May 29, 2024

Ethereum News: Security or Commodity? Consensys Takes SEC to Court to Force the Answer.

May 29, 2024

Crypto enthusiasts cheered the surprise approval last week of spot ether exchange traded funds (ETFs) being prepared for listing on U.S. stock exchanges. It’s only the second time a cryptocurrency-backed group of ETFs has been approved by the Securities and Exchange Commission, a move some analysts say heralds crypto’s growing acceptance among the mainstream.

But the CEO of one of the biggest ether-based companies isn’t feeling the love.

Software juggernaut Consensys, headed by Canadian American entrepreneur Joseph Lubin, is suing the Commission in the hopes a federal judge will rule once and for all that ether, also called ETH, is not a security.

“The SEC seeks to achieve … regulatory dominion (over cryptocurrency) through ad hoc enforcement actions against Consensys and others — enforcement actions that would punish Consensys for accepting and acting in reliance on years of government assurance that ETH is not a security,” the complaint said. “There is nothing right about this picture.”

The complaint was filed April 25 in the Northern District of Texas after Consensus received a Wells Notice from the SEC, indicating it was under investigation for facilitating the sale of what the SEC deemed unregistered securities.

Consensys offers trading platforms and other software applications that operate on the Ethereum blockchain, whose native currency is ether, the world’s second largest cryptocurrency by market share after Bitcoin. Ethereum was founded in 2014 by Russian Programmer Vitalik Buterin and a team of four co-founders, including Lubin, who founded Consensys a year later.

Lubin and others have long complained that, even when asked directly for guidance, the SEC refuses to say whether specific cryptocurrencies are securities under the law, or, as Lubin sees them, commodities. That, Lubin argues, makes it impossible for companies like Consensys to know whether digital assets must be registered before they can be legally traded on their platforms.

The first time companies learn the SEC considers their digital assets securities is typically when they receive a Wells notice, the complaint alleges. In other words, the corporations may be breaking the law and not even know it.

In Consensys’s view, this violates the “fair notice” doctrine of the Due Process Clause of the Fifth Amendment.

Attorneys for Consensys also argue that ether doesn’t meet the criteria of a security, which differs from a commodity in several ways defined by statute.

According to the complaint:

*Ether represents no claim on the proceeds or revenues of the Ethereum network.

*Ether provides no interest in the profits or assets of any enterprise.

*The value of ether is not driven by the efforts of any promoter or organization.

*No governing board manages ETH or defines its characteristics or terms of use.

In addition to asking for a formal declaration that ether is not a security, Consensys is seeking an injunction that would shut down the SEC investigation and bar the Commission from any enforcement action that arises from its contention that ether is a security.

Large sections of the complaint paint SEC Chair Gary Gensler as a flip-flopper on the securities status question and someone who came to the job as Chair with an anti-crypto agenda. At the heart of that agenda, lawyers for Consesnys contend, is an ogoing plan to grab power by claiming jurisdiction over digital assets trading.

Neither Gensler nor the SEC has commented publicly on the lawsuit.

According to the complaint:

*In a June 2018 speech, then Director of the SEC’s Division of Corporation Finance William Hinman said in no uncertain terms, “current offers and sales of Ether are not securities transactions.” Internal SEC documents show that all SEC commissioners backed Hinman’s assessment at the time. (Gensler didn’t join the Commission until 2021.)

*In 2019, the SEC staff published a “Framework for ‘Investment Contract’ Analysis of Digital Assets,” which noted that a digital asset was not likely to be a security if it was governed by “an unaffiliated, dispersed community of network users (commonly known as a ‘decentralized’ network).”

*Gensler, then a professor at the Massachusetts Institute of Technology, told a gathering of investors in 2018 that “Bitcoin, ether, Litecoin and Bitcoin Cash” are “not securities.”

*While teaching a course on blockchains and digital assets, Gensler told his students: “In 2018, the Securities and Exchange Commission has said that regardless of what (ether) might have been in ’14, it’s now sufficiently decentralized that we’ll consider it not a security.”

Since those statements, the complaint asserts, Ethereum has become even more decentralized. It has no board of directors or management team. It’s organized through the voluntary participation of a shifting mass of thousands of users, code developers, and other stakeholders who propose and vote on the rules of the blockchain in massive online meetings.

Per the complaint, because the message that ether was not considered a security by the SEC was so clear, numerous companies built the Ethereum blockchain into an economic engine that tens of millions of people use, conducting an average of a million transactions a day. Ether has a market value of roughly $400 billion, 20 percent of the value of all digital assets combined. At least one in five adults in the U.S. owns crypto today, the complaint states.

Those numbers are all bound to rise dramatically on last week’s news that ether-backed ETFs have cleared the first hurdle on the path to open trading.

The ETFs would allow investors to gain exposure to ether prices for the first time through a standard brokerage account.

Currently, the only ways to speculate on ether’s price fluctuations involve buying ether directly from a crypto exchange or trading futures contracts tied to its price. Both come with more fees and regulatory burdens than spot ETFs. Part of the staggering popularity of ETFs can be attributed to their lowering of those barriers to entry, which would enable retail investors to trade interests in ether like any common stock.

The SEC must still grant final approvals to the eight firms seeking to offer the ETFs, but Thursday’s announcement bodes well for those applications.

Since the SEC first approved a string of Bitcoin ETFs (the first crypto-backed ETFs ever offered for trade) in January, the investment vehicles have logged net inflows of more than $12.6 billion, and the price of Bitcoin climbed to an all-time high.

Crypto bulls are expecting similar action around the ether ETFs, but there’s no sign that the SEC’s move on ether ETFs will deter Lubin from pressing ahead with his lawsuit.

“Consensys, in particular, has built its business around the Ethereum blockchain, launching features like MetaMask Swaps in 2020 and MetaMask Staking in 2023 — that is, years after the SEC assured the public it viewed ETH as outside its domain,” the complaint recounts.

“The SEC’s efforts to pull the rug out now by deeming ETH a security violate the requirement of fair notice.”

If you want to explore opportunities in cryptocurrency, contact our Blockchain team.

Article by Kevin Lynch

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