Are securities and exchange commission officials preparing to shut down Ethereum? It certainly seems plausible given the threatening rhetoric used by officials, notably SEC Chairman Gary Gensler.
In September, the organisation went on a crypto-regulatory binge. First, during its yearly The SEC Speaks conference, representatives vowed to keep up enforcement actions and asked market players to register their goods and services. To reduce conflicts of interest and improve investor protection, Gensler even recommended that cryptocurrency intermediaries separate into different legal firms and register each of their roles, such as exchange, broker-dealer, custodial duties, etc.
The SEC’s Division of Corporation Finance then said that it would be expanding its Disclosure Review Program this fall to include an Office of Crypto Assets and an Office of Industrial Applications and Services to help with the registration of players in the cryptocurrency market. Then, in testimony before various Senate Committees regarding legislation that would overhaul the regulation of cryptocurrencies, Gensler restated his belief that virtually all digital assets are securities, indirectly supporting his argument that these digital assets and the essential intermediaries should register with the SEC.
The SEC’s attacks on Ethereum, however, may have been the most seismic. This could reverse a years-long détente that started when a prior SEC official said that Ether (ETH), along with Bitcoin (BTC), was not a security. According to his testimony before the Senate Banking Committee, Gensler suggested that Ethereum’s switch from proof-of-work to proof-of-stake (PoS) might have subjected Ethereum to the SEC’s oversight because by staking coins, the investing public [is] anticipating profits based on the efforts of others.
Later, the SEC noted that because more Ethereum nodes are situated in the U.S. than any other nation, all transactions taking place on the Ethereum blockchain may be subject to SEC regulation in a complaint brought against a token promoter. The SEC’s present views on Ethereum appear to be obvious overreach on their behalf and additional threat-making intended to persuade the sector to register.
First, in 2018, William Hinman, the then-SEC Director of Corporation Finance, said that the SEC did not consider Bitcoin and Ether to be securities. This appeared to have its origins in both Ethereum’s decentralisation and the distinction between digital tokens, which revolve around a particular project, and cryptocurrencies, which serve as substitutes for fiat money.
However, Ethereum’s switch to Proof-of-Stake (PoS) may have complicated matters because the SEC has suggested that Ether may now qualify as a security under the Howey Test (an asset is a security if it meets all four criteria: it must be an investment of money, part of a common enterprise, have a reasonable expectation of profits, and be derived from the labour of others). It’s unclear how the Merge may have significantly altered Ethereum’s decentralised structure and goals to transform it into a security (it still resembles Bitcoin more than digital tokens).
However, it may be argued that it is closer to matching the Howey elements, especially with additional characteristics resembling crypto-lending, which the SEC has already claimed can turn a product into a security. In contrast to crypto-lending platforms, where tokens are staked and interest is earned by the loan company rather than by the collective efforts of the stakers, PoS is still very different from these platforms. Given that smart contracts are the main application of the Ethereum blockchain and how its currency are mined, it still appears improbable to classify Ether as a security.
Second, the SEC’s claim that transactions on the Ethereum blockchain are subject to U.S. jurisdiction because more of that cryptocurrency’s nodes are situated there than anywhere else would significantly extend the SEC’s jurisdiction beyond the country. According to that logic, the SEC may claim jurisdiction over an Ethereum-based token created in Germany and offered and sold there exclusively to Germans because the U.S.’s cluster of Ethereum nodes makes it appear as though the transactions actually took place there. Such a result would seem very unlikely to meet legal requirements.
Does the SEC’s recent aggressive behaviour portend enforcement measures against Ethereum (who would they suit, anyway?) or against international actors for foreign behaviour on Ethereum? Most likely, this is a negotiation ploy designed to intimidate the industry into willingly submitting to the SEC’s jurisdiction. Because if Ethereum is in danger of being classified as a security or exchange, then all other decentralised finance platforms in the market must be, too, presumably with the exception of Bitcoin (for now).
