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What happens if Ether is a security?

BusinessCryptoWhat happens if Ether is a security?
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Is Ether (ETH), the native cryptocurrency of the Ethereum blockchain and the second largest investment security by market cap behind bitcoin?

The question has been a source of speculation ever since Ethereum switched to a “proof-of-stake” blockchain network last year, where investors can “stake” their coins in exchange for rewards – paid out on bonds. Not much different from the interest paid.

A fresh allegation Thursday from a New York state regulator could push the legal debate to the back burner.

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In a lawsuit filed against Seychelles-based crypto-exchange KuCoin on Thursday, New York Attorney General (NYAG) Letitia James alleged that the firm broke the law by selling unregistered securities. Ether was among the unregistered securities listed in the lawsuit.

Ether has long been treated as a commodity by state and federal regulators, including the Commodity Futures Trading Commission (CFTC). Designating it as a security will have a massive impact on crypto markets, how (and whether) it is traded in the US like currency and others.

The Case for Ether (ETH) as a Security

Ethereum apparently faces additional scrutiny from regulators starting in 2022, when it switches from a “proof-of-work” system to a “proof-of-stake” system for operating its network.

The proof-of-work system, still used by bitcoin, relies on “mining” to secure the blockchain—where computers scattered around the world mine newly issued cryptographic data to solve cryptographic puzzles. Run for the right to earn and write off transactions. chain.

The new system, Proof-of-Stake, abandons mining for “staking”. Ether holders can now lock their crypto with the network in exchange for interest, and as a way to help secure transactions.

“By moving to proof-of-stake, ETH no longer relies on competition between computers, but instead now relies on a pooling method that incentivizes users to own and stake ETH,” the suit explained. “The change to proof-of-stake significantly affects the core functionality and incentive to own ETH, as ETH holders can now only profit by participating in staking.”

concentrated effect

The ghost of a security designation has long hung over the ether, which was originally distributed as part of an ICO — or initial coin offering — to early supporters and investors in 2015.

In his lawsuit against KuCoin, James suggested that ether is a security due to its initial distribution plan as well as the fact that its infrastructure is maintained by a relatively small group of contributors.

James’ lawsuit takes particular issue with the influence held by Ethereum co-founder, Vitalik Buterin, and the non-profit Ethereum Foundation, claiming that they “retain significant influence over Ethereum and are often behind major initiatives on the Ethereum blockchain.” There are a driving force behind that effect. The performance and price of ETH.”

The suit further states that Buterin and the “small number of developers” who control the Ethereum blockchain “stand to benefit from the growth of the network and the associated appreciation of ETH.” Buterin and the developers, the suit says, “promoted it as an investment that was contingent on the development of the Ethereum network.”

“BUTAIN and the Ethereum Foundation received significant amounts of ETH in the ICO and are believed to retain a significant portion of that ETH today,” the suit claimed.

What happens if Ether is a security?

Despite the NYAG’s assertion that Ether may be a security, the decision is far from final.

It is clear that the argument set forth in the suit certainly outlines how at least one regulator – and possibly others, including the US Securities and Exchange Commission (SEC) – is thinking about Ether.

The SEC has worked closely with [New York] “They have more, at least with any other state that I know of,” explained Collins Belton, a California-based crypto attorney and partner at Brookwood PC, “while you can’t say whether it’s going to be mandatory in the US.” Objectively, I think it’s a very strong indicator that these are the kinds of arguments” that SEC Chairman Gary Gensler “is thinking about trying to reform.”

Gensler — who has recently cracked down sharply on the crypto industry — has previously indicated that Ethereum’s switch to proof-of-stake brings it into alignment with the agency’s definition of security.

SEC defines securities based on how testWhich says that a security is “a contract, transaction or scheme under which a person invests his own money in a common enterprise and expects to profit from the efforts of the promoter or a third party.”

Proof-of-stake, by this logic, could bring ether closer to “security” because its interest payments require far less work and rhyme with the “expectation of profit” of the Howey test.

impact on industry

Should ethereum be officially classified as a security by the courts, exchanges wishing to list ether would need to register as securities broker-dealers with the US Securities and Exchange Commission (SEC).

“If you are already registered in New York, now you have a question – do you either delist Ether and/or prevent your New York customers from being able to buy Ether or are you just a broker-dealer? register as?” Belton said.

Belton also pointed out that James’ stance comes as a surprise because most exchanges operating legally in New York (except KuCoin, which was not registered as an exchange) offer ether, the state’s financial Services with the approval of the regulator, New York Department of Finance (NYDFS)

“It’s not that New York didn’t know that Ether was being offered. They knew for years because in order to get licensed and register in New York, you have to actually have assets that you can give to New Yorkers for their financial are planning to offer to be green-listed by the regulator,” Belton said.

“So it’s kind of crazy that their attorney general was saying, ‘Oh, by the way, you guys are selling illegal securities, despite the fact that our financial regulator is letting you do five years with impunity. ,” They said.

It’s not just centralized exchanges that have something to worry about: Decentralized trading platforms – autonomous pieces of software that reside on the blockchain – could also face legal troubles if ether is found to be a security. .

“Technically the way the draft reads, if you’re offering people a platform where they can engage in this type of transaction, whether it’s a commodity or a security, New York is saying, ‘Hey, we think you should probably be a broker-dealer — either a securities broker-dealer, or a commodities BD,'” Belton said. “If that’s true, then this thing is a lot bigger than ‘oh, hey, can exchanges continue to offer ether’?”

There is already a legal precedent for outlawing blockchain-based computer programs, called smart contracts – over the summer, the US government banned it. Tornado Cash Mixer Program for its link to money laundering.

beyond the ether

An ether-as-a-security world would have major implications for crypto writ large.

James’ argument for classifying ether as a security – based on the network’s switch to proof-of-stake – raises questions about whether other tokens can also be classified as securities.

Belton said what the NYAG is saying “could move beyond the ether and affect the rest of the ecosystem.”

Outside of proof-of-work bitcoin, most major blockchains use a stake-based system similar to Ethereum, which means it is possible that regulators may put them in a similar basket.

In the wake of the announcement of the lawsuit against KuCoin by the NYAG, the price of Ether declined by about 7%.

The views and opinions expressed here are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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