What if ether was a security?

Is Ethereum an investment security?

The issue has been the start of a speculative boom since ethereum moved to a proof-of-stake blockchain network last year, in which investors can stake their tokens in exchange for rewards — not too different from the interest payments on bonds . A new charge by New York state regulators on March 9, 2023 could push the legal debate back to the fore.

In Thursday’s lawsuit against Seychelles-based cryptocurrency exchange KuCoin, New York Attorney General (NYAG) Letitia James accused the company of selling unregistered securities illegally. Among the unregistered securities listed in the lawsuit is ether.

Ether has long been considered a commodity by state and federal regulators, including the Commodity Futures Trading Commission (CFTC). Designating it as a security would have a significant impact on the crypto market, revolutionizing how other cryptocurrencies operate and are classified in the U.S. market.

Where ether is a security

Ethereum is apparently attracting more scrutiny from regulators as it switches from proof-of-work (PoW) to the proof-of-stake (PoS) algorithm that runs the network starting in 2022.

The proof-of-work (PoW) algorithm (which Bitcoin still uses) relies on “mining” to secure the blockchain — computers scattered around the world competing to solve cryptographic puzzles for the right to earn money. Newly issued cryptocurrencies and writing transactions to accounts. The new system, the Proof of Stake (PoS) algorithm, forgoes mining in favor of staking. Ether holders can now lock their cryptocurrency to the network in exchange for interest, as a way of helping secure transactions.

“By switching to the proof-of-stake (PoS) algorithm, ETH no longer relies on competition between computers, but instead relies on a method of incentivizing users to own and stake ETH,” Shan said explaining the event. “The move to Proof-of-Work (PoW) algorithms has had a major impact on the core functionality and incentives of owning ETH, as ETH holders now only need to participate in order to profit. Participate in staking”.

Effect of Concentration

The specter of being considered a security has long haunted Ether. Since ETH was initially only distributed to early backers and investors in 2015 as part of an ICO.

In the lawsuit against KuCoin, James argues that ether is a security because of its early distribution scheme and the fact that its infrastructure is maintained by a relatively small group of contributors. James’ lawsuit specifically focuses on the influence of ethereum co-founder Vitalik Buterin and the nonprofit Ethereum Foundation. They claim that they have “significant influence on Ethereum and are often the driving force behind major initiatives on the Ethereum blockchain that have an impact on Ethereum’s functionality and price.”

The lawsuit further states that Buterin and the “minority of developers” who control the Ethereum blockchain “will profit from the growth of the network and the associated appreciation of ETH.” Investments in the development of the Ethereum network are promoted.” “Buterin and the Ethereum Foundation also received a significant amount of ETH during the ICO and expect to retain a significant amount of ETH today,” the lawsuit states.

What if ether was a security?

While the NYAG asserted in the lawsuit that ether may be a security, the ruling was not final. The most obvious thing to see, and the reason given in the lawsuit, is that there is at least one regulator — and possibly others, including the Securities and Exchange Commission (SEC). ) – consider ether.

The SEC works side by side with many other agencies, more than any other state that we know of, at least as far as I know,” said Collins Belton, a currency attorney at California-based Electronics and Partners in Brookwood PC Explaining that SEC Chairman Gary Gensler has been ramping up his crackdown on the crypto industry recently, suggesting that Ethereum’s move to a proof-of-stake (PoS) algorithm brings it closer to the physical definition of a security.

The SEC defines a security based on the Howey test, which states that a security is “a contract, transaction, or investment scheme whereby a person invests his or her money in a general business with the sole expectation of receiving a return from it. Three parties”. By this logic, the proof-of-stake (PoS) algorithm could bring Ether closer to “safety” because its interest payments require little effort and are consistent with the “expected return” of the Howey test.

Impact on the industry

If ethereum is officially classified as a security by the courts, exchanges that want to list ether may have to register as stockbrokers with the U.S. Securities and Exchange Commission (SEC). “If you’re registered in New York, you now have a question — do you delist ether or prevent your New York customers from buying ether. Or just register as a broker-dealer?” Belton said.

Belton also noted that James’ stance is surprising because exchanges legally operating in New York State (excluding KuCoin, which is not registered as an exchange) offer ether and are approved by New York State’s financial regulator, the New York State Department of Financial Services. (New York Department of Financial Services).

“It’s not that New York doesn’t know that ether is being offered. They’ve known it for years, because in order to get licensed and registered in New York, you actually have to have enough assets that you plan to offer to New Yorkers, and that Properties have to be overseen by regulators. Their financial managers are on the green list,” Belton said. “So their attorney general said, ‘Oh, by the way, it’s insane that you’re still selling securities illegally even though our financial regulators have allowed you to do that. With impunity for five years. business’,” he added.

It’s not just centralized exchanges that need to worry: Decentralized exchanges — autonomous software that runs on blockchains — could also run into legal trouble if ether turns out to be a security. “Technically, reading the draft, if you give people a platform to do these types of trades, whether it’s commodities or securities, then New York will say, ‘Hey, we think you probably have to be a broker-dealer – whatever Whether it’s a stock or a commodity broker-dealer,” Belton said.

There is legal precedent for banning blockchain-based computer programs, known as smart contracts — this summer, the U.S. government banned the Tornado Cash mixing program because of its links to money laundering.

James’ logic for classifying Ether as a security — based in part on the network’s shift to proof-of-stake (PoS) — raises questions about whether proof-of-stake (PoS) tokens could also be classified. Whether it is a security or not. Belton said the lawsuit affects other proof-of-stake (PoS) networks. What the NYAG says “could go beyond ethereum and involve the rest of the ecosystem.”

With the exception of Bitcoin’s Proof-of-Work (PoW), most major blockchains use a Proof-of-Stake (PoS) algorithm-based system similar to Ethereum, meaning regulators could place them in a similar basket. The price of ether fell about 7 percent after the NYAG announced its lawsuit against KuCoin.

  • CFTC Chairman: Digital Assets Including Ethereum and Stablecoins Are Commodities
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According to CoinDesk

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