon Fu: They might get a raise, but you are the one to decide to pay them. That’s what they’re going to get. There’s a limit.

Basically, shares or equities represent the value or the profits that are left over after all your liabilities are paid.

Tai Zen: All the expenses that are paid off and what’s left over is what you get…

Leon Fu: …and there’s no limit to that. That’s why equities in a successful business are so valuable.

Tai Zen: When Facebook first came out, I think it was like in the low or mid $20 and now it’s like $140.

Leon Fu: Whatever the company is able to earn a profit, that’s what the owners or the shareholders get.

When you’re buying a stock, you’re buying a promise of whatever future earnings come to the company. You’re giving value today in exchange for value in the future. You’re hoping that you will have profits in the future.

Tai Zen: Yeah, exactly.

Leon Fu: That’s what a stock is. It’s something that you’re buying and we have another term for its called equity. Equity is all the assets after everything’s been paid off.

It’s also a term called homeowners equity. It’s the same concept where your house is worth so much while you have so much debt, then your mortgage on it.

We also have a term called shareholders equity. A share is what represents a piece of that equity.

We have something called a stock market where these shares are traded. Investors set the price of these shares based on all supply and demand. The price that the shares go for is what investors believe the profits of that company will be in the future.

Whether you’re buying McDonald’s, Apple or Google stock, every share has a price to it and it reflects the investor’s expectations of how much that company is going to make in the future.

If the company beats the expectations, the shares typically go up. If the companies don’t match what the market though, they were going down.

Tai Zen: Typically, it will go down, but not always.

Leon Fu: Not always. If they don’t go down, it’s because the market was expecting that.

I’m saying the movement is caused because of the unexpected. That’s what causes the stock to go up or down no matter it is good or bad. That’s really what a stock is.

We’ve talked about the Howey test in the past. That defines what security is. It has to be an investment of money. It has to be an expectation of profit. It has to be where you’re not actively participating in the success of the business. You are not the one running or operating the business. You’re just a passive investor.

That’s what a stock is. The expectation of future profits is what makes stocks and securities…, plus securities America and many other western countries are highly regulated.

Tai Zen: Extremely regulated. You don’t want to break the laws

Leon Fu: If you’re starting a business, you can’t just start selling stocks or shares to the public. You’ll get arrested so fast by the SEC.

Tai Zen: Now, a lot of people like some of our friends, colleagues and family members believe that investing in cryptocurrencies is the same as investing in the stocks.

Leon Fu: It was the same.

Tai Zen: It looks the same. It feels the same. It sounds the same. The only thing that’s different is that it’s called a cryptocurrency token instead of a share company. Basically, you’re getting a token of a network instead of a share of a company

Leon Fu: Because a stock or security is the promise to future profits. Most of the cryptocurrencies are not promising profits. None of them are. Bitcoin isn’t promising profits. Ethereum is not promising any profits.

The DAO did promise profits, so that’s why we’ve mentioned where they could get in legal trouble. However, as far as I know, when I read the terms of the agreement, Ethereum did not promise.

Tai Zen: no

Leon Fu: No one has ever claimed the token represents a share of future profits in some kind of company or some kind of business.

Tai Zen: That’s what makes it a security or not. If it’s a token, it is being used as a fuel or gas to make the network operate. Legally, you cannot call that security.

Leon Fu: Not saying the laws can change in the future because the government can make up whatever laws they want to, but right now, if there is not a promise for profits, it is not a security. Simply, we can trade cryptocurrencies and there’s a market for it.

It’s similar to when we were talking about cars. For example, if you buy a Ferrari, it might start at $500,000. Next year, it’s $1,000,000 because people just decide to raise the price up.

Tai Zen: That doesn’t mean Ferrari’s security.

Leon Fu: That doesn’t mean Ferrari’s security.

Tai Zen: If we buy and sell art, baseball cards or comic books, that’s not a security.

Leon Fu: Yes, that’s right. That’s not a security because it clearly fails the Howey test. There’s no expectation of profit. When you invest in cryptocurrencies, you have to realize that you are not buying security. There’s no promise of any profits whatsoever. Then, the question is what you’re buying.

When you buy a cryptocurrency, typically you’re buying a software product that is promising in the future. We’ll use Ethereum as an example because we’re all familiar with that.

Tai Zen: In the spring of 2017, it’s the second most popular cryptocurrency based on his market cap.

Leon Fu: When the token was issued, it was said that this was not a security. This was a presale of a token that will be used in the software network in the future.

Tai Zen: in the Ethereum network

Leon Fu: in the Ethereum network. It was actually called a donation. Just like in Kickstarter, you are buying a product that will be delivered to you in the future.

It is a limited number in supply. They are selling this now with the promise that they will deliver whatever software product that they’ve described. This will be a token that represents some kind of usage in the network. There was never any promise of future profits.

As an investor, the way I look at this is the price of these tokens are the price of the expectation of future usage of that software product, which is similar to stocks that are traded based on the future expectations of profit. These tokens are traded on the future expectations of the usage of that product.

Tai Zen: Let’s use Ethereum for example.

When it was first released during the Initial Coin Offering or the ICO, it was valued at 30 cents. Last time we checked before making this video, it was around $50.

