The Securities and Exchange Commission is waging a vigorous legal campaign to classify Ethereum, the second most popular cryptocurrency, as a security, according to US companies that have received subpoenas related to the investigation. The news deals a further blow to the crypto industry’s hopes that the agency will approve applications from BlackRock and others for Ethereum ETFs, following the SEC’s approval of a series of Bitcoin ETFs in January.
The SEC’s investigation into Ethereum includes requiring companies to provide any documents and financial records they may have regarding their dealings with the Ethereum Foundation, a nonprofit group that oversees the management and development of the blockchain of the same name.
According to a person at a company that received a recent subpoena, the SEC’s investigation into the Switzerland-based Ethereum Foundation began shortly after the blockchain moved to a new governance model known as “proof-of-stake” in September 2022. Another person at a separate company , which received the subpoena, described it as narrow and focused on the Ethereum Foundation and said they received the subpoena in the past few weeks.
That proof-of-stake event moved the blockchain away from the energy-intensive model used by Bitcoin in favor of one that relies on a trusted network of validators — and gave the SEC a new pretext to try to define Ethereum as a security, according to people at three different companies familiar with subpoenas. People asked Wealth not to identify them or their firms for fear of retaliation from agency chairman Gary Gensler, whom one described as “vindictive.”
The existence of an investigation into the Ethereum Foundation was reported on Wednesday by CoinDeskwhich cites an update to the group’s Github code repository that reportedly provides evidence of research by an unknown government agency.
“The SEC does not comment on the existence or non-existence of a possible investigation,” the agency said in response to a request for comment from Wealth.
Push to label Ethereum as a security
News of the subpoenas comes as the SEC and the Biden administration wage an aggressive campaign to clamp down on the crypto industry, which they characterize as lawless. However, that campaign has sometimes been frustrated by the unclear legal status of cryptocurrencies, leading to a series of legal battles over whether the SEC even has jurisdiction over the industry.
This critical jurisdictional question concerns whether a cryptocurrency is a security, an issue that has not been definitively addressed by the courts. While there is consensus that bitcoin is a commodity instead, under the oversight of the Commodity and Futures Trading Commission, Gensler signaled that his agency considers the vast majority of other cryptocurrencies to be securities that must be registered with the SEC.
The SEC has made this case in recent court cases, except when it comes to Ethereum, whose legal status is even murkier. The state of Ether’s security has long been a point of contention for the agency. Speaking at a conference in 2018, then-CFO William Hinman said ether was not like a security. Emails released as part of Ripple’s trial revealed that SEC officials debated how clear to make the claim, and that one official wanted to say the agency “doesn’t … see a need to regulate Ether.”
That changed under Gensler, who took over the agency in 2021, and after Ethereum moved to proof-of-stake the following year.
At the time, Gensler said that any crypto assets produced by blockchains that use a proof-of-stake model could resemble investment contracts and therefore be classified as securities, although he did not talk about a specific coin. In March 2023, he again proposed that proof-of-stake tokens be regulated as securities, although he has since declined to comment specifically on Ethereum, including at SEC oversight hearings before the House Financial Services Committee.
The issue became more complicated in October after the SEC approved nine ETFs that track the CFTC-monitored ether futures market, suggesting that ether is a commodity. CFTC Chairman Rostin Behnam has said on several occasions that his agency views ether as a commodity.
But last month, controversial crypto firm Prometheum, which has approval to operate as a special purpose broker-dealer, announced its intention to offer custody services for Ethereum as a security under the supervision of the SEC, again adding uncertainty to Ether’s regulatory status. One of the recipients of the recent subpoena speculated that Gensler tried to use Prometheum as a Trojan horse to classify Ethereum as a security.
The recent race between major financial firms, including Fidelity and BlackRock, to get spot Ether ETF approval has put the issue in the spotlight, with all signs pointing to the SEC rejecting applications by their May deadline. Bloomberg analysts indicated that agency officials have not gone back and forth with issuers on details of the potential, as they did with spot bitcoin ETFs that were approved in January.
A potential declaration that Ether is a security could cast further doubt on the process, especially as it would raise questions about the CFTC’s oversight of Ether futures markets.