By Kathy Chu, TruthDAO
The U.S. Securities and Exchange Commission’s recent move to crack down on unregistered crypto assets raises the possibility that Ether, the No. 2 cryptocurrency behind Bitcoin, could soon be in the crosshairs, industry experts say.
Last week, the SEC filed insider-trading charges against a former employee of crypto trading giant Coinbase, the former employee’s brother and his friend. The agency asserts that nine of the tokens they traded were securities, which, if true, would put them under the purview of the SEC. The Justice Department filed similar insider trading charges against the same trio of individuals under a wire fraud statute.
In a blog post last week, Coinbase Chief Legal Officer Paul Grewal said it does not list securities. The three individuals named in the insider-trading complaint -- former Coinbase product manager Ishan Wahi, his brother, Nikhil Wahi, and his friend Sameer Ramani -- could not be reached for comment.
According to people associated with the companies that issued a handful of tokens named in the SEC’s filing, the agency did not communicate with them in advance. Typically -- but not always -- the SEC directly telegraphs discomfort with companies or their offerings before naming them in official filings.
Caroline Pham, a commissioner at the Commodities Future Trading Commission, said the SEC’s allegation that the crypto tokens are securities is an example of “regulation by enforcement.” The SEC declined to comment beyond its filing.
Teresa Goody Guillén, a former SEC litigation attorney who is now a partner at the law firm BakerHostetler, said the SEC's action was a wake-up call for the crypto world. "This case sent a shockwave through the blockchain industry and I would not be surprised if there are further enforcement shockwaves this year,” she said.
The SEC is also involved in a securities lawsuit against Ripple Labs, an enterprise blockchain company. In December 2020, the agency accused Ripple of raising $1.3 billion from the sale of the XRP token that the SEC says is an unregistered security. Ripple maintains that XRP is not a security.
In recent years, U.S. regulators have sent mixed signals regarding the status of cryptocurrencies. In June, SEC Chairman Gary Gensler said on CNBC that bitcoin was the only cryptocurrency he felt comfortable labeling a commodity. He declined to comment on the status of Ether, however.
The omission was not lost on the crypto community: A commodity is regulated by the CFTC while a security falls under the jurisdiction of the SEC. In 2018, William Hinman, the SEC’s former corporate finance director, said bitcoin and ether are not securities. Rostin Behnam, chair of the CFTC, the agency that currently regulates ether futures, has also said that ether is a commodity, not a security.
The SEC says an investment made in a common enterprise, with an expectation of profit depending on the efforts of management and others, can be considered a security. The agency's rationale is based on the so-called "Howey Test," from a 1940s legal ruling that found that a Florida company selling orange groves was, in effect, pitching a security.
In the Twitter universe, opinions about this controversial topic are raging. These two are representative:
Jacob Franek, co-founder of Coin Metrics, a crypto asset data firm, maintains that Ether is not a security because it’s not always an investment. In an analysis posted to Twitter, Franek also notes that staking is competitive and not part of a common enterprise. Courts have generally defined a "common enterprise" as one that features the pooling of assets, among other things.
Adam Levitin, a law professor at Georgetown University Law Center and principal at Gordian Crypto Advisors LLC, also weighed in on Twitter. In a post, Levitin argued that after a major transition of the Ethereum blockchain that could happen this year — when Ethereum moves away from an electricity-intensive model of verifying transactions — there’s a “strong case that Ether will be a security.” That’s because any token issued in a so-called proof-of-stake system is likely to be considered an investment, according to Levitin.
He added that, if the SEC can make the case that Ether is a security, it could force crypto platforms to either delist Ethereum or register themselves as securities exchanges. Either could be highly disruptive to their business, said Levitin. As the second-largest cryptocurrency, Ethereum has a market cap of $208.1 billion, behind only Bitcoin’s $455.5 billion market cap, according to CoinMarketCap.
Gensler has so far declined to answer specific questions about whether he believes Ether qualifies as a security. But when he was a professor at the Massachusetts Institute of Technology, Gensler said that although Ether likely qualified as a security when it was first introduced, it had become decentralized enough by 2018 that the SEC did not classify it as one.
If the SEC takes the position that Ether qualifies as a security once the merge of the blockchain happens, digital assets that use the Ethereum blockchain could also face regulatory scrutiny, analysts say.
As for Gensler, besides making sure certain tokens are registered as securities, the SEC chairman has indicated he believes some cryptocurrency platforms should be under the umbrella of the SEC.
Speaking before the Senate banking committee last September, Gensler drove that point home. Given the sheer volume of tokens listed, he noted, “the probability is quite remote” that crypto trading platforms have “zero securities." And that’s why these platforms need to be registered with the SEC, he summarized.