What you’re saying is that the increase from 30 cents or $50 is just a…

Leon Fu: It’s a reflection of actual usage that people are buying these Ethers because you need these Ethers as fuel to run whatever smart contracts you want to run.

Tai Zen: Some people think that this whole cryptocurrency is a scam or a Ponzi scheme. They don’t think it’s real because they don’t consider it like a stock, which was telling people that it is not a stock. It’s not a security. That’s why it’s not regulated by the Securities and Exchange Commission in the United States of America.

Leon Fu: It’s closer to a Chucky G token. That’s what it is.

You actually need the token to go to Chucky G to play whatever games are there, except Chucky G tokens are not limited in supply. If they were, they would go up in value.

Let’s go back to say the Ethereum is at $50 right now. As you know, there are people running smart contracts that I would say that’s a non-speculative use and they need to pay the gas for it. Therefore, they need some Ethereum.

However, I think most of the value is speculative. I think that’s fair to say it’s not the actual usage, but investors are speculating on future usage, which is similar to stock except there are no profits.

Leon Fu: The reason is they believe that somebody in the future will use these tokens. Just like during the ICO when we paid 30 cents for them, it was on the belief that in the future, after they’ve built this network,…

Tai Zen: …somebody will use that those tokens in the network to run the software…

Leon Fu: …the software that was being described.

I would say it’s fair to say it’s still mostly speculative, but it’s also fair to say there’s actually some actual usage. For example, people actually do need to buy Ethereum, even if it’s just to move other tokens because right now there’s a bunch of Ethereum based ICO that have happened.

Tai Zen: There are tokens that are built on top of the Ethereum network such as Melonport, Golem, ICONOMI.

Leon Fu: You need to have Ethereums in order to move those tokens. If you have one of these other tokens, at very least you need to buy 1 Ethereum or some fraction of it in order to move those tokens to somewhere else.

Although that might be speculative, the underlying usage to move other tokens on top of that is not. You might hate Ethereum and like XYX token, but you still need to go buy an Ethereum so that you can move it.

Tai Zen: So where is the misconception or misunderstanding that people have about?

Leon Fu: When speaking about the stock, what’s typically considered there has to be profits. There’s either going to profit now or there’s got to be a profit to somewhere down the line in the future.

Tai Zen: Even if it’s losing money right now, people will still expect that it’s going to go up and make a profit in the future.

Leon Fu: In these coins, there’s no profit here. People have to realize that any of the traditional formulas that you have in finance don’t apply to the cryptocurrencies because it doesn’t represent the equity of any company.

We have to find other valuation models and most of the time that has to do with the actual usage of the underlying software.

What I’m saying to say it’s a different way of valuing…

Tai Zen: You can’t use the traditional models to value a stock and come over and use it to value the cryptocurrencies.

Leon Fu: You can because there’s no cash.

The ways we analyze the fundamentals of the company is we look at their cash flow, revenues, profit margins, and earnings growth. None of that applies here.

The reason is that’s not what it is. It would be like trying to use that to come up with a fundamental value on gold or silver. It’s metal.

For example, if you’d take a piece of fine art, it has value. There are people like to look at it and people trade it. Sometimes, they pay millions of dollars for it and it’s a store of value, but you can’t use the metrics towards a stock to apply on something like that.

Tai Zen: This a new asset

Leon Fu: It’s a new asset class. It’s a new asset class.

Tai Zen: As you said earlier, you wanted to make this video because there’s a lot of the new cryptocurrency investors that come from the stock world are confused. What was the confusion that you want to clear up?

Leon Fu: The reason I wanted to make this video is we know that cryptocurrencies are traded so much like a stock. Everything on the surface lessons looks just like security. There is an order book. There’s a bit. There’s an ask. There’s a spread. There’s volume traded. There’s the last traded price.

It doesn’t trade like antique cars or fine art, but it seems to have a lot of the same characteristics that we see in NASDAQ or NYSE, except that’s not what it is.

Tai Zen: Is there anything else that you want people to understand besides that?

Leon Fu: No, that’s what I wanted to go over.

Tai Zen: Thanks for watching this video. He just wanted to make this video cause there’s a lot of confusion when people force it into the cryptocurrency market and be mistaken for a stock. They’re trying to compare the cryptocurrencies tokens that we buy and sell on the exchanges to a regular stock that’s being bought and sold on exchanges.

We just want to make sure that you understand it’s not the same thing because the stocks are securities and the tokens that are being traded in the cryptocurrency world are not securities, at least not according to the way the laws are set right now.

Leon Fu: That’s right. There’s no guarantee the SEC might decide to change the laws.

Tai Zen: In that case, we have to comply with the law.

Thanks for watching this video. We had fun broadcasting this, at least I did. I always have fun broadcasting this with, the great oracle of cryptocurrency.

Give us a thumbs up if you like this video. Give us a thumbs down if you don’t like it, so we won’t waste time making it.

We’ll look forward to seeing you in a future video.


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2 Responses

  1. Hi Tai,
    Is there a newsletter with recommendations or are there just these types of videos in my inbox?
    The videos are very helpful thank you.

    1. This is just the Basic Newsletter. We are working on a paid Premium Newsletter with in depth research on each crypto with recommendations and suggestions coming out later this year.

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