Reasons and objections to the SEC's attempt to classify ETH as a security

Compilation: Wu Shuo Blockchain

Recent reports indicate that the U.S. Securities and Exchange Commission is considering treating Ethereum as a security. The decision could have far-reaching consequences for the entire cryptocurrency market, including potentially hampering plans to launch an Ethereum ETF. Reports from CoinDesk and Fortune revealed this possibility, sparking concern and concern in the market. If Ethereum were classified as a security, it would mean that it would need to comply with regulatory requirements under securities laws, which could change how Ethereum is positioned and traded, creating uncertainty for investors and the market. This move may also trigger regulatory oversight in other countries. According to sources, the U.S. Securities and Exchange Commission has subpoenaed a number of U.S. companies to submit documents related to the Ethereum Foundation. The Ethereum Foundation is a Swiss-based non-profit organization responsible for advancing the Ethereum blockchain technology. The investigation apparently began shortly after the Merge incident in 2022 that introduced Ethereum staking.

U.S. Securities and Exchange Commission Chairman Gary Gensler said that after Ethereum’s proof-of-stake upgrade, the proof-of-stake chain paid users token rewards to lock their tokens as a security model. This model is similar to an investment contract and may be classified as a security. Although he did not mention Ethereum (ETH) directly, the opinion sparked discussions about cryptocurrency compliance. Gary Gensler also pointed out that regulators need to pay close attention to the cryptocurrency market to ensure that investors are properly protected while promoting innovation and market development. This position indicates that the regulatory attitude towards the cryptocurrency industry may gradually become stricter to ensure market order and investor rights. However, he has filed lawsuits against some U.S. and international cryptocurrency exchanges, Including Coinbase, Kraken and Binance, accusing them of selling securities to US investors without proper registration, including Cardano (ADA) and Solana (SOL).

Although the SEC has never directly defined ETH as a security in its enforcement actions, this has confused cryptocurrency lawyer Ignacio Ferrer-Bonsoms. In a recent blog post, Ferrer-Bonsoms compared Ethereum to Cardano and highlighted the SEC’s differing attitudes toward the two cryptocurrencies. He noted that if the SEC determines that one violates securities laws, the other should be evaluated by the same standard. This perception has sparked widespread discussion and controversy in the field of cryptocurrency regulations. Ferrer-Bonsoms believes that the difference in the SEC’s attitude toward Ethereum and Cardano may lead to more uncertainty about cryptocurrency regulation in the future. He highlighted the challenges regulators face when dealing with these emerging technologies and assets, particularly the uncertainty around defining what constitutes a security. This inconsistency may create problems for market participants

The Ethereum Foundation and Cardano Foundation have raised millions of dollars through token sales to support network development. The Ethereum Foundation raised $18 million worth of Bitcoin, while the Cardano Foundation raised $62 million. Both foundations have established foundations in Zug, Switzerland, to manage their respective networks. Additionally, both allocate tokens to their founders and foundations.

In addition, these two foundations also carry out specific work to increase the value of their tokens. Ferrer-Bonsoms pointed to the burning mechanism introduced in Ethereum’s EIP-1559 upgrade in August 2021, which can sometimes lead to deflation on the network. He emphasized: “In this way, investors may view tokens as investments with potential value-added.” A cryptocurrency that is a commodity, Ethereum’s founding team members are still very active in the industry. Vitalik Buterin, despite announcing a soft retirement on his 30th birthday, regularly introduces new ideas to Ethereum tools and influences the network's development path, while Joseph Lubin oversees the influential Ethereum incubator ConsenSys.

Although there is technically a Bitcoin Foundation, it has virtually no influence and does not pay salaries to Bitcoin Core developers.

Objection

Still, not everyone agrees that Ethereum is a security. On top of that, the Commodity Futures Trading Commission (CFTC), the SEC’s smaller sister agency, has allowed ETH futures trading for years, implying that it is a commodity. And, in the CFTC’s lawsuit against Sam Bankman-Fried, the agency made it clear that ETH is a commodity (like BTC and USDT).

In fact, the SEC’s unilateral determination of ETH as a security will have serious consequences for U.S. businesses and investors who already interact with or rely on Ethereum, including major exchanges that trade millions of dollars in ETH futures every day Such as CME Group and Cboe Global Exchange.

The best argument for ETH not being a security is (and so far it isn't) - changing status would have severe ramifications. That’s the equivalent of saying, “You can’t suddenly change your position a decade later and cause people to lose hundreds of billions of dollars,” and the CFTC will likely fight back, Austin Campbell, an assistant professor at Columbia Business School, told CoinDesk.

Former CFTC Commissioner Brian Quintenz, now head of Crypto policy at a16z, also echoed this point at X, saying that when the SEC approves ETH futures in October 2023 (a few months after the merger) When the ETF trades on its regulated stock exchange, "it expressly acknowledges the status of the underlying ETH as a non-security and outside its jurisdiction."

Quintenz added: “Given that the SEC has informed the market that ETH is not within its jurisdiction, it will be interesting to see what excuses, if any, the SEC will use if it delays or rejects an ETH ETF.” Note that this news comes a day after the U.S. Securities and Exchange Commission was hit with unprecedented court sanctions for its “serious abuse of power” in its lawsuit against cryptocurrency company DEBT Box.

Brian Frye, Spears-Gilbert Law Professor at the University of Kentucky, said the best argument against classifying ETH as a security is that “ETH looks more like BTC than any other token.” He added, “SEC has stated multiple times that it considers BTC to be a commodity, not a security...primarily due to the lack of centralized control."

Frye admitted that the existence of the Ethereum Foundation cast a shadow of doubt on this argument . However, it is undeniable that Ethereum’s stakeholders extend far beyond the founding companies. In some areas, Ethereum can even be considered more decentralized than Bitcoin - including the number of applications and developers running on it.

Additionally, IntotheBlock found that as of six months ago, there were more than twice as many long-term ETH holders (73.5 million) as Bitcoin holders (33.61 million). There are 5,370 addresses holding 1,000-10,000 ETH, but only 1,920 addresses holding 1,000-10,000 BTC.

None of that may matter given Gensler’s apparent path of attack on the cryptocurrency industry, which he believes is rife with fraud and financial abuse. Ironically, almost everyone in the cryptocurrency space wants Gensler to spend his time prosecuting actual crimes instead of harassing legitimate businesses or attacking decentralized protocols.

Frye thinks this apparent overextension could be Gensler's undoing. "The SEC is going too far and may stumble. It relies on the Howey test, which provides an extremely broad definition of 'security' and therefore gives the SEC very broad regulatory powers."

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