Why the SEC Shouldn’t Classify ETH as a Security
Recent reporting from CoinDesk and Fortune suggests the U.S. Securities and Exchange Commission is preparing to classify ether (ETH), the native token of the second-largest blockchain, Ethereum, as a security. The move would undoubtedly have severe repercussions for the entire crypto industry, including derailing plans for an spot ETH exchange-traded fund.
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Citing several unnamed sources, Fortune reported that the SEC has subpoenaed several U.S. companies for documents related to their dealings with the Ethereum Foundation, the non-profit that organized the launch of the eponymous blockchain and is based in Switzerland. Apparently, the probe began shortly after the Merge event that introduced ether staking in 2022.
Shortly after Ethereum’s proof-of-stake upgrade, SEC Chair Gary Gensler said that proof-of-stake chains, which pay users token rewards for locking up their coins as a security model, resemble investment contracts and could be classified as securities — though he did not mention ETH by name.
He has, however, launched lawsuits against a number of U.S.-based and international crypto exchanges including Coinbase, Kraken and Binance on the grounds that they were selling securities to U.S. investors without the appropriate registrations. These include assets like Cardano’s (ADA) and Solana’s (SOL).
ETH has never been named outright as a security in an SEC enforcement action, a point that strikes crypto attorney Ignacio Ferrer-Bonsoms as contradictory. In a recent blog, Ferrer-Bonsoms compared Ethereum to Cardano to argue that if the SEC considers one to fall afoul of securities laws then it must consider the other the same way.
Both the Ethereum Foundation and Cardano Foundation raised millions via token sales to fund network development ($18.3 million in bitcoin versus $62 million, respectively); both govern their respective networks through foundations based in Zug, Switzerland; and both allocated tokens to their founders and foundations.
Moreover, both foundations contribute work specifically to increase the value of their tokens. Ferrer-Bonsoms noted Ethereum’s burn mechanism, introduced in the EIP-1559 upgrade in August 2021, that made the network (sometimes) deflationary. “In this way, investors may perceive the token as an investment with expectations of value appreciation,” he wrote.
Indeed, unlike bitcoin (BTC), the only cryptocurrency that is hands-down a commodity under U.S. law, members of Ethereum’s founding team are still highly active in the industry. Vitalik Buterin, despite announcing a soft retirement on his 30th birthday, regularly introduces new ideas for Ethereum tools and influences the network’s roadmap while Joseph Lubin oversees the influential Etheruem incubator ConsenSys.
And while technically there is a Bitcoin Foundation, it has almost no influence and does not pay salaries for Bitcoin Core developers.
The case against classification
That said, not everyone agrees that Ethereum is a security. Most importantly, the Commodities Futures Trading Commission (CFTC), the SEC’s smaller sister agency, has for years allowed ETH futures trading, implying that it is a commodity. And, in the CFTC’s lawsuit against Sam Bankman-Fried, the agency outright said ETH is a commodity (alongside BTC and (USDT)).
Indeed, the SEC’s unilateral determination that ETH is a security would have severe repercussions for U.S. businesses and investors that already interact or rely on Ethereum, including major exchanges like CME Group and Cboe Global Exchange that trade millions of dollars of ETH futures per day.
The best argument that ETH isn’t a security is that it hasn’t been up to now and changing status would have harsh impacts. It’s “the whole ‘you can’t just arbitrarily change your mind and damage people for hundreds of billions of dollars after a decade’ and also by the way the CFTC will likely fight back” argument, Austin Campbell, a Columbia Business School assistant professor, told CoinDesk in an interview.
Brian Frye, the Spears-Gilbert Professor of Law at the University of Kentucky, said the best reason against classifying ETH as a security “is that ETH looks more like BTC than any other token.” He added that “the SEC has repeatedly said it considers BTC a commodity, rather than a security, I think primarily because of the lack of centralized control.”
The existence of the Ethereum Foundation casts a shadow of a doubt on that argument, Frye admitted. However, it is undeniable there are thousands of stakeholders in Ethereum beyond the founding corporation. In some areas even, Ethereum could be considered more decentralized than Bitcoin — including the number of applications running on it and developer count.
Further, IntotheBlock found that, as of six months ago, there are more than double the number of long term ETH holders (73.5 million) than bitcoin (33.61 million). There are 5,370 addresses holding between 1,000-10,000 ETH but only 1,920 addresses with between 1,000-10,000 BTC.
None of this may matter considering Gensler’s apparent warpath against crypto, an industry he sees as rife with fraud and financial abuses. The ironic thing is nearly everyone in crypto wishes Gensler would spend his time prosecuting actual crime, rather than harassing legitimate business or attacking decentralized protocols.
Frye sees this apparent overreach as potentially Gensler’s undoing. “The SEC is getting too far out over its skis and is liable to crash. It’s relying on Howey, which provides an extremely broad definition of ‘security’ and consequently gives the SEC very broad regulatory authority,” he said, referring to one of the tests the agency uses to define “investment contracts.”
“But the Supreme Court can change Howey. And, the more aggressively the SEC regulates, the more likely a case will go to SCOTUS. As soon as one gets there, the Supreme Court is likely to ‘clarify’ Howey by narrowing it.”
