Is Ether a security? What happens if the SEC says it is?

Ethereum (ETH), the second-largest crypto by market cap, has been under scrutiny regarding its classification as a security by the U.S. Securities and Exchange Commission (SEC). Recent reports indicate that the SEC is considering whether to classify ETH as a security, which has significant implications for the cryptocurrency market and ETH’s ecosystem. 

This classification debate has sparked discussions within the crypto community and among regulators. If the SEC determines that Ether is indeed a security, it could lead to various outcomes, impacting both the crypto market and ETH’s operations. 

The consequences may include regulatory compliance requirements, potential legal actions, market volatility, and changes in ETH’s development and usage.

Ether’s road ahead is not pleasant

The United States Securities and Exchange Commission (SEC) is debating whether to categorize ETH, the second-largest crypto by market cap, as a security. According to reports, the financial watchdog has issued subpoenas to three organizations as part of a probe into the ETH Foundation, the ecosystem that powers the ETH blockchain network.

The announcement follows the SEC’s reluctance to approve spot ETH ETFs, leaving applicants such as Hashdex and ARK 21Shares (pdf) awaiting final rulings in May. While the agency approved 11 Bitcoin ETFs earlier this year, it appears that ETH ETFs will meet regulatory challenges.

On February 26, the Ethereum Foundation’s GitHub page stated that the group had “received a voluntary inquiry from a state authority that included a requirement for confidentiality.”

Since the introduction of Bitcoin in 2009, there has been much debate about whether cryptocurrencies such as Ether are a sort of currency, security, or commodity. SEC Chair Gary Gensler, who taught a blockchain and crypto course at the Massachusetts Institute of Technology, is well-known for his tough stance on crypto regulation.

He has referred to the bitcoin industry as the Wild West, highlighting the necessity for regulation. The SEC’s recent action has jolted the possibility of spot Ethereum ETFs. 

The ETH blockchain network, which underwent a big upgrade earlier this month, is home to thousands of decentralized finance (DeFi) applications, and the move is likely to have an impact on the crypto market.

SEC decision about ETH could create another XRP situation

A number of digital assets lawyers have stated that the Ethereum Foundation’s “voluntary inquiry” disclosed in its GitHub repository is not cause for concern. Subpoenaing cryto companies is a common practice in this market. 

The Ethereum Foundation’s canary — a reference to “canaries in coal mines,” which signifies whether a government has probed a website — had to be removed ultimately.

Shortly after ETH’s proof-of-stake update, SEC Chair Gary Gensler stated that proof-of-stake chains, which pay users token rewards for locking up their money as a security mechanism, are similar to investment contracts and might be categorized as securities — though he did not mention ETH by name.

He has, however, filed lawsuits against a number of US-based and foreign crypto exchanges, including Coinbase, Kraken, and Binance, alleging that they were selling securities to US customers without the necessary registrations. These include assets like Cardano (ADA) and Solana (SOL).

ETH has never been explicitly identified as a security in an SEC enforcement case, which crypto attorney Ignacio Ferrer-Bonsoms finds incongruous. In a recent blog post, Ferrer-Bonsoms compared ETH to Cardano, arguing that if the SEC believes one to be in violation of securities rules, it must also scrutinize the other.

Both the ETH Foundation and the Cardano Foundation raised millions of dollars through token sales to fund network development ($18.3 million in bitcoin and $62 million, respectively); both govern their respective networks through foundations based in Zug, Switzerland; and both distribute tokens to their founders and foundations.

A US federal judge recently criticized the SEC’s “gross abuse of power” for “deliberately perpetuating falsehoods” in its dispute with crypto startup DEBT Box. This comes on top of an extraordinary closure by a three-judge appeals panel, which criticized the agency’s yearslong prohibition of spot bitcoin ETFs as “arbitrary and capricious.”

In short, if the SEC is attempting to make a case for rejecting spot ETH ETFs by targeting the underlying asset, it must have a strong justification.