In 2018, former Securities and Exchange Commission (SEC) director William Hinman famously opined that Ethereum — as it existed then — wasn’t a security. For years, that speech caused confusion about the securities classification of thousands of other ICOs.
Legions of securities lawyers were shocked at Hinman’s conclusion. The New York Attorney General believes ETH is a security. Even SEC chair Gary Gensler disagreed.
Eventually, the truth came out: Hinman had a financial conflict of interest when he gave that speech. He was making millions of dollars from a pro-Ethereum entity at the time.
Before he became chairman of the SEC, professor Gary Gensler explained to students in a 2018 MIT course, “In my opinion, Ethereum passed the Howey Test and that means that it would be considered a security.” He continued, “I don’t even think there’s much doubt what this was in 2014 when they raised the $18 million.”
Still, industry insiders accused the SEC of failing to provide clear guidance or send fair notice to issuers of digital assets that they might qualify as securities. Instead of categorizing thousands of ICOs explicitly, the SEC has chosen to explain its determinations in civil lawsuits, slowly, on a case-by-case basis.
Although the SEC has classified some of the largest ICOs as securities offerings like XRP, TRX, and TON, it has avoided classifying ETH.
No financial harm, no reason to sue
Not only is there no basis for financial harm from ICO investors, Ethereum also enjoys one of the most populous fan bases in the crypto industry. Millions of US constituents support Ethereum.
Nevertheless, some aspects of Ethereum are worryingly similar to an investment contract — a type of security. For example, Vitalik Buterin explicitly told investors that he was hoping for the price of ETH to quintuple during an interview at the 2014 Texas Bitcoin Conference (Ethereum’s ICO raised approximately $18 million worth of BTC in 2014).
“What we’re hoping is something like what happened with Mastercoin (MSC), so if that slice is something like 20%, and then the value of ether goes up by five, then we basically have the entire initial BTC that we got all over again.”—Vitalik Buterin, March 6, 2014
Promising investment returns is a hallmark of a securities offering. After Mastercoin’s (MSC) initial rally, its price eventually collapsed to nearly $0. In contrast, ether has rallied consistently over the years. So, because Ethereum ICO investors haven’t experienced financial harm as a result of their investment, no one has successfully challenged the securities classification of Ethereum’s ICO in a civil lawsuit.
Similarly, Congress charged the SEC with protecting investors. With no harm involved with Ethereum’s ICO, commissioners chose to focus on other enforcement targets. As the years passed and the price of ETH increased, the statute of limitations expired.
Nevertheless, questions about Ethereum’s present-day securities classification remain. In particular, SEC Chairman Gary Gensler has loudly warned of the risks of Ethereum’s transition to Proof-of-Stake as heightening its securities likeness. On a related matter, all five commissioners have agreed to sue Ethereum staking services like Kraken.
NYAG believes ETH is a security
Although not a securities regulator, the NYAG oversees conduct in Wall Street, the world’s largest financial center. In her lawsuit against KuCoin, NYAG Letitia James explained her designation of ETH as a security.
- New York’s chief lawyer alleged KuCoin failed to register as a broker-dealer in securities like ETH and falsely represented itself as a compliant exchange.
- NYAG classified ETH, LUNA, and UST as alleged securities.
- The SEC agrees with at least two of those three designations, LUNA and UST, and hasn’t classified ETH.
The NYAG explicitly acknowledged that her lawsuit is the first time a major regulator had classified ETH as a security in court. She called ether “a speculative asset that relies on the efforts of third-party developers in order to provide profit to the holders of ETH.”
James also alleged KuCoin sold unregistered securities through KuCoin Earn, a product that allowed users to earn interest on digital asset deposits. She alleged KuCoin failed to register as a securities and commodities broker in New York before launching its earn product.
The lawsuit seeks to block KuCoin from operating in New York until it can comply with state regulations. It also asks that KuCoin stop misrepresenting that it’s an exchange and implement geo-blocking based on IP address and GPS-based location.
Even if the ICO passed Howey, would ETH today pass Howey?
Whether ETH is a security has been a matter of debate that hinges on whether its promoters have passed the four prongs of the US Supreme Court’s Howey Test. It specifies that an offering is likely a type of securities offering, known as an investment contract, if purchasers:
- Invest money,
- into a common enterprise,
- with a reasonable expectation of profit,
- to be derived from the efforts of others.
It’s possible that Ethereum’s ICO passed the Howey Test, but the statute of limitations for an SEC lawsuit has expired on 2014 events. On the other hand, it’s possible that ETH today, with its proof-of-stake yield and various other financial qualities, could pass the Howey Test. Only a US court ruling on an SEC lawsuit would settle this question.