On Feb. 26, 2024, a discreet modification appeared on the Ethereum Foundation website.
A GitHub commit announced the deletion of the website’s footer and warrant canary. The statement explained that this action was taken following a confidential inquiry from a state authority, which was made voluntarily.
A warrant canary is essentially a notice or symbol, such as a yellow bird for the Ethereum Foundation, displayed on a company’s website to signify that they have not received any government demands for subpoenas or search warrants to date.
If a government agency asks for information, a company could instead make the text disappear, subtly indicating to viewers that a subpoena has been served.
The Ethereum Foundation has deleted this significant part from their statement, suggesting that they are currently subject to a clandestine probe. Unfortunately, due to the confidentiality agreement involved, the Ethereum Foundation is unable to provide any additional information.
According to unnamed sources, Fortune magazine wrote that the US Securities and Exchange Commission (SEC) is reportedly investigating the Ethereum foundation based on their ongoing effort to determine if Ethereum’s cryptocurrency, Ether (ETH), should be categorized as a commodity.
The timing of the investigation couldn’t be less convenient, as the May deadline for SEC approval of Ether ETFs is fast approaching.
The question of whether Ether qualifies as a security has been a topic of much discussion for some time, but recently, there have been growing uncertainties.
Why is the SEC looking into the Ethereum Foundation now, over nine years since its inception? Does the SEC have the authority to probe an entity located outside of the United States, such as Switzerland? Could the approval process for a proposed Ether exchange-traded fund (ETF) be postponed because of this investigation? Lastly, what could be the implications for Ethereum and the wider cryptocurrency market if Ethereum is deemed to be a security?
Is the Ethereum Foundation actually under SEC investigation?
The Ethereum Foundation cannot provide further details due to a confidential clause.
The Ethereum Foundation has been contacted by a government agency with a query, but it does not necessarily imply that the organization is under investigation.
Professor Carol Goforth from the University of Arkansas School of Law, who focuses on business associations and securities regulation, elaborated on this point for CryptoMoon: This detail holds significance due to its connection with the rules governing businesses and securities.
“If we assume the foundation is not the subject of the investigation, the SEC’s power to mandate cooperation may be limited.”
The Securities and Exchange Commission (SEC) thinks that the Ethereum Foundation might have relevant information for an ongoing investigation they’re conducting.
Goforth made it clear that the foundation is willing to work together, explaining that their goal of keeping Ether an active trading commodity in US markets is strong motivation for cooperation with regulators.
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Another motivation for working with the SEC is to clarify “why Ether does not fit the definition of an investment contract according to the Howey test” and thus serve as evidence that it should not be classified as a security.
If the Ethereum Foundation is under investigation by the SEC, it may take several years for the SEC to progress from an investigation to filing a lawsuit against them.
Effects on the crypto market if Ether is classified as a security
A continuous examination of Ethereum’s situation might harm its progress until the issue is settled, potentially influencing judgments like the listing of an Ether ETF and the asset’s wider acceptance – as demonstrated by the financial implications of the Ripple-SEC legal dispute.
Basel Ismail, CEO of investment analytics company Blockcircle, told CryptoMoon:
“If Ethereum were to be classified as a security, it would be atrocious for the short-term market valuation of the entire crypto ecosystem.”
If a well-known, decentralized blockchain with a large number of global developers is classified as a security in someone’s viewpoint, then the majority of crypto projects might also fit that description.
A trader can consider it a given that any ERC-20 token, which has fundraised using a comparable method, will likely be subject to the identical registration procedures and regulations.
According to him, the ripple effect might cause “significant damage” or even “bankruptcy” for numerous companies in that industry, as their financial reserves may not be sufficient to weather such a sudden impact.
Exchanges dealing in Ether that function within the American financial system are obligated to treat Ethereum as a security. Consequently, these exchanges have two options: they can remove Ethereum from their listings or register themselves as securities broker-dealers with the Securities and Exchange Commission (SEC).
Goforth pointed out that any trading platform connecting buyers and sellers is required to register as a securities exchange or adhere to an exemption, such as functioning as an Alternative Trading System (ATS). However, either choice involves substantial disclosures and securing approval from the Securities and Exchange Commission (SEC).
