To date, there is no official or clear decision on whether Ether, the Ethereum blockchain token, is considered a security according to the SEC.
But in the SEC’s recent lawsuit against Binance and Coinbase, tokens such as ADA (from Cardano) have been listed as “securities”, i.e. securities. Cardano is quite similar to the way Ethereum is governed, with a foundation located in the canton of Zug, Switzerland. For example, the SEC’s complaint against Binance mentions that there are three entities responsible for Cardano, such as the Cardano Foundation, a Swiss entity that is the legal custodian of the Cardano protocol and owner of its trademark.
Also both Ethereum and Cardano networks were funded through issuance of their native token, ETHER and ADA respectively. The Ethereum team raised approximately $18.3 million in Bitcoin during the token sale, which was equivalent to over 31,500 BTC at the time of the ICO. In the case of Cardano, from 2015 through 2017, Input Output Hong Kong (“IOHK”), a company founded by Hoskinson and Wood, conducted a token sale in which they sold approximately 25.9 billion ADA in exchange for Bitcoin at an average price of $0.0024 per token, raising approximately $62 million for Cardano.
One of the criteria for considering a token as a security in the SEC’s claims against Binance and Coinbase is the amount of tokens allocated to the team and the team’s efforts to increase the value of the token, e.g., through burn measures to make the token deflationary. In this way, investors may perceive the token as an investment with expectations of value appreciation.
In the case of Ether, 18.80% of the ICO was allocated to the founders and their foundation[1]. This meets the criteria established by the SEC in its demand to various tokens. It also coincides that Ethereum announced some time ago a deflationary policy for its token[2].
. All this leads us to conclude that the SEC’s decisions are not consistent or do not follow clear criteria. This undoubtedly generates a great deal of legal uncertainty and legal insecurity. And a perception that not everyone is judged by the same yardstick. Which is why Coinbase recently sued the SEC demanding normative and regulatory clarity.
If ADA is considered a “security” by the SEC, the logical consequence is to consider Ether as a security. The reality is that Ether is not mentioned as a security in the SEC’s lawsuits against Binance and Coinbase, and therefore we can deduce that, in any case, it is not categorized as a security by the SEC.
It is true that both Ethereum and Bitcoin have been classified as commodities by the CFTC in the lawsuit against Binance (March 2023).
As to why Ethereum has not been considered a security, it appears that the central criterion for the SEC is its decentralization. However, this concept would require further clarification from the authority.
The only public information from the SEC found in this regard is a speech dated June 14, 2018 by Don William Hinman, Director of the Division of Corporation Finance, titled “Digital Asset Transactions: When Howey Met Gary (Plastic)”[3]
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Mr. Hinman stated that “the digital asset itself is simply code. But the way it is sold, as part of an investment, to non-users, by developers to develop the business, can be, and in that context, most of the time is, an asset, because it represents an investment contract.”
That is why he considered in the referred speech that it makes sense to regulate these transactions as securities transactions. The objective of the Securities Law is to eliminate the asymmetry of information between promoters and investors. In a public distribution, the Securities Act sets forth the information investors need to make an informed investment decision, and the promoter is liable for false or misleading statements in offering materials. These are important safeguards and are appropriate for most ICOs.
The central question is whether or not a digital asset is a security. In this regard, Mr. Hinman noted that. “if the network on which the token or coin is to operate is sufficiently decentralized, where buyers would no longer reasonably expect a person or group to undertake essential management or business efforts, the assets may not represent an investment contract.” In this sense, “when the efforts of a third party are no longer a key factor in determining the success of the enterprise, material information asymmetries diminish. As a network becomes truly decentralized, it becomes difficult and less meaningful to identify an issuer or promoter to make the required disclosures.”
Mr. Hinman also highlighted Bitcoin as an example of decentralization: “I don’t see a central third party whose efforts are a determining factor in the enterprise. The network on which Bitcoin operates is in place and appears to have been decentralized for some time, perhaps since its inception. Applying the disclosure regime of the federal securities laws to the offer and resale of Bitcoin would seem to add little value.”
