“It Never Was a Security”: Ethereum Under The Regulatory Spotlight

Ethereum (ETH), the second largest cryptocurrency by market capitalization, is facing scrutiny from American regulators this month.

The cryptocurrency is subject to a looming enquiry by the US Securities and Exchange Commission (SEC) as well as the Commodity Futures Exchange Commission (CFEC) for its token presale in 2014. According to the Wall Street Journal, regulators are taking a close look at the cryptocurrency and whether it should be classed as a security, as set out in the Securities Act 1933.

The major point of concern is the presale of ETH tokens in 2014. In total, 31,000 BTC were raised by the Ethereum Foundation to fund the development of Ethereum – worth around $18.3 mln at the time (and about $300 mln at press time).

Regulators are concerned that the presale itself could be classed as securities sale, due to the fact that investors likely bought tokens in the hopes that their value would increase in the future. If this is found to be the case, the Ethereum Foundation should have registered ETH as a security before the token sale was carried out.

SEC and CFTC regulators are due to meet May 7 to discuss the appropriate course of action. Another focal point is the influence that the Ethereum Foundation holds over the cryptocurrency.

Ethereum co-founder refutes claims

At the beginning of May, Ethereum Foundation cofounder Joseph Lubin addressed the situation at a tech conference in New Orleans. Lubin confidently stated that there were no concerns that the cryptocurrency would be classed as a security:

“We spent a tremendous amount of time with lawyers in the US and in other countries, and are extremely comfortable that it is not a security; it never was a security… many regulators that matter understand what Ethereum is.”

Furthermore, Lubin believes that Ethereum does not need to be regulated, because it does not meet the classifications of a security at all.

The Howey test

In 1946, the US Supreme Court resided over a case between the SEC and WJ Howey Co. As Investopedia explains, the case laid the foundation for what is now commonly known as the ‘Howey test’.

Quite simply, Howey Co. sold a portion of its citrus farm to investors, who bought the land in the interest of earning profits from the citrus farming operation. It was eventually deemed to have been a securities contract by the Supreme Court, because of this definition given by Justice Murphy:

“The scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.”

In layman’s terms, the Howey test is used to determine if the value of a transaction between two parties is dependent on one of the parties work. This very test has been the subject of much speculation when it comes to cryptocurrencies, and especially initial coin offerings (ICO).

Arguments against securities classification

In the case of Ethereum, Lubin is of the opinion that it is not a security for two reasons.

Firstly, Ethereum’s blockchain requires miners to validate transactions, create new blocks and unlock ETH tokens. Lubin believes the fact that many parties are involved in the work creating value rules out classification as a security:

“I think we already have a regulatory scheme; securities laws in this country govern securities. If you fail the Howey test, you’re not a security. This is a way of accessing a shared compute resource, so I’m not sure [ETH] needs to be regulated in any way.”

Secondly, the Ethereum Foundation refuted claims made by former CFTC chairman Gary Gensler last week, who said both Ethereum and Ripple should be considered as unregistered securities.

Ethereum Foundation head Aya Miyaguchi diffused any talk of the organisation’s influence over the value of the cryptocurrency in a letter to the New York Times. Miyaguchi stated that the foundations does no control the supply or issuance of ETH, and it’s own holding of ETH amounts to 1 percent of the total supply, which is in fact lower than amounts held by other users in the network…

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