She emphasized an important issue that might compel crypto exchanges to remove Ethereum from their platforms before registering as securities exchanges.
On the contrary, numerous cryptocurrency exchanges might choose to withdraw their listings instead of going through the extensive registration procedure with the Securities and Exchange Commission.
According to Goforth’s observation, if a crypto exchange intends to register as a securities exchange, it will be prohibited from facilitating trades for any unregistered security assets.
If the SEC has not labeled most cryptocurrencies as securities, then a crypto exchange would face risks if it facilitated trading in these unregistered assets. According to one perspective, this could effectively mean “stay out of the US market.”
Most ERC-20 tokens, unlike Ethereum with its substantial market value, would likely struggle if they were delisted from U.S. exchanges.
Ismail pointed out that a lack of liquidity would result in thinner order books, leading to significant price swings and making it difficult for market makers to maintain the asset’s price stability for an extended period.
Does the SEC have jurisdiction over the Ethereum Foundation?
It’s not productive to fret over potential consequences if the Ethereum Foundation resides in Switzerland while the Securities and Exchange Commission (SEC) is the US regulator.
The SEC has the authority to regulate companies based in the US, but according to Goforth, it can also extend its reach to activities outside the country if these activities significantly affect the US.
In the crypto sphere, a notable occurrence took place in 2020 when the SEC (Securities and Exchange Commission) prevented Telegram from releasing its GRAM token through a global injunction. Despite being located outside of U.S. jurisdiction, Telegram was forced to refund $1.2 billion and pay a penalty of $18.5 million.
Goforth made it clear that there is no legal obligation for the Ethereum Foundation to collaborate. Yet, she emphasized the importance of collaboration in the SEC’s decision-making process and how this factor could be taken into consideration.
Without cooperation from the Ethereum Foundation, the SEC might send a subpoena, compelling the group to disclose any information the regulatory body demands in accordance with the law.
Could Ether move to DEXs abroad?
Should centralized American markets for Ethereum trading cease operation, decentralized exchanges (DEXs) could serve as viable substitutes.
Due to their decentralized structure and broad scope, Ethereum projects may be able to evade regulations by taking advantage of the complexities involved, given that these platforms are challenging for regulators to control.
Sergey Gorbunov, the CEO of Interop Labs and a co-founder of Axelar protocol, shared with CryptoMoon his perspective: “Should ETH be classified as a security, decentralized exchanges (DEXs) are likely to continue functioning due to their inherent decentralized global structure.”
Yet, he acknowledged that there would be obstacles to face, including “compliance rules in specific regions” emerging.
Gorbunov explained that this latest regulatory change could pose a risk to Decentralized Exchanges (DEXs) which link up with centralized cryptocurrency platforms to source liquidity.
Although decentralization can make it harder for regulators to intervene, it doesn’t ensure complete safety. U.S. regulators have shown they can shut down platforms like Tornado Cash by going after the developers instead.
Goforth pointed out that the Securities and Exchange Commission (SEC) might go after specific founder groups, promoters, or other influential figures in a network. Conversely, Gorbunov suggested that regulators could instead focus on individuals or entities that contribute to the open network, such as validators or contributors.
A silver lining?
The SEC’s decision to categorize Ethereum as a security carries ominous consequences, according to Ismail. While this might initially harm market sentiment and hinder adoption, potential benefits may emerge over the long term.
An solution for the disagreement between the Ethereum Foundation and the SEC could be reached, with the foundation potentially facing a large penalty and becoming required to register as a security in the American marketplaces instead.
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Trading with Ether should follow the same regulations as stocks and bonds, according to Ismail. This situation, he suggested, would bring much-needed clarity to market participants regarding regulations. In his view, this development could ultimately prove advantageous for the cryptocurrency market’s overall valuation in the long run.
If the SEC decides to sue the Ethereum Foundation, the final decision regarding the nature of Ether – being a commodity or a security – will be clear-cut. Regardless of the verdict, it would significantly influence Ether’s market value and have substantial repercussions for the Ethereum blockchain ecosystem. This could potentially be the most pivotal lawsuit in the history of cryptocurrency.
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2024-04-09 18:27