- A recent SEC investigation into insider trading has revived the debate over whether Ethereum is eligible for security.
- Some claim that ETH has passed the Howie test due to its launch method and the move to Ethereum’s Proof of Stake.
- It is argued that ETH investors buy assets in the hope of profit, as ETH stackers make money by examining blocks on the Ethereum network. However, security classification by the SEC is unlikely.
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Can the SEC have a basis for classifying Ethereum as security after completing a “merge” into Proof of Stake? Cryptographic briefing Explore one of the hottest issues in cryptography.
Ethereum and SEC
Approximately seven years after the Ethereum network began creating blocks, the debate about whether the token should be classified as security remains fierce.
Prior to the launch of Ethereum in July 2015, the network sold native token ETH through an Initial Coin Offering (ICO) in exchange for Bitcoin. Approximately 50 million ETH were sold during the ICO, and the Ethereum Foundation, a non-profit organization established to control the development of networks, exceeded $ 18 million.
In the early days of Ethereum, many claimed that ETH would have passed the SEC’s Howie test. The Howey test, which is used to assess whether an asset constitutes a security, determines whether a particular transaction is an investment contract based on three criteria: whether it is a monetary investment, whether it is a general enterprise, and so on. And whether there is). Expectations of profits clearly derived from the efforts of others.
The Ethereum Foundation sold ETH directly to the public. In other words, it met the requirements for investing money. In addition, launching the Ethereum network, where ETH is the currency, requires the direct input of over 100 developers and is probably qualified as a general enterprise. Finally, the Ethereum ICO occurred in August 2014, 11 months before the network’s July 2015 launch. This suggests that investors reasonably expected the value of ETH purchased to increase when the network was launched. This relied on the efforts of the Ethereum developers. Therefore, the proceedings filed against the Ethereum Foundation at the time may have determined that ETH is security under the Howey test.
However, despite the ambiguity about Ethereum’s status as security that plagued early days, the SEC has since focused on network status. In a 2018 speech, William Hinman, a former SEC director of corporate finance, said:
“… Aside from the funding associated with the creation of Ether, Ether’s current offers and sales are not stock exchanges, based on my understanding of Ether’s current status, the Ethereum network and its decentralized structure.”
Based on Hinman’s assessment, it is unlikely that the SEC will retroactively classify Ethereum as security. By the time he gave his speech in 2018, he argued that the Ethereum network was sufficiently decentralized and its token, ETH, was no longer considered security under US law. Hinman added that regulating ETH transactions under securities law is “less valuable” to investors and regulators.
Hinman’s comments shattered immediate concerns that ETH could be considered security, but the “merging” of the Ethereum network into the upcoming proof of stake rekindled the debate. An update scheduled for later this year will significantly change the basic structure of Ethereum Network functionality. The current proof-of-stake system, in which independent miners compete to solve complex equations and mine blocks, is replaced by a proof-of-stake verification mechanism. Proof of stake is commonly used in other blockchain protocols, but for Ethereum, details of how the new verification system works can affect Hinman’s previous assessment. there is.
Protocol changes from Ethereum Marge may relieve the ambiguity surrounding whether Ethereum is a security, but other developments such as recent insider trading proceedings may be considered securities. It helped clarify the SEC’s position on crypto assets. A lawsuit filed against two former Coinbase employees and their friends alleges that the trio bought and sold 25 different crypto assets with insider information, with “at least nine” eligible for securities. Explicitly stated that there is a possibility.
The wording used in the proceedings is an extension of the definition of security outlined in the Howey test. Most notably, he explained the SEC’s view that if the organization that issued the crypto asset removes itself from the development of the project and the asset cannot continue to function, it should be classified as security. .. With the help of new clarifications, the SEC will allow AMP, RLY, DDX, XYO, RGT, LCX, POWR, DFX, and KROM tokens to fully configure security or display critical security-like features. Insisted.
The combination of new filings from the SEC and Ethereum’s long-awaited merge update raises questions once again among crypto enthusiasts: Can the SEC classify Ethereum as security in the future?
