Forward the Original Title ‘以太坊经典是一种商品，以太坊是一种证券’

Howey test

To determine whether a unit of value, contract, or transaction is a security, the U.S. Securities and Exchange Commission (SEC) uses the so-called Howey test, the basis for the Supreme Court ruling on what constitutes a security in 1946.

Under the test, a unit of value, contract or transaction qualifies as a security if it has the following elements:

1. money investment
2. in an ordinary enterprise
3. reasonable profit expectations
4. generated by the efforts of others

Bitcoin (BTC) and Ethereum (ETH), along with Ethereum Classic (ETC) after Ethereum split from Ethereum in 2016, were identified as commodities by the Commodity Futures Trading Commission (CFTC) in 2015 because there is no common enterprise guiding them and their rewards do not come from the efforts of others due to their decentralization.

The question is whether Ethereum still qualifies as a commodity now under its proof-of-stake (PoS) consensus mechanism.

Compare ETC and ETH using Howey test

ETC, ETH, and Howey Test

The table above is used to compare the performance of ETH and ETC in the Howey test.

As shown in the table, in our opinion, Ethereum now passes the test and should therefore be classified as a security as it involves all four elements. But since ETC is still a decentralized project, it should remain a commodity.

In the following sections, we explain our comparison and rationale.

1. Money investment:

In the first element of the Howey test, it is clear that both ETH and ETC are monetary investments in a unit of value. Many people use both cryptocurrencies simply as a method of payment and therefore a unit of exchange rather than an investment. But for many, they are a store of value and a way to profitably trade in the markets.

2. In an ordinary enterprise:

ETH is a common venture since the move to Proof-of-Stake in September 2022 because Proof-of-Stake is centralized. This model uses capital rather than proof-of-work based mining to determine who produces blocks. This gives the betting business strong economies of scale, inevitably concentrating the industry into a tiny and entrenched betting pool.

These pools can filter who may participate and/or who may be part of the validator set, or possibly the node operators themselves validating blocks and transactions.

These few entities will be static, meaning they will rarely rotate out of the industry because of the trenches of their business, they will coordinate their actions with the Ethereum Foundation, and all of this combined will form a common enterprise to guide the future of the system.

This level of centralization, along with the lack of proof-of-work cryptographic stamps when producing blocks, completely removes the point of chain choice, giving Ethereum the free-access, permissionless, censorship-resistant, and immutable properties that make it common enterprises with traditional centralized functions and controls.

ETC is still a commodity because it will keep using Proof of Work (PoW) for the foreseeable future.

Therefore, there will not and will never be a business or group that controls ETC, and mining and owning Bitcoin will always be completely independent activities.

ETC has no basis to guide the system roadmap. The production or verification of blocks is a free, decentralized, and value-based activity.

3. Reasonable profit expectations:

As mentioned before, while both ETH and ETC can be used purely as units of exchange, they can also be used as stores of value for price appreciation, so both have reasonable profit expectations.

4. Generated by the efforts of others:

For the same reasons that Ethereum is now a common enterprise, it is also a system in which expectations for the system’s success, and therefore its future profits, are derived from the efforts of others.

These “others” will be completely identifiable as they will be 4 or 5 large staking pools and the Ethereum Foundation, all of which will function as a single enterprise.

The PoS system is not a performance system like PoW, but rather a complete partnership between pools and validators, with validators essentially being the same as pools because they operate as contractors.

In the system, validators are tasked on a per-block basis, with one generating a block, then sending it to other validators for voting, and finally distributing it to the rest of the network, which must accept it without dissent.

Because ETC operates on PoW and is decentralized, miners can appear or leave from anywhere in the world at any time, competing in complete isolation to construct blocks, send them for verification to other parts of the network, and earn rewards based solely on their merits. There are no other filters or conditions.

The reason why ETC was previously classified as a commodity still exists today: there is no common enterprise, so the future value of the token is determined solely by the market’s future widespread adoption, rather than by a defined collaborative group composed of centralized pool operators or managers as in Ethereum.

