Can Ethereum Survive If SEC Regulates ETH’s Security?
In the year
The site's footer and site's security canary have been removed in accordance with GitHub's commit: “This commit removes the footer because we received a voluntary confidentiality requirement from a state authority.”
A security canary is usually some text or visual element — in the case of the Ethereum Foundation, a yellow bird — that some companies include on their websites to indicate that they've never been served with a government subpoena or document request.
If a government agency requests information, the company can remove the text, implicitly indicating to visitors that a subpoena has been received.
The Ethereum Foundation has removed this key part, which indicates that the foundation is actually under secret investigation. Due to the confidentiality clause, the Ethereum Foundation cannot provide further details.
Citing anonymous tips, Fortune reports that the United States Securities and Exchange Commission (SEC) is opening an investigation into the foundation as part of its campaign to declassify the Ethereum asset Ether (ETH) as a commodity.
The reported request could not come at a worse time as the May deadlines for SEC approval of Ether Exchange Traded Funds (ETFs) approach.
The debate about the safety of Ether has been going on for several years, now doubts are beginning to appear.
Why is the SEC investigating the Ethereum Foundation 10 years after its launch? Does the SEC have jurisdiction over a company located in Switzerland? Will the spot Ether ETF be delayed as a result of this action? After all, what will happen if it is classified as a security on Ethereum and the crypto market?
Is The Ethereum Foundation Really Under SEC Investigation?
The Ethereum Foundation cannot provide further details due to the confidentiality clause.
The Ethereum Foundation received a request from a government official, this does not mean that the organization is the subject of the investigation.
Carol Goforth, a professor at the University of Arkansas School of Law who specializes in trade unions and securities regulation, explained the importance of this list to Cointelegraph.
“The SEC's authority to order cooperation may be limited if we assume that the basis is not the subject of the investigation.”
The SEC may believe that the Ethereum Foundation has information that may assist the commission in a separate investigation, e.g.
Either way, Goforth explained, the foundation is open to collaboration. “The desire to see Ether continue to be actively traded in the US markets” will be a clear incentive to cooperate with the authorities, she said.
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An additional reason to cooperate with the SEC is to “explain why Ether does not meet the Hawaii investment contract test” and is therefore used to prove that it is not a security.
On the other hand, if the Ethereum Foundation is the subject of an investigation, the SEC “could take two years to move from investigation to prosecution,” Goforth said.
The impact on the crypto market if Ether is classified as a security
The ongoing investigation is harmful to Ethereum until the issue is resolved and may affect decisions such as the approval of the Ether ETF and the further acceptance of the asset – as an example of the value of the Ripple / SEC lawsuit.
Basel Ismail, CEO of the investment analysis firm, told Cointelegraph:
“If Ethereum is classified as a security, the short-term market value of the entire crypto ecosystem will be disastrous.”
In his opinion, if the market-leading blockchain, which is relatively decentralized and counts thousands of active developers, is considered secure, almost all crypto projects can fall into this category.
For the trader, “it is safe to assume that any other ERC-20 token that has raised capital using the same funding mechanism will have to comply with the same registration procedures and regulations.
In his opinion, the contagion effect could ultimately “destroy many companies” in the sector as their treasury funds are not sufficient to withstand such a shock.
Crypto exchanges that list Ether and operate in US markets directly support an asset that is legally considered a security. Therefore, the exchanges are forced to choose between delisting Ethereum from their platform or registering with the SEC as a broker-dealer.
Goforth explained that any trading platform must be registered as a securities exchange or as an alternative trading system (ATS) to exempt buyers and sellers. Goforth said both options would require extensive disclosures and approval from the SEC.
She also made a critical point that requires crypto exchanges to choose a way to liquidate ETH before registering as a securities exchange.
However, many exchanges may choose to simply delist rather than go through the significant process of filing with the SEC.
As Goforth noted, once a crypto exchange seeks to register as a securities exchange, it cannot provide exchange services for any security asset unless that security is registered.
Since only the SEC has officially declared that Bitcoin is not a security, no crypto assets are registered and a crypto exchange will be “at risk” if it helps its customers buy or sell any other currency. In her view, this would be “tantamount to saying do not do business in the United States.”
While Ether's significant market value may take a hit when Ether is delisted from US exchanges, the same cannot be said for most ERC-20 tokens.
As Ismail explained, “Liquidity will be released, and order books will be very shallow, creating significant price volatility and hindering the opportunity for market makers to stabilize asset prices for a period of time.
Does the SEC have jurisdiction over the Ethereum Foundation?
If the Ethereum foundation is in Switzerland and the SEC is the US regulator, what's the point of worrying about the possible consequences?
The SEC may technically have jurisdiction over companies located in the United States, but Goforth noted that it may seek extraterritorial jurisdiction if the challenged activity has a material effect in the United States.
A previous example occurred in the crypto industry when the SEC issued a global injunction against Telegram's planned release of the GRAM token in 2020. Telegram eventually had to pay back $1.2 billion and pay $18.5 million in fines.
Goforth confirmed that no specific legal obligations require the Ethereum Foundation to cooperate. However, she said, the SEC may take that into account when deciding how to view cooperation and what action to take.
If the Ethereum Foundation doesn't cooperate, the SEC could issue a subpoena, which would legally compel the firm to share any data its regulators demand.
Can Ether move to DEXs abroad?
Decentralized exchanges (DEXs) may be an alternative if centralized exchanges stop trading ETH in the US market.
The decentralized nature of such platforms makes them difficult for regulators to target, coupled with their global reach, allowing Ethereum-based projects to engage in regulatory arbitrage.
Sergey Gorbunov, CEO of Interop Labs and co-founder of the Acceler protocol, told Cointelegraph that “if ETH is secure, DEXs can continue to operate because of their decentralized global nature.”
However, he acknowledged that some challenges will arise, such as “new compliance requirements in certain jurisdictions.”
For example, Gorbunov showed how this new regulatory reform threatens DEXs that connect to central crypto exchanges for liquidity purposes.
But decentralization does not guarantee safety from regulators. US authorities have demonstrated their ability to target developers and shut down platforms such as crypto mixer Tornado Cash.
Goforth said the SEC could target “some founding team, promoters or other active participants,” while Gorbunov said regulators could target individuals or organizations that support the open network, such as code verifiers or contributors.
A silver lining?
The implications of the SEC classifying Ethereum as a security seem dire. However, while Ismail may be detrimental to marketing and adoption in the short term, there may be positive effects in the long term.
The Ethereum Foundation and the SEC may find a solution to the problem where the foundation is forced to pay a “serious penalty” and register as a security in the US markets.
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Ether trading must comply with the same rules that apply to stocks or bonds. Ismail said this result would at least provide regulatory transparency for market participants. In his opinion, in the long run this could be beneficial for the value of the crypto market.
If the SEC brings the Ethereum foundation to court, the conclusion will be binary – ether is a commodity or a security. Any outcome will have a ripple effect on the token's market value, and the impact on the ecosystem built on the blockchain will be huge. It may be the most critical case in the crypto ecosystem.
