The fear of Ethereum being labeled security was ignited again as US senator Cynthia Lummis (R-Wyo.) said on Wednesday that Bitcoin is the only cryptocurrency that can be considered a commodity now that Ethereum has gone through its Merge.
“It’s starting to look more like bitcoin is the only thing that would qualify as a commodity,” said Lummis (R-Wyo.), a longtime bitcoin holder and advocate.
During her appearance at CoinDesk TV’s “All About Bitcoin” program on Dec 7, she said that Ether could be deemed a security “because of the way [it] moved from proof-of-work to proof-of-stake” earlier this year. The “inability to (unstake tokens) right now makes it susceptible to being (considered) a security,” she added.
This categorization could change, Lummis said, as it is possible Ether will become “sufficiently decentralized that it could later be deemed a commodity.”
For those uninitiated, Lummis, a member of the Senate Banking Committee, along with Sen. Kirsten Gillibrand (D-N.Y.), is sponsoring the Responsible Financial Innovation Act, which, if passed, would give the Commodity Futures Trading Commission (CFTC) the main power to set regulatory standards for crypto. The bill aims to clearly define what can be deemed a security or a commodity.
For now, the question of whether Ethereum is a security or not remains a complex one. On the one hand, Ethereum is a decentralized platform that runs smart contracts, which means that it is not subject to the control of any central authority. And on the other hand, Ethereum does have a native currency, Ether, which is used to pay for gas and transaction fees on the network. This has led some to argue that Ethereum is a security, while others maintain that it is not. But what do the regulators have to say about it?
Ethereum already declared a commodity?
Ethereum’s nature may be in question, and it has been so as far back as 2018 when the former Director of Corporate Finance at the US Securities and Exchange Commission (SEC), William Hinman, said that: “…putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.”
Here, Hinman was referring to Ethereum’s launch. Ahead of its release in July 2015, the network sold its native ETH token through an initial coin offering (ICO) in exchange for Bitcoin. During the ICO, approximately 50 million ETH were sold, which netted the Ethereum Foundation over $18 million.
Hillman argued that by that time, the Ethereum network had sufficiently decentralized to the point where its token, ETH, could no longer be considered a security and, if regulated otherwise, would add “little value” for investors or regulators.
It wasn’t only Hinman, though. Former SEC chair Jay Clayton also made it clear back in 2019 that he didn’t consider Ether security.
Interestingly, most recently, financial regulators in Belgium declared that Bitcoin and Ethereum should not be classified as securities.
According to the document released by the Financial Services and Markets Authority (FSMA) of Belgium, cryptocurrencies without an issuer are not securities. BTC and ETH are specifically exempt from operating as securities within the EU country’s financial system.
“If there is no issuer, as in cases where instruments are created by a computer code, and this is not done in execution of an agreement between issuer and investor, for example, bitcoin or ether, then in principle the Prospectus Regulation, the Prospectus Law and the MiFID rules of conduct do not apply,” said the document.
However, if the instruments have a payment or exchange function, additional rules can be applicable to them, as per the Belgian regulator.
As for transferable instruments with an issuer, EU-based MiFID rules say they are likely to constitute a security. As such, besides BTC and ETH, other cryptocurrencies will be designated as having a centralized issuer, and so they will have to produce an honest prospectus of information for potential investors and adhere to the EU’s MiFID rule, which requires financiers to avoid conflicts of interest.
This inclusion of Ethereum in the exemption from securities laws by FSMA sets a precedent in the development of crypto asset regulatory frameworks worldwide.
The Merge has Reignited Fears
While the comments from Hinman quelled the fears of Ethereum being labeled as a security, this debate in the US was reignited with the Merge.
The Merge moved the Ethereum network from the PoW consensus algorithm to the cheaper, faster, and energy-efficient PoS, which now comes with significant implications.
It took years for the Ethereum network to reach here, but watching Ethereum’s decentralization progress alongside the Merge has been fascinating. Now post-merge, we are expected to see increased security due to reliance on the broader set of validators.
But in addition to technological advancement, Merge is causing some serious issues for Ethereum. Based on Hinman’s assessment, it is highly unlikely that the SEC will classify Ethereum as security retroactively. However, shortly after the merger, SEC Chairman Gary Gensler said cryptos with a proven history of staking might be eligible to be considered as securities.
Gensler, who is a former chair of the Commodities Futures Trading Commission (CFTC), previously also said that Ethereum meets what is known as the Howey test. The Howey test is a criterion guiding whether or not to classify an asset as a security under US laws.
In traditional markets, stocks and bonds are classified as securities. And for crypto to be considered a security, it must meet certain criteria. First, it must be an investment of money. Second, there must be an expectation of profit from the investment. Third, the investment must be in a common enterprise. Lastly, there must be a reasonable degree of risk involved in the investment.
Cryptos that meet these criteria are typically considered to be securities. When it comes to Ethereum, it is decentralized and not controlled by any single entity. This means that no major party could be considered responsible for its performance or security.
