Ethereum Under Regulatory Scrutiny

May 4, 2018 | Taylor Letterman

Cryptocurrency and Government Regulation

Cryptocurrency has been difficult for the government to regulate ever since Bitcoin seemed to creep out of a computer programmer’s basement somewhere. But now that Bitcoin is more or less being left alone by big brother, the eyes are drifting to other coins to deem whether or not they should be regulated as securities.

The U.S. Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) are attempting to determine whether the same rules designed for stocks should be applied to other digital currencies such as Ethereum.

These regulators are set to meet early next week to discuss whether the creators of other cryptocurrencies, aside from bitcoin, ‘exert significant influence over their value in the same way a company’s stock price depends on its managers and their strategy, performance, and investments’.

The Main Altcoin Under Scrutiny – Ethereum

Up until this point, regulations around stocks, and other “investable” items, hadn’t been considered applicable to cryptocurrency. However, now there’s the idea that if a single person creates a coin does that greatly affect the intrinsic value of said coin? This concept is in direct correlation to how a company’s stock price depends on its managers and how those managers run the company. For instance, if a big name like Disney creates a coin, does that coin suddenly hold greater value merely because Disney created it and not some anonymous 17-year-old kid?

The Discussion

Bitcoin is considered a commodity because at it’s initial creation it was not attached to an Initial Coin Offering (ICO). But many believe Ethereum lies in between commodity and security. It began with an ICO to help fund development of the Ethereum platform. If Ether is ruled as a security it will be required to register with the SEC and follow all guidelines. If that happens, it could seal the fate for almost all other cryptocurrencies.

How Do We Determine if Ethereum is a Security?

Regulators believe when Ethereum came into being in 2014, its creation was an illegal securities sale. It’s founders didn’t register the sale with the SEC, which if it is ruled a security, is a direct violation of U.S. law. If you wanted to buy it, they’d sell it to you regardless – no regulations attached. People bought Ether because they believed the launch would make the asset rise in value. .

That is the basis of what makes something a security according to the “Howey Test.”

The “Howey Test”

The “Howey Test” is named after a 1946 Supreme Court case. The case involved a citrus farm that decided to lease out large portions of land in order to finance additional development. The purchasers with no skill, knowledge, or equipment on how to care for citrus trees, bought the land under the assumption that it would generate a profit based on the efforts of someone else. That is the basis for a security. There’s the idea that there’s something to be gained from a purchase, and that gain relies on the third party involved.

In the case of cryptocurrencies, there is the question of whether or not investors are participating in a speculative enterprise. Then if so, the profits those investors are hoping for are entirely dependent upon the work of a third party. But since cryptocurrencies are decentralized, who (or what) is the third party?

Cryptocurrencies are autonomous and distributed networks built to be decentralized. So that begs the biggest question – how do we determine the third party?