Still on its “warpath against crypto”, the US Securities and Exchange Commission (SEC) might be close to ruling ether (ETH) as a security – a scenario that has the crypto world up in arms, writes editor Daniel Kuhn. Repercussions would be huge, not only for the native token of Ethereum, but also for the crypto industry and the larger financial landscape. In an opinion piece for CoinDesk, Kuhn discusses why the warpath might be the wrong path for SEC.

The “best argument” against defining ETH as a security is simply that it has never been considered one up to now, says Kuhn. The cryptocurrency is important to many US businesses and investors, with major exchanges such as CME Group and Cboe Global Exchange trading ETH futures to the tune of millions of dollars every day.

He quotes Austin Campbell, an assistant professor at Columbia Business School, who summed up the issue in an earlier interview with CoinDesk – “you can’t just arbitrarily change your mind and damage people for hundreds of billions of dollars after a decade”. Even SEC’s sister agency, the Commodities Futures Trading Commission (CFTC) is acting against the regulator, having allowed ETH futures trading for years, therefore implying that it is a commodity.

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Much at stake

It seems in trying to define ETH, comparisons with bitcoin (BTC) are inevitable. The article quotes Brian Frye, Spears-Gilbert professor of law at the University of Kentucky who says that the best reason against classifying ETH as a security “is that ETH looks more like bitcoin (BTC) than any other token” – the argument here being that BTC has been ruled as a commodity under US law.

But if ETH’s similarities to BTC have to be mentioned, then the differences cannot be ignored either. In 2022, Ethereum held the “Merge”, during which it transitioned from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) one. The PoW model, which is still used by BTC, secures and verifies the blockchain by getting miners to solve a puzzle. The first to solve it gets to verify the latest transactions and update the blockchain with it, and is rewarded with a pre-determined amount of crypto.

In the PoS model, validators for the blockchain are generally selected based on the amount of crypto they hold, which is their stake, and the length of time they have held it. A selected validator first validates the latest block of transactions on the chain. The accuracy of the block is then confirmed by other validators. A threshold number of verifications have to be met before the network updates the blockchain with the transactions. Like in the PoW model, all participating validators are rewarded with crypto – but here, in proportion to their stake.

A matter of definitions

According to Kuhn, ETH’s PoS model could be a crutch for the SEC in ruling it as a security, especially when considered together with what Ethereum calls the burn mechanism.

The network uses the burn mechanism to permanently remove tokens from circulation, limiting supply and bumping up the value of ETH. Users are thus encouraged to hold their coins not just for a chance to validate transactions and earn more coins, but also to benefit from possible value appreciation – much like investors with traditional securities.

Nevertheless, crypto enthusiasts believe the SEC is overreaching. Added to the debate is the authority’s use of the Howey Test in defining investment contracts. The test, which has roots in a 1946 court case, states that an asset is a security as long as it involves an investment of money into a common enterprise with the expectation of profit from the effort of others. Frye points out that this is “an extremely broad definition of security, and consequently gives the SEC very broad regulatory authority”.