The SEC attempts to classify ETH as a security: What are the reasons? What are the objections?

Author: Daniel Kuhn, CoinDesk

Compiled by: Wu Says Blockchain

Recent reports from CoinDesk and Fortune indicate that the U.S. Securities and Exchange Commission (SEC) is preparing to classify Ethereum as a security. This move will undoubtedly have serious repercussions for the entire cryptocurrency industry, including jeopardizing plans to launch a spot ETH ETF.

Fortune cited several unnamed sources reporting that the SEC has summoned several U.S. companies to provide documents related to the Ethereum Foundation. The Ethereum Foundation is a non-profit organization based in Switzerland that organized the launch of the blockchain of the same name. Apparently, this investigation began shortly after the Merge event in 2022, which introduced Ethereum staking.

Shortly after Ethereum's transition to proof-of-stake, SEC Chairman Gary Gensler stated that proof-of-stake chains pay token rewards to users for locking up their tokens as a security model, similar to an investment contract that could be classified as a security—although he did not explicitly mention the name ETH.

However, he has indeed filed lawsuits against several U.S.-based and international cryptocurrency exchanges, including Coinbase, Kraken, and Binance, for selling securities to U.S. investors without proper registration. These securities include those like Cardano (ADA) and Solana (SOL).

ETH has never been directly identified as a security in the SEC's enforcement actions, which has puzzled cryptocurrency lawyer Ignacio Ferrer-Bonsoms. In a recent blog post, Ferrer-Bonsoms compared Ethereum to Cardano, arguing that if the SEC considers one to be in violation of securities laws, it must view the other in the same light.

Both the Ethereum Foundation and the Cardano Foundation raised millions of dollars through token sales to fund network development (specifically, $18 million in Bitcoin and $62 million); both manage their respective networks through foundations based in Zug, Switzerland; and both allocated tokens to their founders and foundations.

Moreover, both foundations specifically contribute work to increase the value of their tokens. Ferrer-Bonsoms pointed out the burning mechanism introduced in Ethereum's EIP-1559 upgrade in August 2021, which made the network (at times) appear deflationary. He wrote, "In this way, investors may view the tokens as an investment with expectations of value growth."

In fact, unlike Bitcoin, which is the only cryptocurrency explicitly classified as a commodity under U.S. law, members of Ethereum's founding team remain very active in the industry. Vitalik Buterin, despite announcing a flexible retirement on his 30th birthday, regularly introduces new ideas for Ethereum tools and influences the development roadmap, while Joseph Lubin oversees the influential Ethereum incubator ConsenSys.

Although there is technically a Bitcoin Foundation, it has little influence and does not pay salaries to Bitcoin core developers.

Counterarguments

Nevertheless, not everyone agrees that Ethereum is a security. Most importantly, the Commodity Futures Trading Commission (CFTC), the SEC's smaller sister agency, has allowed ETH futures trading for years, implying that it is a commodity. Furthermore, in the CFTC's lawsuit against Sam Bankman-Fried, the agency explicitly stated that ETH is a commodity (just like BTC and USDT).

In fact, the SEC's unilateral determination of ETH as a security would have serious consequences for U.S. businesses and investors that have interacted with or relied on Ethereum, including major exchanges like CME Group and Cboe Global Markets that trade millions of dollars in ETH futures daily.

The best argument against ETH being a security is that it is (so far) not one—changing its status would have serious implications. This is akin to saying, "You can't suddenly change your position after ten years, causing people to lose hundreds of billions of dollars," and the CFTC is likely to push back, as expressed by Columbia Business School assistant professor Austin Campbell in an interview with CoinDesk.

Former CFTC commissioner Brian Quintenz, now head of policy at a16z Crypto, also responded to this on X, stating that when the SEC approved ETH futures ETFs to trade on its regulated exchanges in October 2023 (months after the Merge), "it explicitly acknowledged the underlying status of ETH as a non-security and outside its jurisdiction."

Quintenz added, "Given that the SEC has already communicated to the market that ETH is outside its jurisdiction, it will be interesting to see what excuse (if any) the SEC uses if it delays or denies the ETH ETF." Notably, the day before this news broke, the SEC faced unprecedented court sanctions for "serious abuse of power" in its lawsuit against cryptocurrency company DEBT Box.

Brian Frye, a law professor at the University of Kentucky's Spears-Gilbert, stated that the best argument against classifying ETH as a security is that "ETH looks more like BTC than any other token." He added, "The SEC has repeatedly stated that it considers BTC a commodity, not a security… primarily due to the lack of centralized control."

Frye acknowledged that the existence of the Ethereum Foundation casts a slight shadow over this argument. However, it is undeniable that the stakeholders in Ethereum far exceed the founding company. In some respects, it could even be argued that Ethereum is more decentralized than Bitcoin—considering the number of applications and developers running on it.

Additionally, IntotheBlock found that, as of six months ago, the number of long-term ETH holders (73.5 million) is more than double that of Bitcoin holders (33.6 million). There are 5,370 addresses holding 1,000-10,000 ETH, but only 1,920 addresses holding 1,000-10,000 BTC.

Given Gensler's apparent attack path on the cryptocurrency industry, these points may be irrelevant, as he views the industry as rife with fraud and financial abuse. Ironically, almost everyone in the cryptocurrency space hopes Gensler will spend his time prosecuting actual criminals rather than harassing legitimate businesses or attacking decentralized protocols.

Frye believes this apparent overreach could be Gensler's downfall. "The SEC is going too far and may trip up. It relies on the Howey test, which provides an extremely broad definition of 'security,' thus granting the SEC very broad regulatory power."