Why the US SEC Believes Ethereum (ETH) is a Security

4 min read

On September 15th, 2022, the Ethereum community was elated that the long-anticipated Merge between the Beacon Chain of ETH2.0 (Consensus Layer) and the Mainnet of its proof-of-work network went about successfully without any major hiccup. However, the transition of Ethereum to a proof-of-stake algorithm might have increased its scrutiny by the United States Securities Exchange Commission.

Ethereum is a Security – US SEC Chairman 

On the same day as the Ethereum Merge, the United States Securities and Exchange Commission (SEC) Chairman Gary Gensler released a statement pointing out that cryptocurrencies and intermediaries that allow holders to stake their coins might pass the Hewey Test that is used to determine whether an investment is a security or not.

The Howey Test applies to any contract, scheme, or transaction  that an investor agrees upon based on ‘a reasonable expectation of profits to be derived from the effort of others.’ Chairman Gensler used this simple definition to explain that, ‘from [Ethereum’s] perspective…that’s another indicia that under the Howey test, the investing public is anticipating profits based on the efforts of others.’

The SEC has Jurisdiction Over Crypto Assets – US SEC Chairman.   

SEC Chairman Gensler’s comments were made less than a day after he testified before the US Senate Committee on Banking, Housing and Urban Affairs regarding ‘The Gold Standard of Capital Markets.’ 

In his testimony to the US Senate Committee, Chairman Gensler once again stressed that ‘most crypto tokens are securities.’ He added that ‘offers and sales of these thousands of crypto security tokens are covered by the securities laws’ and should therefore be regulated by the US SEC. 

Ongoing Lawsuit Against Ian Balina Hints That the SEC Has Jurisdiction Over Ethereum

In another twist of events, popular crypto personality and Initial Coin Offering (ICO) promoter Ian Balina was, on September 19th, served with a civil lawsuit by the US SEC for his role in popularising the 2018 Sparkster (SPRK) token launch. 

According to the SEC, Mr. Balina, who described himself as a crypto investor, promoter, and influencer, ‘failed to disclose the compensation he received from the issuer while he publicly promoted the tokens.’ He also ‘failed to file a registration statement with the SEC for the tokens that he re-sold using an investing pool that he organized.’ Consequently, he carried out unregistered securities offerings. 

What makes the Ian Balina lawsuit stand out is that the SEC brings the jurisdiction of transactional validation into the equation. The enforcement agency states that Mr. Balina was based in the US when transacting with investors. The transactions were further validated by Ethereum nodes that ‘are clustered more densely in the United States than in any other country.’ For that reason, the transactions more or less took place in the United States. 

Such a claim by the US SEC, and the agency winning the lawsuit, could have a ripple effect on the Ethereum ecosystem because it would normalize the idea that the agency has authority to regulate the network. The Ethereum community could mitigate such an outcome by further decentralizing the network outside the United States and ensuring no one country hosts a significant majority of validators of the new Proof-of-stake network. 

The SEC is Not Interested in Applying Existing Laws – Ripple CEO

The actions of the SEC in the last few weeks have raised several eyebrows in the crypto and blockchain industries. Ripple’s CEO, Brad Garlinghouse, believes that the agency is not interested in applying existing laws regarding securities. According to Mr. Garlinghouse, the SEC is attempting to remake laws to expand its jurisdiction beyond the authority granted to them by Congress. 

Ripple’s General Counsel, Stuart Alderoty, also believes that the SEC is overstepping its mandate. In an interview with Coindesk, Mr. Alderoty explained that the SEC’s ‘policy in the United States of regulation by enforcement is a failed policy and is creating havoc in the marketplace. The havoc ultimately hurts the retail consumer.’ He pointed out that ‘Congress only gave the SEC jurisdiction over securities’ and not digital assets.  

A Conclusion of the SEC Lawsuit Against Ripple Could Provide Clarity on XRP and Even Ethereum

To note is that Ripple is currently fighting a lawsuit by the SEC, which alleges that the company, Brad Garlinghouse, and its co-founder Chris Larsen carried out an unregistered securities offering by selling $1.3 billion worth of XRP to investors.  

The lawsuit has been ongoing for nearly two years, and a conclusion should be in the pipeline between this year and 2023. The end of the case and a verdict will clarify whether XRP is a security and will also set a precedent for determining whether the SEC has proper jurisdiction over Ethereum. 

Congress Needs to Provide Clarity on the SEC’s Jurisdiction Over Crypto

Furthermore, President Biden’s White House recently published its first-ever framework for regulating crypto. The framework only encouraged the SEC and Commodity Futures Trading Commission (CFTC) ‘to aggressively pursue investigations and enforcement actions against unlawful practices in the digital assets space.’ It also stated that the SEC and CFTC should do so within their mandate. 

As stated by Ripple’s General Counsel Stuart Alderoty, the US Congress determines the mandate of the SEC and CFTC. Therefore, clear guidelines on crypto regulation will most likely come from the US Congress passing new laws or amending existing ones to streamline the digital asset industry.

The Responsible Financial Innovation Act Intends to Provide Proper Definitions on Which Digital Assets are Commodities and Securities

Such legislation in the US could become a reality as Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) have introduced the ‘Responsible Financial Innovation Act.’ The proposed legislation aims to create a complete regulatory framework for digital assets. It also encourages responsible financial innovation, flexibility, transparency, and strong consumer protections.  

The ‘Responsible Financial Innovation Act’ also intends to create a standard to determine which digital assets are commodities and securities. It will provide the foundation of clear definitions in the digital asset industry and provide regulatory clarity on the mandate of the SEC and CFTC regarding digital assets.