Is Ethereum a Security?

Is Ethereum a security? The question has financial experts divided. Some experts believe that cryptocurrencies like Ethereum should fall under security laws, while others argue that Ethereum's decentralized nature sets it apart. The outcome of the debate is still uncertain, but it's a topic that continues to spark discussion in the media and among industry leaders. 

Is Ethereum a Security?

Whether or not Ethereum is considered a security is a matter of debate and interpretation. In general, a security is a financial instrument that holds value, represents ownership in an asset, and can be traded between parties. Some examples of securities are stocks or bonds. Ethereum is a blockchain-based platform that enables the creation and execution of decentralized applications and smart contracts. ETH, the native token of Ethereum is used to pay for transaction fees and services on the network.

The Securities and Exchange Commission (SEC) has not provided a clear ruling on whether Ethereum is a security, but it has stated that cryptocurrencies and coin offerings may be considered securities and subject to federal securities laws. The SEC has also said that whether a particular asset is a security depends on the facts and circumstances of the case.

The Howey Test Applied to Cryptocurrency

The Howey Test is a critical evaluation tool used by the Securities and Exchange Commission (SEC) in the US to determine whether a specific asset should be considered a security under federal laws. Securities, such as stocks and bonds, are financial instruments that meet the criteria established by the Howey Test.  

According to The Securities Act of 1933, an investment contract must satisfy all three requirements to be considered a security. These requirements are: 

1. An investment of Money 
2. In a common enterprise 
3. With reasonable expectations of profits 
4. Derived solely from the efforts of others 

The first requirement of the Howey test, “An investment of money,” is often debated when it comes to Ethereum. Some argue that validators depositing their ETH in the smart contract to validate transactions and secure the Ethereum blockchain is not considered “an investment of money,” as they are putting ETH as collateral to participate in the proof of stake (PoS) mechanism and not making a purchase or investment. However, others argue that the ETH deposited as collateral can be viewed as a risk and may fall under the investment criteria. 

Under the second requirement of the Howey Test, “In a common enterprise,” there are two tests of Commonality that can be applied. 

1. Horizontal Commonality: This test refers to the individual's capital being tied to each other by pooling of funds and proportional distribution of profits. Some argue that staking ETH qualifies as horizontal commonality because the fund is staked in a similar smart contract. While others debate that since no one has direct control over the staked ETH,  there is no grouping of funds. The staked ETH remains distinct and bound to the node. Additionally, there is no pro-rata  distribution of profits, as validators are not incentivized or penalized on the transactions that the validators validate.
2. Vertical Commonality: This test focused on the relationship with the investor and the promoter. The argument is that it does not apply to  Ethereum, since there is no promoter. Etherum is a decentralized and open-source project, anyone can be a validator. The actions depend on the codes of the smart contract. 

The third requirement of the Howey Test states that for an investment to be considered a security, there must be “with reasonable expectations of profits” Some argue that there is a reasonable expectation of profits because the value of ETH is expected to go up and down and investors are able to profit. However, it is also seen as a passive investment not an active one.  

The fourth requirement states that for an investment to be considered a security they are derived solely from the efforts of others. Ethereum's validators are made to work to maximize their uptime and stay connected with the network, which is not solely dependent on the efforts of others. 

The Argument for Ethereum Being a Security

The argument that Ethereum is a security centers around the idea that the purchase and holding of Ethereum can be considered an investment of money, and therefore a security, under the Howey Test. They also argue that there is a common enterprise, as Ethereum is a decentralized network where all participants are working towards the same goal of maintaining the network. Finally, they argue that there is a reasonable expectation of profits derived from the efforts of others, as the value of Ethereum can increase and the holders can profit from the efforts of the Ethereum developers and miners. 

Ethereum switching from a proof of work to a proof of stake consensus mechanism, has had people speculate that the ETH ticker doesn't necessarily mean it is the same token anymore and should be considered a security.

Why Ethereum Isn’t a Security

The argument that Ethereum is not a security is based on the idea that buying and holding Ethereum does not meet the criteria of an investment contract under the Howey test. 

First, the argument is that buying Ethereum is not an investment of money, but rather a purchase of a utility token that is used to access the Ethereum network and its various decentralized applications. It is not a passive investment, but rather an active participation in the network.

Second, the argument is that there is not a common enterprise, as Ethereum is a decentralized network where participants are not pooling their funds and there is no central authority controlling the network. Each individual's capital is distinct and not tied to each other.

Third, the argument is that there is no reasonable expectation of profits derived solely from the efforts of others. The value of Ethereum is determined by the market demand and supply, the value of the network, and the efforts of the individual holders who use and contribute to the network. The rewards for holding and participating in the network is not solely dependent on the efforts of others.

What Happens If The SEC Says Ethereum Is A Security?

If the SEC were to officially classify Ethereum as a security, it would have a significant impact for the Ethereum network and its community.

It would mean that any transactions involving the sale or exchange of Ethereum would be subject to federal securities laws, including registration and disclosure requirements. This could make it more difficult for individuals and companies to buy and sell Ethereum, and may also make it more difficult for new decentralized applications to launch on the Ethereum network.

Another impact that could happen is it would mean that exchanges that list Ethereum would be subject to greater regulatory inspection,and may be required to register as securities exchanges. This could lead to some exchanges delisting Ethereum or not listing it in the first place..

Another possibility would mean that individuals involved in the sale or exchange of Ethereum may be held liable for failure to comply with securities laws, which could result in fines or other penalties.

It's also worth noting that the classification of Ethereum as a security could have a negative impact on the overall crypto market, as it could lead to more regulatory inspections  and more difficulties for crypto projects to launch and operate.

How to Buy Ethereum

Whether or not Ethereum is technically a security, its still available on a wide range of the best cryptocurrency exchanges. A few of the best crypto exchanges that offer Ethereum trading are Uphold, Coinbase, Robinhood, eToro and HYCM. If you don't already have an account with a crypto exchange you will have to make a new one and verify your identity with the exchange. As soon as your account is verified you can deposit funds and start buying Ethereum.

What Are Security Tokens?

Security tokens and cryptocurrency are similar in the way they are created and stored. However, the difference lies in the purpose and intended use of the tokens. Security tokens are a new way to transfer ownership of assets utilizing the blockchain platform.  They allow for the digitization of assets and create automation with being in compliance with securities laws. They offer similar rights and benefits as traditional securities, like stocks and bonds. They have the ability to freeze or lock certain tokens if they are being held by a restricted person.

The market for security tokens is still in its early stages, but it is expected to grow significantly in the coming years as more and more assets are tokenized and more investors are attracted to the benefits of security tokens.

What Is Ethereum Considered, If Not a Security?

Ethereum and other cryptocurrencies are a relatively new and a unique asset class that do not fit neatly into traditional investment frameworks. Unlike stocks or bonds, which are clearly defined as securities under U.S. laws, Cryptocurrencies like Ethereum are decentralized and operate on a blockchain network, making it hard to apply the same legal criteria as traditional investments.

It is important to understand that although Ethereum the platform is not currently considered a security. Some tokens built on Ethereum blockchain may be considered securities by the SEC, depending on how they are structured, marketed and offered to investors.