Understanding how the Merge puts Ethereum in Sec’s crosshair

TL: DR

The switch to proof-of-stake (PoS) for Ethereum may have put the cryptocurrency back in the sights of the Securities and Exchange Commission (SEC).

In a statement issued on September 15, US Securities and Exchange Commission Chairman Gary Gensler stated that staking-based crypto are potentially securities that the agency should regulate.

According to the SEC chairman, stocks-based cryptocurrencies are likely to pass the Howey test, which is used to assess whether an asset is a security under SEC's jurisdiction or a commodity, similar to precious metals or scarce natural resources.

The Howey test states that a transaction in which money is invested in a common enterprise with a considerable expectation of profits to be derived through the efforts of others qualifies as a security.

Introduction

The Ethereum Merge has finally gone live, but it might have raised a dust of uncertainty, especially regarding securities laws. The Merge, which was a fundamental change of the consensus mechanism of Ethereum, took place last month amidst wide speculations, hopes, and conjectures about the future of the world's second most valuable cryptocurrency. Essentially, the Merge is the buzzword for the switch of the blockchain to a proof-of-stake consensus model cutting its carbon emissions by 99.5%. In this new model, users stake ether to win the right to validate new transaction data on the blockchain in Ethereum. The Merge has been widely hailed as a victory for the environment amid the climate crisis. Yet, it may also be what brings the network into the crosshairs of US regulators.

Ethereum in SEC's Crosshairs

In a statement issued on September 15, US Securities and Exchange Commission Chairman Gary Gensler stated that staking-based cryptocurrencies are very likely securities the agency should regulate. This assertion bodes ill for Ethereum, which may be charged or coerced into compliance by the SEC shortly. Registered securities must provide information about their management team, provide regular financial updates, and outline potential business risks.

Users earn Ether through proof-of-stake by locking up their coins and validating transactions. According to Gensler, when validators stake their coins, it means that "the participant is anticipating profits based on the efforts of others," just like the case of a stockholder who invests with the expectation that a company will make money.

Gensler later clarified that he was referring to staking-based cryptocurrencies in general, not Ethereum specifically. Still, his remarks came shortly after ether became the largest cryptocurrency by market capitalization to use proof-of-stake.

Post Merge ether and the Howey Test

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According to the SEC chairman, stake-based cryptocurrencies are likely to pass the Howey test, which is used to assess whether an asset is a security under the jurisdiction of SEC or a commodity, similar to precious metals or scarce natural resources.

The Howey test, derived from a 1946 Supreme Court decision, states that a transaction in which money is invested in a common enterprise with a considerable expectation of profits to be derived through the efforts of others qualifies as a security

In a speech on September 8, Gensler stated that much of the crypto industry satisfies the Howey test and is thus operating illegally by failing to register with the SEC. Gensler said that he believed the vast majority of the nearly 10,000 tokens in the cryptocurrency market are securities. He asserted that the securities laws apply to the offers and sales of these thousands of crypto security tokens.
Crypto advocates have called for cryptocurrencies to be under the jurisdiction of the Commodity Futures Trading Commission (CFTC). They believe CFTC will be less stringent than the Securities and Exchange Commission (SEC). Gensler admitted that a small number of cryptocurrencies, including bitcoin, could be classified as commodities rather than securities.

A critique of SEC's position

The call by the SEC to regulate staking-based crypto under the agency sounds like trouble for Ethereum. Because network nodes are densely clustered in the United States, the SEC claims jurisdiction over ETH transactions.

The organization has previously been chastised for its regulatory approach to cryptocurrency, for example, in the BlockFi case, when the SEC announced actions against this company in February for failing to register high-yield interest accounts that the SEC considers to be securities. One of the SEC's requirements is that BlockFi's business activities be brought into compliance with the 1940 Investment Company Act within sixty days.


As a result, BlockFi was put up for auction, and two other companies with similar businesses failed, according to Stu Alderoty (Ripple General Counsel). The SEC has used Howey's 1940 legislation to regulate modern and not yet fully developed financial technology, which many crypto enthusiasts have described as absurd. Some observers argued that the SEC's claim that all Ethereum falls under US jurisdiction is false. According to the SEC's logic, because the Ethereum blockchain node network is more densely clustered in the United States than anywhere else, the SEC should count all Ethereum transactions of American origin worldwide.

However, according to Etherscan, the United States now only has 46.19% of all Ethereum nodes. It is far from a simple majority. Similar to the SEC statement, one could argue that bitcoin should be regulated solely by the European Union. As the сertified AML specialist, Slava Demchuk put it; these statements are simply the result of the SEC lawyers' hazy understanding of how cryptocurrencies work. However, we cannot dismiss the possibility of the SEC's previous tendency to regulate through enforcement.

Conclusion

Regulatory bodies have increased their efforts to regulate the crypto space. According to reports, the SEC and the Commodity Futures Trading Commission have proposed requiring hedge funds to report their bets, including cryptocurrency exposure. Meanwhile, the US Federal Reserve issued a new set of guidelines for banks planning to engage in cryptocurrency activities, requiring financial institutions to notify them of their actions.

Ethereum might have turned full circle on security identity concerns with the Merge. The question of whether a crypto asset is a security or a commodity is one that key industry players have asked the SEC to clarify. Faryar Shirzad, Chief Policy Officer of Coinbase, previously stated that current securities regulations do not work for digitally native instruments and crypto. Arguably, this is a major problem beyond the war of superiority in the crypto industry.



Author: Gate.io Observer: M. Olatunji
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