Ethereum crypto currency on dollar banknotes

SEC finally catching on to Ethereum centralization, according to new enforcement action

The U.S. Securities and Exchange Commission (SEC) appears to be warming up to the notion that Ethereum is a highly centralized network, according to a lawsuit filed against crypto promoter Ian Balina. The change in tone is likely to have serious implications for the SEC’s attitude toward whether digital asset networks like BTC and ETH constitute securities offerings.

The SEC is accusing Balina of offering unregistered securities in relation to his re-sale of the Ethereum-based SPRK token to an investing pool he organized, as well as failing to disclose that he’d been paid by SPRK’s offeror to promote the tokens. Significantly, the SEC said that because those who contributed to the investing pool did so in ETH, those transactions took place in the U.S. by virtue of the fact that ETH transactions are validated by a network of nodes “clustered more densely in the United States than any other country.”

The effect the SEC’s reasoning would be to theoretically bring the entirety of the Ethereum network within the jurisdiction of the SEC, including any projects built atop the network. Though despite the outraged response from many ‘crypto’ supporters, it’s important to remember that it is merely a statement of the SEC’s case against Balina and has no legal effect whatsoever. Balina will presumably challenge the SEC’s reasoning concerning jurisdiction, though it’s unlikely the SEC needs to rely on this argument in order to establish jurisdiction over Balina’s case, which concerns a U.S. defendant taking investments within the U.S. in every material respect.

Nonetheless, the brief comment has rightly been ascribed great significance by proponents of Ethereum who are outraged by the idea that any regulator might have oversight over the network, and who would argue that Ethereum is decentralized and not answerable to any legal authority.

This is one of the more persistent myths among crypto evangelists: the idea that these so-called decentralized projects mean that anything that takes place on or with them somehow exists ‘outside’ the real world and is therefore not subject to the reach of the judicial system. Remember Changpeng Zhao’s laughable claim that Binance isn’t based within any jurisdiction because “Bitcoin has no office,” and you’ll get the idea.

The myth is especially thin when it comes to Ethereum, whose development is closely managed by core developers under the banner of the Ethereum Foundation: it is these people who propose the rules by which the protocol operates and who spring into action should disaster strike (as happened in 2016). This was true before Ethereum’s move to proof of stake, but now that the network’s consensus mechanism is essentially pay-to-win, control over the network overwhelmingly lies with whoever holds the most ETH—and 40% of the liquidity in the network is concentrated in the top 100 holders.

But before you even get to the realities of proof-of-stake, the SEC is entirely correct to point out that the Ethereum network is primarily effected inside the United States. Ethernodes.org shows that 44.89% of Ethereum nodes are based in the United States, more than triple the number of any other country. To argue that these transactions cannot fall within the jurisdiction of a U.S. regulator is convenient for those who want to resist all regulation over digital assets, because if these transactions can’t be said to be taking place in the U.S., then they can’t be said to be taking place anywhere.

But this approach from the SEC is most significant because it provides a strong signal that the SEC is finally ready to assert its authority over the more egregious violations of securities laws taking place within the digital asset industry; focusing too closely on the SEC’s justification for jurisdiction here is missing the forest for the trees. Yes, it’s significant that the SEC is using the concentration of Ethereum nodes in the U.S. as reasoning for Ethereum transactions taking place in the U.S., but the fact that the SEC seems to be warming to the idea that there is no decentralization in Ethereum should be much more foreboding. The SEC’s idea that Ethereum and BTC are decentralized has “to date” saved those assets from being classified as securities until now, but if this myth has indeed begun to melt away, a reclassification may be on the horizon.

Many will read these signals from the SEC as a drastic departure from their hitherto cautious approach toward ETH and BTC, the two largest digital assets by market capitalization. However, the writing has been on the wall since well before Ethereum completed its transition to proof-of-stake. SEC officials have often excused the likes of Bitcoin and Ethereum under proof-of-work as failing to meet the threshold for securities due to their belief that those projects are sufficiently decentralized—implying that a move away from the POW model might be cause for regulators to reassess their stance. And following the completion of Ethereum’s upgrade to proof-of-stake, SEC Chair Gary Gensler became even more forthright: the Wall Street Journal reported that Gensler told reporters that the introduction of a ‘staking’ mechanism could bring Ethereum within the Howey test for securities.

Ultimately, while the SEC’s stated case against Ian Balina doesn’t depend on this point, it’s a sign that regulators are beginning to see the myth of decentralization for what it is. It’s undoubtedly a bad sign for those projects who have profited off this myth, but it’s a good sign for those wanting sensible regulation over digital assets.

Follow CoinGeek’s Crypto Crime Cartel series, which delves into the stream of groups from BitMEX to BinanceBitcoin.comBlockstreamShapeShiftCoinbaseRipple,
EthereumFTX and Tether—who have co-opted the digital asset revolution and turned the industry into a minefield for naïve (and even experienced) players in the market.

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