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Ethereum: A Security or Not? Exploring the Debate

Lincoln Murr

Summary: For the past fifteen years, cryptocurrencies have been an exciting new asset class with very little government oversight. As their popularity continues to grow, regulatory bodies have been grappling with the question of how to categorize these digital assets. A key issue is whether Ethereum should be considered a security under U.S. regulations. Let’s explore ...

For the past fifteen years, cryptocurrencies have been an exciting new asset class with very little government oversight. As their popularity continues to grow, regulatory bodies have been grappling with the question of how to categorize these digital assets. A key issue is whether Ethereum should be considered a security under U.S. regulations. Let’s explore whether or not Ethereum could be declared a security after SEC Chairman’s Latest Testimony.

Ethereum is a smart contract blockchain, which uses the native currency, Ether, to pay for the storage and use of these smart contracts. A portion of this transaction fee is removed from the overall supply, like burning oil. Another portion is given to the decentralized group of validators who secure and govern the network. Proponents of classifying Ethereum as a security argue that it meets the criteria laid out by the Howey Test, a legal standard established by the U.S. Supreme Court to determine whether an investment contract constitutes a security. The Howey Test consists of four elements: investment of money, a common enterprise, expectation of profits, and reliance on the efforts of others.

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It is very likely that Ethereum automatically passes at least one aspect of the Howey Test, namely the investment of money. The other three elements are more contentious, and we will start with an overview of why Ethereum could be a security. First, the Ethereum blockchain can be seen as a common enterprise maintained by stakers and developers. Additionally, the Ethereum Foundation, even though it is a nonprofit itself, has some influence over the direction of the protocol due to its role as the maintainer and grant provider for several parts of the Ethereum ecosystem. Second, individuals buy ETH expecting profits, just like any other speculative cryptocurrency. Finally, the reliance on the efforts of others comes from the developers and network validators. Without them, the network would either be nonexistent or significantly less useful. It would be like the internet without any websites, and ultimately valueless.

Another issue related to Ethereum’s status was its initial coin offering, or ICO in 2014. At the time, Bitcoin could be used to buy ETH, which went to the Ethereum Foundation. If this were to be done today it would likely violate securities laws. Still, it is possible that Ethereum is now sufficiently decentralized to null and void this issue.

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Unfortunately, Ethereum’s recent transition to a proof-of-stake blockchain has also raised some concerns about it being a security. Now, buying Ethereum and staking it directly leads to an expectation of profits, and the argument becomes whether or not it is derived from the efforts of others in a common enterprise. Bitcoin is likely safe from being declared a security due to its decentralization, emphasis on proof of work and lack of an ICO.

On the other hand, there are several reasons that Ethereum should not be declared a security, and it may fall into a unique status alongside other cryptocurrencies. While it is true that investors buy ETH with the expectation that it will increase in price, it also has utility as the fuel of the Ethereum blockchain and is necessary for executing transactions or using smart contracts. Additionally, Ethereum is one of, if not the, most decentralized blockchains for several reasons. Not only are there over 500,000 validators but there is extreme diversification of development as well. Instead of one organization contributing the majority of the code, there are several, and there are even multiple different applications, known as clients, that users can choose from to interact with the blockchain. 

To date, there has been no official announcement as to whether or not Ethereum is a security. In recent months, SEC Chairman Gary Gensler has been insinuating that Ethereum may be a security, while also reaffirming that Bitcoin is not. In his most recent appearance in front of the United States House Financial Services Committee, he dodged questions from Congressman Patrick McHenry about Ethereum’s status. Gensler, a former MIT blockchain professor, has spearheaded cryptocurrency regulation efforts since his appointment in 2021.

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Whether or not Ethereum is a security remains to be seen, and there is no clear or common answer between regulators and government officials. In the best-case scenario, Ethereum is either classified as a commodity or some sort of new asset class. In the worst case, it is a security whose trade and exchange falls under the purview of the U.S. government and the Securities and Exchange Commission. In the meantime, the Ethereum ecosystem continues to grow and decentralize until it may reach a point where it becomes too big to control effectively. 

By Lincoln Murr

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