Is ETH a Security? (2024)

I wanted to do a longer piece on this as the topic is rearing its ugly head again. The current situation is somewhat frustrating for anyone building on or near the EVM, regardless of whether you're on the "I build tokens that are securities" or "I build memecoins" end of the spectrum, which began the take down of the Ethereum Foundation's warrant canary on or around February 26th (it was a stylized yellow canary). The use of a warrant canary (essentially while this stays up an organization hasn't received a confidential government warrant) and its location being a little obscure took a while to percolate, in fact it wasn't really noticed until a Github commit to take down the canary was noticed a few days ago, and that was followed by media reports of SEC subpoenas flying yet again regarding ETH and the Ethereum Foundation. But the larger issue being even if you're not building directly on Ethereum or a Layer 2 or a Layer 3, uncertainty around how the SEC is viewing ETH, Ethereum and the Ethereum Foundation makes a lot of people quite reasonably nervous.

On the why and what is this and where is it going, this is a great Unchained session https://unchainedcrypto.com/podcast/the-real-reason-why-the-sec-might-be-going-after-ethereum/ and DLx Law partner Gregory Strong makes some very good points, starting with (a) the one thing the SDNY does agree on at the moment is tokens themselves are not securities so ETH alone is not a security and (b) while "decentralization" is a concept that is restricted to staff comments and has never made it as a legal concept, there is quite a lot of Howey line case law on what level of managerial control is needed for a common enterprise and the Ethereum Foundation is unlikely to rise to that standard with regard to Ethereum.

I think I'd add a few things. Why investigate the Ethereum Foundation and why now? Technically speaking the ETH sale was conducted in the summer of 2014 and the entity which was the primary party on the Terms and Conditions (which still float around the internet as an example of lots of things) was Ethereum Switzerland GmbH, which was liquidated about 3 years later (which was the plan and was disclosed). The Ethereum Foundation was already founded (on July 14, 2014) at the time the sale began but it was not actually party to the sale, neither technically were the founders although several could arguably be considered promoters. Also let's add into the mix the statute of limitations for the '33 Act, which case law over the last years has added some color to, and for various reasons for a Section 5 breach, is five years. So five years brings us to somewhere around August 2019, and Ethereum Switzerland GmbH was well into liquidation at that point. Thus by now the SEC very much timed out on the original sale. So now you see why staking and PoW would lead the SEC to wonder whether the door has been opened again and in that case who that door has been opened against. Why is the SEC paying attention eighteen months after staking came into place, well as mentioned on Unchained, that could because it takes that long for the wheels to turn, and it could be a litigation preparation exercise for the ETH spot ETF requests, which should hopefully be good news for everyone as it does not really go to ETH or the use of EVM compatible technology.

Much is made that for many years there has been various commentary that ETH is not a security, beginning with the then SEC Director of Corporate Finance, Bill Hinman's Gary Plastic speech. So looking at that Hinman speech, let's review exactly what he said, and no, he didn't say ETH wasn't a security. Hinman said:

"And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value."

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The points being here: (1) the original fundraise aside, (2) based on what he's been told and his current understanding of ETH, (3) the decentralized nature of Ethereum, (4) current offers and sales of ETH, and (5) there isn't a central managerial entity exercising common control that makes a disclosure regime make sense. The sticky points being (2) and (3), (5) being the most interesting, more on (3) below.

The Hinman Papers, which were finally made public recently as part of the Ripple litigation, and are formed of some early drafts and email discussions around the speech plus a deposition are, despite debate, not ground breaking. The drafts and emails are just the draft going back and forth and the kind of comments that you could expect in a legal based agency on a draft that was trying to drive a policy path. The deposition is a little more and do go to what Hinman knew and where it came from, but not much. It is however in some places epic if you know the history and the case, but I can short cut it for you - the value is Jorge Tenreiro, who is representing both the SEC and Hinman on behalf of the SEC, cracking in the direction of the Ripple & Co lawyers after 11 hours of what should have been maximum a 7 hour deposition in Part 9 at 3/58 or 411.

Obviously the Hinman speech went on to become the Digital Asset Framework, which one can debate the utility of, and both have fizzled in their utility in the face of the enforcement cases which follow neither. Also I'm going to add that for however frustrating it is, the comments of SEC Staff, even Directors of the Division of Corporate Finance are just that, they aren't legislation, they aren't the dicta of a judge in a case, every one of these speeches has a disclaimer which you should take at face value and even entire batches of No Action letters which do have some legal weight get taken down in entire batches. The biggest argument on the converse (again not to Unchained) is the impact on the ETH futures that the CFTC is currently regulating that the SEC would really upend those by determining ETH to be a security but I don't think that is what the SEC would attempt to do, I think it would be attempting to argue that certain sales of ETH are investment contracts.

Finally going to (5) as to whether the Ethereum is decentralized and how much control the core devs and the Ethereum Foundation exert, Angela Walch wrote this excellent if now a little aging discussion "Deconstructing 'Decentralization': Exploring the Core Claim of Crypto Systems" in the context of Hinman's speech, which is worth a read and a consideration as these issues have not much changed however many DEX's we have these days.

So hopefully the current brouhaha is, as mentioned on Unchained, a pre ETH spot ETF litigation prep exercise and not the beginning of open warfare on ETH, Ethereum and broader EVM technology. But this is is the never ending challenge and why so many financial services providers turn to private permissioned chains that never had public sales or are at least insulated from them to a reasonable degree.