SEC Inquiry: Should regulators treat Ethereum as Security or NOT?

SEC Inquiry Should regulators treat Ethereum as Security or NOT

The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) will soon conduct a probe into the Ethereum cryptocurrency, particularly its token presale of 2014. Tomorrow (May 7), both agencies will meet to forge the path for further deliberations, and one question will dominate discussions. How should ethereum (ETH) be classified? According to a report on Wall Street Journal, the regulators look at the Securities Act of 1933 to decide if ETH will be classified as a security or not.

SEC and CFTC: The Ethereum probe       

Ethereum, the second biggest cryptocurrency by market cap will be the focus of an extensive probe by regulatory agencies in the United States. This month, the Securities and Exchange Commission responsible for regulating the securities industry, alongside the Commodity Futures and Trading Commission (CFTC), which regulates futures and options markets, will seek to probe the Ether token sale was conducted in 2014 as well as the influence of Ethereum Foundation on the value of Ether.

Ethereum Token Sale

From 22 July to 2 Sept 2014, the Ethereum Foundation distributed its first allocation of Ether in its presale raking in 31,591 bitcoins, worth $18.4 million at the time and about $300 million at current prices. The US regulators will point their torchlights to this presale to determine if these coins bought at the time represents securities and how the gains made from that investment should be treated.

Influence of Founders and Ethereum Foundation

The regulators will also the influence issuing foundations have on the prices of these cryptocurrencies. Of particular interest to the SEC and CFTC is the similarity of the role played by The Ethereum Foundation towards the Ether and those Companies management play towards the price of their stocks.

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Last month, Gary Gensler, a former CFTC chairman under the Obama regime, said that Ethereum and Ripple should be classified as unregistered securities. In his interview with New York Times, Gensler based his argument on two major points; one, that they were first issued by their founders in ICOs.

Aya Miyaguchi, Head of Ethereum Foundation while responding to Gensler’s claims took the opportunity to counter the impression that the foundation had influence over the issuance and value of Ether. In a letter to New York Times, she said explained that the foundation holds just about one percent of the total coin supply and is by no means the biggest holder in the network.

The Case for Ethereum as a Security

On the part of SEC, all ICOs are classified as security offerings so there is a huge chance this classification would as well be applied to cryptocurrencies including Ether. Since investors bought ETH in the token presale with hopes that the value would go up in the future, regulators will see this as similar to the purchase of company stocks as securities

The Ethereum foundation, on the other hand, is adamant Ether is not a security.

Ethereum definitely not a Security – Ethereum co-founder

At a tech conference last week, co-founder of Ethereum Foundation, Joseph Lubin made a case against Ethereum being a security. He declared that he was not concerned about that the Ether will be treated as a security. “We spent a tremendous amount of time with lawyers in the US and in other countries, and are extremely comfortable that it is not a security; it never was a security […] Many regulators that matter understands what Ethereum is.” He said.

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In his argument, Lubin points to the many parties involved in creating value for the Ether as contradicting the Howey’s test for a security. Ethereum blockchain requires several miners (or nodes) to create new blocks and validate transactions.

In line with this stance, Lubin believes there was no need for the SEC or other such agencies to regulate the cryptocurrency.  “I think we already have a regulatory scheme; securities laws in this country govern securities. If you fail the Howey test, you’re not a security. This is a way of accessing a shared computing resource, so I’m not sure [ETH] needs to be regulated in any way,” Lubin said.

The Howey test

A security can be defined as “[a scheme which involves] an investment of money in a common enterprise with profits to come solely from the efforts of others.” This statement embodies the ‘Howey Test’ which was derived from a 1946 case between the SEC and WJ Howey Co.

The test, which has propped up severally in the debate of ICOs, is used to ascertain if the value of the transaction between two parties depends on the work done by one of the parties. If so, the transaction may be categorized as a security.

What will happen if Ethereum is labeled a Security?

If SEC insists Ethereum is a security and decides to treat it as such, there would most likely be a tumultuous time for the second largest cryptocurrency.

Gensler, who will teach Blockchain at MIT this fall, said that “if they are deemed to be securities, it could become illegal for Americans to trade them on most of the exchanges where they are now traded.” He further noted that this would ultimately bring down the prices since it will be harder to buy and sell ethers. Essentially, American-based exchanges will have to stop trading to register the cryptocurrency as a security.

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Furthermore, Ethereum, if judged to have violated the SEC laws, may attract punishment in form of fines, penalties and even jail time (though unlikely) to parties involved. Other ICOs developed under the Ethereum blockchain will also be affected by the development.

It is almost a certainty that if SEC declares Ethereum a security, a legal battle between the agency and the Ethereum Foundation will ensue and the Foundation will have a good case.

It is worthy to note that Ethereum remains one of the major “good guys” in the cryptocurrency space and definitely not the “bad guys” SEC should have their hand full with. The Ethereum project has brought up many revolutionary applications of blockchain technology.

 

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