Ethereum’s developers have locked in a date for the network’s next big upgrade, dubbed ‘Shanghai’: April 12. While ETH fans will laud the update for introducing the ability to ‘unstake’ ETH, it couldn’t be happening at a worse time.
SEC chair Gary Gensler indicated again this week that proof-of-stake models—like those used by Ethereum—are securities. Meanwhile, the NYAG filed charges against the KuCoin exchange for illegally selling securities and specifically named ETH as a security in large part due to the fact that Ethereum is not decentralized after all.
Add to that the fact that the past 12-24 months have seen legislators, regulators, and law enforcement all clamp down on illegalities within the industry in different ways. For instance, in January, the SEC took action against lend-to-earn programs jointly operated by Genesis and Gemini on the basis that they amounted to illegal securities offerings. Nexo Capital paid the SEC a $45 million dollar settlement over its lend-to-earn program around the same time.
Most notable about these actions is that they confirm that the SEC is beginning to deconstruct the myth of decentralization and the role it plays in determining whether a given asset offering amounts to a security. Look at the language used by Gensler in an interview with The Block in 2021, right as the SEC began to look at lend-to-earn products:
“I would note to your readers that if you’re investing on a centralized exchange or a centralized lending platform, you no longer own your token. You’ve transferred ownership to the platform. All you have is a counterparty risk. And that platform might be saying, as many of them do, we’ll give you a four percent or seven percent return if you stake your coins with us or you actually transfer ownership and we the platform will stake your tokens. That takes on all the indicia of what Congress is trying to protect under the securities laws.”
This should represent an enormous red flag for Ethereum and BTC—two projects that the SEC has long considered the rare exceptions to its general position that most digital assets are, in fact, securities. That’s because these exceptions arise from the SEC’s assumption that both projects are decentralized: without a centralized body governing projects like these, according to the SEC’s logic, it can’t be said that investors had a reasonable expectation of profits relying on the efforts of others, as is required by the Howey test for securities (their belief that BTC is not a security is also based on a misguided interpretation of that project’s history).
These exceptions were always highly tenuous and at odds with reality. As time has gone on, they have become increasingly difficult to justify. Now, it seems, regulators and law enforcement have finally seen the lie for what it is.
Ethereum was always a security—but now it’s obvious
The idea that Ethereum is anything but a security has always been a sham. This was obvious from Buterin’s own marketing at the time of the ETH ICO right through to the language used on Ethereum websites today. The point is made repeatedly: ETH production will slow dramatically over time, increasing scarcity and, as a consequence, value.
The Ethereum foundation website also refers to the fact that ETH is viewed as an investment.
But the biggest lie of all was that Ethereum is or has ever been decentralized. This was obvious back in 2016 when a decentralized autonomous organization (DAO) holding almost 15% of all ETH in circulation was hacked. Ethereum’s developers, led by founder Vitalik Buterin, proposed, approved, and implemented the solution to fork the network and recover the stolen assets. There was the charade of a vote on the proposal, but just 6% of all ether holders participated, and 25% of the votes came from a single address, while the proposals at the heart of the vote were still authored by Ethereum’s core team. This can be seen again as recently as this week with the Shanghai update announcement: If Ethereum is decentralized, then who is designing, proposing, and implementing these radical upgrades? That would be the very same people that intervened after the DAO hack, of course. This is not decentralization by any realistic definition.
The notorious Ethereum 2.0 upgrade, which moved the network’s consensus mechanism from Proof-of-Work to Proof-of-Stake, did nothing to change this reality. If anything, the migration to Proof-of-Stake moved Ethereum even deeper into security territory. In contrast to Proof-of-Work, where miners are at least undertaking work of their own in solving hash puzzles, those staking under a Proof-of-Stake system are relying entirely on the work of others to deliver profits on whatever coins have been staked. In fact, this week, Gensler again indicated that Proof-of-Stake networks are likely to trigger U.S. securities laws, saying:
“Whatever they’re promoting and putting into a protocol, and locking up their tokens in a protocol, a protocol that’s often a small group of entrepreneurs and developers are developing, I would just suggest that each of these token operators … seek to come into compliance, and the same with the intermediaries,” he said, reported by The Block.
Authorities are already taking action on the basis that ETH is a security
This sea change by authorities is not just a speculation over some hypothetical future enforcement drive. Instead, the enforcement drive is already here.
Last week, the New York Attorney General filed charges against exchange KuCoin over failing to register as a securities and commodities broker-dealer: ETH, which is listed by the exchange, was expressly labeled a security in the charges. The language used by the NYAG couldn’t be clearer:
“ETH’s development and management is largely driven by a small number of developers who hold positions in ETH and stand to profit from the growth of the network and the related appreciation of ETH.”
“Buterin and the Ethereum Foundation retain significant influence over Ethereum and are often a driving force behind major initiatives on the Ethereum blockchain that impact the functionality and price of ETH.”
The language could have been taken straight from Howey: ETH is not decentralized, and the continued development of the network is closely governed by a core group of developers who promote the asset on the basis that its value will increase over time. It is a classic security.
The NYAG’s action is against KuCoin rather than anyone directly connected to Ethereum, but between Ethereum’s recent upgrades, Gensler’s public statements on centralization and the SEC’s recent enforcement actions, it seems that the SEC charges against Ethereum and its developers directly can’t be far away. The ramifications of an SEC case against Ethereum can be much wider reaching: the SEC is empowered to levy fines and penalties against those violating the U.S.’ securities regime, including disgorgement of all profits made in connection with an unregistered securities offering and injunctions against carrying on further business. In short, it could spell the end of Ethereum altogether.
And if the myth of decentralization with respect to ETH has finally been pierced, then you can bet that BTC is up for the same treatment.
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