As the Ethereum merge recedes into the background and even the potential chaos caused by ETHPoW dissipates, some questions resurface. How should cryptocurrencies be regulated? Also, which regulatory body has the power to make decisions on this and how is this regulation enforced?
In testimony issued hours after the successful completion of the merge on September 15, 2022, SEC (Securities and Exchange Commission) Chairman Gary Gensler made a statement that immediately resonated with the cryptocurrency community. Gensler said PoS cryptocurrencies qualify as securities under the Howey test, which determines whether an asset is an “investment contract” and therefore subject to federal securities laws.
The fact that the Howey test was adopted into law by the Supreme Court in 1946, and that financial markets were in very different circumstances than at the time of the law’s enactment, continues to attract attention as it is consistently cited as a key criterion for determining regulatory jurisdiction.
Here’s what investors need to know about whether or not ether and other PoS cryptocurrencies fall under the regulation and edict of the SEC
Can it withstand the Howey test? The elements of the Howey test that have been used as justification for classifying PoS cryptocurrency as securities are that 1) PoS investors are pledging money (in the form of tokens) to fund an enterprise with the hope of profiting from its efforts, and 2) the investing public is anticipating profits based on the work of the others.
The fact that Lido, Coinbase, Binance, and Kraken hold nearly two-thirds of staked ether—the unidentified (yet frequently assumed—focus of these comments—seems to support this assertion). These centralised exchanges are receiving deposits to support their business operations and earnings from retail investors and customers who stake tokens there to earn returns.
These perspectives appear to be fair critiques of PoS regimes on the surface, but they actually draw attention to an important point that is sometimes overlooked: switching from PoW to PoS does not always alter the nature of participant interaction.
The state of the economy has not changed. Although there has been much discussion about the migration from PoW to PoS, the fundamentals of blockchain consensus procedures have not altered. Validators and miners are an open, theoretically infinite pool of participants in both PoW and PoS, and the only need for participation is the acceptance of a cost. In a PoW system, the cost is the money invested to mine, whereas in a PoS system, the cost is mostly the opportunity cost of holding crypto rather than spending or using it.
Both consensus protocols allow anybody, at any moment, to allocate these resources to these activities, which contributes to the development of an open and transparent market environment with minimal entry barriers. Participants who are dishonest, unethical, or otherwise uninterested in the process will be replaced by those who are more eager to participate honestly and ethically.
These facts render the coordination and cooperation of efforts required to initiate the Howey test as a significantly weaker case. As lock up periods end, investors want larger returns as interest rates and inflation remain high, and developers continue to process the PoS pivot, the concentration of ownership of staked ether will surely decrease.
The issue of classification is still open. The fact that the SEC – under previous leadership and chair Gensler – have not issued a definitive checklist or guide as to what criteria crypto would need to possess for securities classification, along with prior comments by both the SEC and the Commodity Futures Trading Commission (CFTC) agreeing that ether acted more like a commodity, continue to create an environment of regulatory ambiguity and uncertainty. However, the 80 enforcement proceedings the SEC took against Ripple and other parties as well as the $100 million fine and the $2 billion in fines assessed against BlockFi and other parties as of year’s end 2021 demonstrate how vehemently the SEC is prepared to discuss and control these issues.
It is more crucial than ever for investors to exhibit reasonable caution when investing, complete their due research, and stay current on market movements as the controversy over how to classify cryptocurrencies continues to rage.