Is ETH after merging eligible for security?
To determine if the SEC has any reason to consider Ethereum as security after merging, it is important to understand exactly how the update will affect your network.
Ethereum is currently using a proof-of-work verification mechanism, where miners propose and verify blocks. Miners use their computing power to solve the complex equations needed to mine blocks. The network automatically rewards miners with two ETHs for each mined block and the priority charges included in the transaction.
After the merge, Ethereum’s mainnet docks with the Beacon chain and switches verification to the Proof of Stake mechanism. Proof of Stake allows anyone with at least 32 ETHs to set up a complete validator node on the Ethereum network and join other validator pools to validate blocks. After each block is validated, a qualified validator will earn a small reward along with a priority fee from the transaction.
Future technical changes that Ethereum will receive as part of the merge have led to some debate surrounding its security status. Adam Leavy, a law professor at Georgetown University Law Center, Insisted After the merger, there is a “strong case” where Ethereum is classified as security. Under Proof of Stake, he says, verifiers pool ETH in a “common company” and meet the second point of the Howey test. In addition, validators receive rewards from themselves and others who validate the Ethereum network, so they are expected to benefit “from the efforts of others.”
However, Levitin has received some opposition to the interpretation of Ethereum’s proof of stake verification mechanism. Adam Cochran, a partner of Cinneamhain Ventures Counterargument Levitin’s claim that people running validators on the Ethereum proof of stake chain do not pool funds question whether running validators constitutes a “common company” doing. “The node you are maintaining will be rewarded for running that job and will be slashed if it fails. The success or failure of a node will not affect the interests of others,” he said, a validator for one person. Claimed that his interests did not depend on the success or failure of others.
Not only Cochran, but also Jacob Franek, a contributor to Alliance DAO. It pointed out With no identifiable ETH issuer today, it is difficult to claim that the profit received by a validator is a security associated with any entity. With reference to the SEC definition of crypto asset security outlined in a recent insider trading lawsuit, verifiers continue to add blocks to the chain, even if Ethereum developers stop working on the protocol, and stackers You will continue to receive rewards. This undermines the argument that ETH can be security.
The final point about Ethereum’s staking benefits also helps to refute the security standards found in the Howie test. Currently, most securities under the jurisdiction of the SEC make up a share offering from registered companies. Investors who own them do not have to perform any special obligations or labor to ensure that they receive profits in the form of dividends from the issuer.
However, for Ethereum staking, ETH holders must have sufficient computer hardware, install and configure the required client software, maintain an internet connection, and have validator nodes working properly and honestly. You need to confirm. Some argue that stackers receive payments to perform certain services rather than benefiting from the actions of others because of the significant effort required to profit from betting ETH. increase.
In addition, stackers who fail to validate transactions face a slash that is “slashed”. This is the process by which the network automatically obtains the validator ETH to punish false alarms for transactions. Ultimately, historical precedents show that it shouldn’t be as security, as Ethereum validators derive from their own efforts, not the efforts of other investors or Ethereum developers. ..
Howie’s test standards and precedents set by previous SEC cases make it difficult for regulators to claim that Ethereum constitutes security. The SEC may try to expand the scope of crypto assets by declaring more securities, but Ethereum appears on the organization’s cross even after the merger into Proof of Stake. The chances are getting lower and lower.
In addition, the SEC’s ongoing proceedings to determine whether the sale of Ripple’s XRP tokens constitute a securities offering further further proceedings to prevent regulators from being involved in another long and costly proceeding. It can be discouraging. Still, without a firm ruling, the question of whether Ethereum is classified as security could continue to surface in the crypto world. The SEC has made some progress, including the decision to classify Bitcoin as a commodity, but there have been few judgments on other assets. However, as Ethereum and the wider crypto space grow, it becomes harder for regulators to keep ignoring it. Therefore, the SEC may be forced to consider the second largest asset in cryptospace early and decisively rather than later.
Disclosure: At the time of writing this feature, the author owned ETH, BTC, and several other cryptocurrencies.