A new lawsuit that has KuCoin sued brought up the question many investors have been debating for a while: whether or not ETH is a security for investments? The second-largest cryptocurrency by market cap behind bitcoin and the native currency of the Ethereum blockchain is under scope because of the allegation.
Ever since Ethereum last year converted to a “proof-of-stake” blockchain network where investors can “stake” their tokens in exchange for incentives – not too dissimilar from the interest that is paid out on bonds – the question has been a topic of simmering curiosity.
A new accusation made on Thursday by a New York state regulator may bring the legal discussion back to the forefront.
KuCoin sued: What if ETH is a security?
Letitia James, the attorney general of New York, filed a lawsuit against KuCoin, a cryptocurrency exchange based in Seychelles, on Thursday, alleging that the company sold unregistered securities in violation of the law. Ether was one of the unregistered securities named in the lawsuit.
State and federal agencies, such as the Commodities Futures Trading Commission, have long regarded ether as a commodity (CFTC). The cryptocurrency market would be greatly affected by its designation as a security, which would fundamentally alter how (and whether) the currency and others like it are traded in the United States.
The decision is not final, notwithstanding the NYAG’s claim in its lawsuit that ether might be a security. It is evident from the logic presented in the lawsuit how at least one regulator, and perhaps others, like the U.S. Securities and Exchange Commission (SEC), are categorically thinking about ether.
Why was the allegation made?
Starting in 2022, when it transitioned from a “proof-of-work” scheme to a “proof-of-stake” approach for running its network, Ethereum reportedly came under more scrutiny from regulators.
The still-in-use proof-of-work method, known as “mining,” required computers all over the world to compete to solve cryptographic problems in order to earn newly-issued cryptocurrency and add transactions to the chain.
The new proof-of-stake method does not use mining for “staking.” Holders of ether can now lock up their cryptocurrency with the network in exchange for interest and to aid in transaction security.
“By shifting to proof-of-stake, ETH no longer relies upon competition between computers, but instead now relies on a pooling method that incentivizes users to own and stake ETH,” the suit explains. “The shift to proof-of-stake significantly impacted the core functionality and incentives for owning ETH, because ETH holders now can profit merely by participating in staking.”
The claim of concentrated influence
Ether, which was initially delivered to early supporters and investors in 2015 as part of an ICO, or initial coin offering, has long been dogged by the threat of a security designation.
James claimed in her lawsuit against KuCoin that ether is a security because of its early distribution strategy and the fact that only a small number of contributors are responsible for maintaining its infrastructure.
James’ lawsuit specifically criticizes the power held by Vitalik Buterin, the co-founder of Ethereum, and the nonprofit Ethereum Foundation, alleging that they retain: “significant influence over Ethereum and are often a driving force behind major initiatives on the Ethereum blockchain that impact the functionality and price of ETH.”
The suit further argues that Buterin and the “small number of developers” that run the Ethereum blockchain “stand to profit from the growth of the network and the related appreciation of ETH. ” According to the lawsuit, Buterin and the developers “promoted it as an investment that was contingent on the growth of the Ethereum network.”
“Buterin and the Ethereum Foundation also received significant quantities of ETH in the ICO and are believed to retain significant stakes of that ETH today,” the suit that has KuCoin sued argued.
What would be the impact on the industry if ETH is a security?
Exchanges intending to list Ether will likely need to register as securities broker-dealers with the U.S. Securities and Exchange Commission should Ethereum be formally categorized as a security by courts (SEC).
“If you’re already registered in New York, you now have a question – do you either delist ether and/or block your New York customers from being able to buy ether or do you just simply register as a broker-dealer?” Belton explained.
Belton also noted that James’ stance is unexpected given that exchanges functioning legally in New York (excluding KuCoin, which was not registered as an exchange) do indeed provide ether, with the New York Department of Financial Services, the state’s financial authority, having given its blessing.
“It’s not like New York had no idea that ether was being offered. They knew for years because to get a license and to register in New York, you actually have to have the assets that you plan to offer to New Yorkers green-listed by their financial regulator.” Belson also added, “So it’s kind of insane that their attorney general was saying, ‘Oh, by the way, you guys are selling illegal securities, despite the fact that our financial regulator has been letting you operate with impunity for five years.’”
Centralized exchanges aren’t the only ones who need to be concerned: If ether is determined to be a security, decentralized trading platforms—autonomous programs that run on blockchains—might also run into legal issues.
The U.S. government already outlawed the Tornado Cash mixer program for its connections to money laundering, setting a legal precedent for restricting blockchain-based computer programs known as smart contracts. Therefore if the rule of the case that has KuCoin sued was that ETH is a security, there would be legal space for the SEC to take action against ETH.
If you want to inspect the working mechanism of ETH, you can go to its official website and check out how they manage the ETH. If you want to keep on track of latest developments about cryptocurrency, make sure to stay in tune with our articles and take a look at the previous ones below.
