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What Would Happen if the Regulators Establish That Ethereum is a Security?

At the moment, Ethereum (ETH), the second most popular cryptocurrency on the market in terms of market capitalization, is facing a debate lead by the United States Securities and Exchange Commission (SEC) and the United States Commodity Futures Trading Commission (CFTC). The topic of the debate is how to classify the cryptocurrency in order to regulate it.

The debate was caused by various declarations made by some high functionaries from both regulatory entities. There were even talks about a possible reunion of both governmental entities to discuss the initial coin offering (ICO) organized by the Ethereum Foundation back in 2014.

The debate focuses on the question whether the ether, the native cryptocurrency of the Ethereum blockchain network, is a security or not and the possible consequences if the cryptocurrency is classified as a security by the SEC. If this happens, the ether would be treated like a stock or a security and it would be subject to all the strict requirements and regulations imposed by the financial regulators of the United States of America.

To determine if a certain type of investment is a security or not, the SEC uses the Howey test. The name of the test comes from a legal case led in the United States in 1946 and this test is used to classify the tokens available on the market.

The Howey test identifies four fundamental characteristics that help define a security, among them is that it is offered in exchange for money, that there are profit expectations, that the investment is focused on a joint venture and that the earnings depend on the efforts of a promoter or a third party.

When the aforementioned characteristics are considered, the majority of the analysts point out that, after applying the Howey test, an initial coin offering is in line with the concept of securities since it conforms with the four fundamental characteristics of a security. This makes the Howey test a valid tool that helps determine whether the tokens sold to the investors in 2014 by the Ethereum Foundation were non registered securities. On the other hand, there are series of other variables that should be taken into account in order to classify the ether, but only the ones that deny the governmental criteria are focusing on them.

Bitcoin did not pass the Howey test and it is different than the ether because it is catalogues by the majority of the regulators as a product. This is because Bitcoin did not have an ICO and the efforts for its creation and promotion came from the miners, the cryptocurrency market and the crypto community.

This way, the Howey test constitutes one of the main elements on which the declarations made by the majority of the government functionaries are based.

Jay Clayton, the Chairman of the SEC, confirmed that Bitcoin was not a security, but a pure mean of exchange, even though he did not express the same opinion about other cryptocurrencies and affirmed the majority of them were securities because they were used to finance projects. In these cases, according to Clayton, we are talking about securities and they should be treated and regulated as such.

The same ideas and thoughts are shared by the former director of the CFTC, Gary Gensler. He thinks that both the ether and ripple (XRP) could be classified as securities that do not conform with the current legislations or that operate in a gray zone when it comes to the regulations.

Hester Peirce, a commissioner from the SEC, expressed a moderate opinion and assured she was not ready to make a generalized statement about the way the cryptocurrencies other than Bitcoin should be catalogued. For Peirce, this subject is debatable since some cryptocurrencies function as securities, others as currencies and some as other things.

Generally speaking, according to the criteria published by the regulators, if the ether, ripple and all the cryptocurrencies that the government decides to include, are classified as securities, sus investors broke the law of the United States of America by emitting and negotiating financial instruments.

In the first place, various analysis mention the legal consequences, because a decision by the SEC to declare the ether as a security would implicate fines, sanctions and trials for damage caused to the ones that trade with this cryptocurrency. The forum of the Law School at Harvard, listed the fines imposed when these regulations are broken. The fines range from 80,000 dollars to 775,000 dollars for the companies and from 7,500 dollars up to 160,000 dollars for the individuals that break the law.

On the other hand, it is likely the Ethereum Foundation would take the matter to the court and thus start a lawsuit that would last for months or even years, according to law experts from the United States.

At the same time, some financial and commercial consequences could be considered and the impact the aforementioned classification would have on the cryptocurrency market. The price of the cryptocurrency will surely be affected, since this would mean all the cryptocurrency exchanges operating in the United States of America would be performing transactions with a security that does not comply with the current legislations. This means the trading of the ether would be stopped in order to make adjustments, register the securities and trade according to the parameters issued by the SEC.

In consequence, it would not be able to exchange these assets in the majority of the cryptocurrency exchanges, because they do not have the necessary licenses for the trading of this type of financial instruments on the territory of the United States of America.

Likewise, the decentralized character of the Ethereum blockchain network would also be questioned, as well as the open code protocols developed in the network and allow many companies to perform commercial transactions without the presence of a central authority. Moreover, it would also affect the development and legal status of many cryptocurrencies based on the Ethereum platform.

This also brings another important consequence since it would create a greater legal pressure on the initial coin offerings, especially because they are already subject to scrutiny by the regulators in the United States and around the world.

While the debate continues, the majority of the analysts conclude it is not likely the SEC would declare the ether as a security or start a process to apply the Howey test to the ICO concluded back in 2014. The legal implications would last for long and consume a lot of resources that could be invested in other cases, especially in the frauds that could affect the investors.

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