Following this example, Mr. Hinman explained the reasons why Ether is not a security, following the example of Bitcoin: “And setting aside the fundraising that accompanied Ether’s creation, based on my understanding of the current state of Ether, the Ethereum network and its decentralized structure, the current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value.”
But by contrast fundraising has been one of the criteria applied in the SEC’s lawsuit against Binance and Coinbase to qualify a token as a security. This is the case of ADA, MATIC, AXIE, SAND or MANA, among others. That is why it has little consistency not to apply this criterion to the case of Ethereum.
Mr. Hinman also emphasized that the use of tokens in a decentralized network can also qualify as a security: “even digital assets with utility that function solely as a medium of exchange in a decentralized network could be packaged and sold as an investment strategy that can be a security. If a promoter were to place Bitcoin in a fund or trust and sell interests, it would create a new security. Similarly, investment contracts can be made with virtually any asset (including virtual assets), as long as the investor reasonably expects to profit from the promoter’s efforts.”
For Mr. Hinman, some facts and circumstances to consider are, and this list is illustrative, not exhaustive:
Is there a person or group that sponsored or promoted the creation and sale of the digital asset, whose efforts play a significant role in the development and maintenance of the asset and its potential increase in value?
In the case of Ethereum, clearly the answer is yes.
The founding team (including Vitalik Buterin, among others) and the Ethereum Foundation are behind Ethereum. This is not the case with Bitcoin, given that we don’t even know who Satoshi Nakamoto is. Should Vitalik Buterin resign and leave it to the DAO to organize itself without anyone to lead in order to become more like Bitcoin?
Has this person or group retained an interest or other interest in the digital asset such that they would be motivated to undertake efforts to cause an increase in the value of the digital asset? Would buyers reasonably believe that such efforts would be undertaken and may result in a return on their investment in the digital asset?
In the case of Ethereum, the answer is yes.
Has the promoter raised an amount of funds in excess of what is necessary to establish a functional network, and if so, has the promoter indicated how those funds will be used to support the value of the tokens or enhance the value of the enterprise? Does the promoter continue to spend funds from proceeds or operations to enhance the functionality and/or value of the system on which the tokens operate?
In the case of Ethereum, the answer may be yes for both questions.
Are buyers “investing,” i.e., seeking a return? In that sense, is the instrument being marketed and sold to the general public rather than to potential network users at a price that reasonably correlates to the market value of the good or service on the network?
In the case of Ethereum, yes.
Does it make sense to apply Securities Act protections? Is there a person or entity that others trust and that plays a key role in the company’s profit making such that disclosure of its activities and plans is important to investors? Are there informational asymmetries between the promoters and potential purchasers/investors of the digital asset?
This seems to be the case for Ethereum as well.
Do individuals or entities other than the developer exercise governance rights or significant influence?
It is clear that Vitalik Buterin wields a lot of influence. This is the case with the Ethereum Classic fork and with “The DAO”, notwithstanding the fact that it was a community decision.
Perhaps Ethereum was born as a security according to SEC criteria and is now considered as a commodity. Therefore, we can deduce according to the statement once made by Mr. Hinman: “And leaving aside the fundraising that accompanied the creation of Ether, according to my understanding of the current state of Ether, the Ethereum network and its decentralized structure, the current offers and sales of Ether are not securities transactions.”
According to this statement, Ethereum’s fundraising was a security’s own, but now, being a decentralized platform, it is no longer one. But the SEC should report when a token may no longer be considered a security. And, more importantly, what decentralization requirements exist to cease to be classified as a security.
I end with an excerpt from a fall 2018 graduate course called “Blockchain and Money” at MIT. The professor was Gary Gensler, current chairman of the SEC . In Lecture 6: Smart Contracts and DAPPs on September 25, 2018 he said regarding Etherum “In 2018, the SEC has said that, regardless of what it might have been in ’14, NOW it is sufficiently decentralized and therefore not a security.”[4].
[1] https://coincodex.com/ico/ethereum/
[2] https://moralismoney.com/blog/what-is-eip-1559-and-will-ethereum-go-deflationary-with-it
[3] SEC.gov | Digital Asset Transactions: When Howey Met Gary (Plastic)
[4] Gary Gensler Says SEC Believes Ethereum Is Not a Security—At MIT in 2018 – Decrypt
