SEC Declares Ethereum Not a Security

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The news that the US SEC deemed Ethereum not a security is not surprising at all. Some may ask why this is so despite the fact that Ethereum is the best performing cryptocurrency with a current market cap of $14 billion, second only to Bitcoin $68.8 billion as at the time of post. The decision by the SEC however is not news as the same had been announced some time in 2018.Why does Ethereum not fit as a security? Let us have a look at some of the reasons why SEC came to this conclusion.

What constitutes a security?

A Supreme Court ruling in 1949 set the rules as to what characterizes securities, known as the Howey Test. In a summary of the case, two corporate defendants based in Florida offered real estate contracts for portions of land with orange trees. The defendants offered prospective buyers an option to lease any purchased land back to the defendants, who would tend to the land, harvest, pool, and market the orange yield. Coincidentally, most of the buyers were not farmers and did not have interest or the agricultural expertise, and were happy to lease the land back to the defendants. However, the U.S. Securities and Exchange Commission (SEC) argued that this was illegal practice and the defendants were promptly sued.

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Since the defendants had not filed a securities registration statement according to the SEC, they had broken the law. The Supreme Court at the time launched investigations as to the agreements signed between the defendants and the purchasers of the land and they concluded that the leaseback was indeed a security. The case was a landmark decision that helped develop attest to determine which transaction constitutes an investment or not, and if it is then it will be subject to securities registration requirements.

The said transaction is an investment contract if it fulfills the following criteria:

  • It is an investment of money or exchangeable for money
  • The investment is in a common enterprise and therefore tradable.
  • There is an expectation of profit from the work of the promoters or the third party.

As for the term ‘money’, the definition is not exactly limited to that term and could include other assets that fulfill the other two conditions. It is also important to note that if the profits that emerge from an investment contract are only deemed a security if they are not controlled by the investor, but by a third party.

Ethereum fails as a security due to the friction between the transactions and asset ownership. The platform implements smart contracts coined the ERC-20, which completely eliminate the third party efforts to effect traditional contracts. William Hinman, Director of SEC division of corporate finance , stated that the decentralized nature of the Ether transactions do not qualify as securities since the efforts of the third party are no longer a factor to determine the success of the enterprise.

This test is relevant to ICOs especially because of the fact that regulation has been slow and uncertain. As such, the SEC feels that deeming Ethereum a security is counterproductive as ICOs are used for crowd funding and are usually designed to work as the projects’ final product and not necessarily to generate future profits or ownership in a company.

Recommendations

In revision, the decision leaves room for innovation and maybe in future, Ethereum and other cryptocurrencies can cross the threshold into being treated as securities if they deliver a future token to investors or tokens that represent a certain future profit based on the efforts of a contacted developer. Another way to allow them to be classified as securities is to probably change the programming model that effects smart contracts to include financial primitives such as equity, debt, risk, dividends and payments.

 

 

 

 

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