Interpreting the legal status of ETC and ETH from a historical perspective

Crowdfunding

From 2014 to 2016, Ethereum and Ethereum Classic were one project, so we called it ETH/ETC during this period.

The project is funded through crowdfunding. According to the Howey test, it can be inferred that ETH/ETC crowd selling is indeed a security。

It was founded by Vitalik Buterin; then, he collaborated with several individuals to form a group of co-founders; they committed to expecting profits from investments; created a foundation in the name of the network, and even registered its trademark; sold a unit of value before the creation of the cryptocurrency to raise development funds; and promoted the crowdfunding and the functionalities, benefits, and appreciation potential of Ethereum, similar to any initial public offering of stocks.

However, the status of this security may be limited to the period between the crowdfunding and the launch of the network on July 30, 2015.

ETH/ETC issuance

On July 30, 2015, the project’s initial securities were converted into the ETH cryptocurrency, subsequently classified as commodities by the CFTC.

This step can be interpreted as the initial exchange and exit of the initial joint venture between investors, Vitalik Buterin and his partners, and the Ethereum Foundation as the project’s directors.

From this point onwards, the project evolved into a truly decentralized, proof-of-work-based public blockchain.

Ethereum split

Even though Ethereum was separated from the ETC mainnet due to the DAO hard fork in 2016, ETH has remained decentralized because it is still a proof-of-work blockchain.

This period lasts until September 15, 2022.

ETH moves to proof of stake

Starting September 15, 2022, Ethereum cannot be described as a decentralized project as it migrates to Proof-of-Stake. In fact, at the moment it migrated, 51% of blocks were subject to scrutiny by large staking pools to comply with international sanctions imposed by the U.S. Office of Foreign Assets Control (OFAC). After a few months, as many as 70% of the blocks were censored.

As mentioned earlier, PoS relies on large and entrenched pool operators controlling the network. This, coupled with the control and influence previously held by the Ethereum Foundation, along with developers’ incredible influence on protocol decisions (such as altering the coin supply six times in its history), makes it a centralized project reliant on others from a unit-value perspective.

Like Bitcoin, ETC is still a commodity

At the same time, Bitcoin has maintained the commodity status determined by the CFTC in 2015, and ETC is also functionally a commodity, just like BTC, because it has the exact same consensus design and decentralization guarantees.

Summary

It is worth noting that anything built on top of Ethereum Classic may be considered a commodity or security. As a broad and decentralized computing system, the status of dapps, Layer2 systems, and tokens will depend on their design.

Structures within ETC resembling corporate stocks, bonds, or derivatives of DAOs will be classified as securities. ERC-20 tokens can create coins, meme coins, or other tokens not subject to the Howey test, which may be classified as commodities.

However, ETC as the foundational layer for these technologies remains a generic commodity.

The proof-of-stake algorithm in Ethereum Classic implies ongoing collaboration among validators, who are contractors of pool operators. They produce blocks, vote on them, and then broadcast them to the rest of the network, which must accept them without question.

Moreover, involvement in running validation clients by stakeholders from the public or node operators will be filtered and restricted by pool operators. There is no decentralized freedom of entry and exit, so it clearly resembles a typical enterprise.

ETH/ETC underwent a centralized sales process during the crowdfunding period, but later transitioned into a decentralized blockchain upon launch, as a proof-of-work system.

When ETH separated from the ETC mainnet in 2016, ETC separated from the primary community of developers and leaders at the Ethereum Foundation, becoming more decentralized at the social layer. This is when its “code is law” principle was established.

ETC has never had a clearly defined group of initiators. All the different components within ETC are constantly rotating and migrating.

Based on all the reasons mentioned above, our conclusion is that Ethereum Classic remains a commodity, while Ethereum is a security.

Disclaimer：

1. This article is reprinted from [Ethereum Classic]. Forward the Original Title‘以太坊经典是一种商品，以太坊是一种证券’.All copyrights belong to the original author [Donald McIntyre]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.