Finally, Ethereum is not marketed as an investment or a way to make money. Instead, it is intended to be used as a platform for building decentralized applications, which makes it more akin to a utility token than security.
As for validators, they deposit their ETH in the smart contract to validate the transactions and keep the blockchain secure, which isn’t necessarily “an investment of money.” For these reasons, it is unlikely that Ethereum would be considered a security.
Ethereum Under Scrutiny, But what about Bitcoin?
While Ethereum’s status as a security is still being debated, Bitcoin is confirmed not to be a security. In contrast to Ethereum, regulators and Bitcoin advocates point to the leading cryptocurrency’s unique characteristic as a decentralized digital asset without a specific founder or foundational body.
Created by the pseudonymous Satoshi Nakomoto in 2009, Bitcoin supply is capped at 21 million coins, while Ethereum has no limit. There is no centralized body issuing BTC, nor has it a joint enterprise that can profit from inward capital movement from institutional and retail investors.
However, US regulators and bitcoin maximalists advocate that Ethereum is security, citing the presence of a recognizable co-founder Vitalik Buterin and a centralized body called the Ethereum Foundation. Moreover, they claim that because its issuance can be controlled via updates of the underlying code, Ether should be deemed a security.
SEC Chair Gensler also said during his 2018 MIT lectures that compared to bitcoin, “Ethereum is a bit more centralized and has more leadership.”
The Ethereum Foundation, however, states on its website that it is a non-profit organization. “Their role is not to control or lead Ethereum” but rather to support the network and related technologies.
But some argue that Ethereum holders can stake their assets under its new PoS validator method and generate yield in the form of Ether.
SEC head Gelser has also said on multiple occasions that if a crypto asset allows staking, that makes it a security. This is because “the investing public is anticipating profits based on the efforts of others.”
“Many of these tokens… the investing public is hoping for a return just like when they invest in other financial assets we call securities. Many of these financial assets, crypto financial assets, have the key attributes of a security,” said Gensler.
Gensler, however, is not only after Ethereum but the entire cryptocurrency industry. Just this week, he said that the SEC needs more money in order to hire more staff and increase its investigative powers. He also believes that the agency needs to be given more authority to pursue cases involving overseas entities. He believes this will allow the SEC to better protect investors and ensure that companies adhere to US laws.
“If the SEC has the authority Mr. Gensler claims, why did he fail to uncover the largest crypto Ponzi scheme in US history?” wrote Rep. Ritchie Torres (D-N.Y.) in a letter to the Government Accountability Office requesting a review of the SEC’s role with the collapsed crypto exchange FTX. “One cannot have it both ways, asserting authority while avoiding accountability.”
Gensler also believes that there is no need for tailored crypto rules, something crypto market participants have called for due to crypto’s decentralized nature. “The rules are there,” said Gensler. “The law firms know how to advise their clients to comply.”
This is not the first time that Gensler has spoken out about the need for more regulation in the cryptocurrency space. It is clear that Gensler believes that the SEC needs more power to regulate the cryptocurrency space. Click here if you would like to know how Bitcoin works.
What does it mean for the Crypto Ecosystem?
There is no doubt that Ethereum’s upgrade “The Merge” has caused quite a stir in the cryptocurrency community. Some have even called it a “reversion to security” for the Ethereum network. While it is true that The Merge has brought some much-needed security updates to Ethereum, it has also raised regulator scrutiny.
The SEC is actually locked in a legal battle with another crypto project, Ripple, for issuing the XRP cryptocurrency, which the agency claims to be an “unregistered securities offering.” In the SEC vs. Ripple case, the defense team argues that Ripple believed XRP, along with bitcoin and Ether, are not securities.
The SEC has yet to issue a formal ruling on Ethereum, though. While in 2018, they did state that they believed that Ethereum was not a security, the SEC has also said that they may reconsider their position on Ethereum in the future.
So, for now, it seems that Ethereum is not a security, but this could very well change in the future, as regulators’ comments point out.
But if Ethereum is truly classified as a security, as opposed to a commodity, then Ethereum may be subject to more stringent requirements on registration, disclosure, and accreditation for investors by the SEC.
It would also have several implications for the plethora of tokens built atop the Ethereum network. For one, it would mean that these tokens would also be considered securities and would be subject to all the associated regulations. This could significantly impact how these tokens are traded and used, as well as how the Ethereum network is run. It could also have a major impact on the price of Ethereum, as the increased regulation could lead to a decrease in demand for the currency.
Moreover, it could put the user funds at risk and put a host of key players, including issuers and exchanges, in hot water. For instance, if considered security, websites offering to trade on Ether would need to obtain a license from a federal regulatory agency. And in this case, cryptocurrency exchanges would have to register with US commodities regulators, as they would be considered to be trading securities and face penalties if they did not.
The regulators’ commentary on Ethereum being a security in the past has been confusing, to say the least. Some have said it is a security, while others have said it is not. This confusion is likely due to the fact that Ethereum is a decentralized platform and, as such, does not fall under the traditional definition of security. However, the regulators’ stance on Ethereum remains unclear, and this confusion is unlikely to be resolved anytime soon.
