Key takeaways

• Different regulatory bodies and jurisdictions classify Ethereum as various things, from a security to a currency to a commodity. 
• Initially seen as a security during its ICO due to centralized control, it was later deemed decentralized enough to shake that classification.
• ETH functions as a medium of exchange and store of value but is not recognized as legal tender, limiting its use as a currency.
• The CFTC classifies ETH as a commodity because of its fungibility and active trading. However, traditional commodity regulations may not fully suit digital assets.

Ethereum — The Swiss army knife of digital assets

Regulatory bodies and jurisdictions can’t agree on a single classification for Ethereum — it’s technically a security, a currency and a commodity. This creates somewhat of a conundrum for the world’s second-largest cryptocurrency by market capitalization.

Ether’s (ETH) versatility and broad functionality set it apart, even if this makes it harder to define. Yet it isn’t exactly suffering from its ambiguous classification, even with the United States Securities and Exchange Commission still potentially holding it under the agency’s jurisdiction.

Without a strict classification, Ether can potentially avoid the full brunt of regulations specific to securities, commodities or currencies. Indeed, Ether’s broad functionality allows it to be used in various ways, from running decentralized applications (DApps) to enabling smart contracts and acting as a medium of exchange. This versatility is key to its value and widespread adoption.

Here’s what causes the trilemma: Is ETH a security, currency or commodity? 

• Ether was initially classified as a security during its initial coin offering (ICO) but is generally not considered a security now due to its decentralized nature.
• Ether functions as a medium of exchange but does not meet the traditional definition of a currency.
• The US Commodity Futures Trading Commission classifies Ethereum as a commodity, and it is regulated as such in futures markets.

While the trilemma of classifying cryptocurrencies as securities, commodities or currencies applies broadly across the cryptocurrency landscape, not just to Ether, Ether is actually fairly unique in the fact that it’s “indefinable.” 

For example, Bitcoin (BTC), Litecoin (LTC) and Bitcoin Cash (BCH) are not as frequently referenced in the securities debate. Their classifications are more straightforward, with Bitcoin and its derivatives widely accepted as commodities and digital currencies, largely escaping the same level of regulatory ambiguity that Ether faces.

Ether, the security 

The Howey test determines whether an asset is a security in the US by assessing if it meets the criteria of an “investment.”

The test consists of four criteria:

1. Investment of money: Money is invested into the asset.
2. Common enterprise: The investment is in a shared venture, meaning investors’ fortunes are tied together.
3. Expectation of profits: Investors expect to make a profit.
4. Efforts of others: The profits come from the efforts of a promoter or third party, not the investors themselves.

If a transaction meets all four criteria, it is classified as a security and is subject to securities regulations. Let’s put Ether under the magnifying glass. 

Investment of money: During Ethereum’s ICO in 2014, investors bought ETH expecting its value to increase. They exchanged money or other cryptocurrencies like Bitcoin for ETH.

Check. 

Common enterprise: The funds from the ICO were pooled and managed by the Ethereum Foundation to develop and promote the Ethereum network. This pooling of resources means the success of the project depended on the combined efforts of the investors and the foundation.

Check. 

Expectation of profits: Investors expected ETH’s value to rise as the Ethereum network grew and became more widely adopted.

Check. 

Efforts of others: The success and value of ETH depended heavily on the Ethereum Foundation and its developers, who were responsible for creating, promoting and maintaining the network. Investors’ profits largely relied on these efforts.

Check. 

As a result, the US Securities and Exchange Commission has indicated that Ethereum was initially sold as a security during its ICO because it met the criteria of the Howey test at that time. Indeed, it would still be in the “security” bracket if it didn’t slowly begin to erase the check in the fourth bracket. 

Over the years, the number of nodes (computers running the Ethereum software) has grown, spreading control and verification of transactions across a broader network and reducing reliance on any single entity.

As such, in 2018, the SEC revised its classification, arguing that the network has since evolved into a sufficiently decentralized system, reducing the reliance on the efforts of a central entity. As a result, Ether may no longer be classified as a security in its current state. 

Is security classification out of the question for Ether? 

Not necessarily. It’s important to consider a few key points:

• When the Howey test was established in 1946, the concept of an asset operating on a decentralized ledger was entirely foreign. The regulatory framework did not account for the complexities introduced by blockchain technology and decentralized networks.
• The asset’s price movements can’t be solely attributed to the actions of individual investors. Significant factors influencing Ethereum’s value include the development activities by core developers, network upgrades and broader adoption by enterprises and decentralized applications. These influences resemble the “efforts of others” component of the Howey test.
• Ethereum’s transition to proof-of-stake (PoS) introduces a new dynamic where validators, who earn rewards for securing the network, could be seen as analogous to the “efforts of others” that contribute to the investment’s success.

Because of these factors and the evolving nature of regulatory interpretations, Ether’s reinstatement as a security is a real possibility.

Did you know? Despite its decentralized status now, Ethereum’s ICO raised over $18 million in just 42 days, a fact that initially classified it as a security due to the centralized control during its launch.

Ether, the currency 

Currencies are used as a method of payment with legal recognition in the financial system.

In Japan, Ether is a legal method of payment. But does this make it a currency in the traditional sense? 

In trying to establish a definition, let’s take a look at the “currency” checklist. 

1. Currency must serve as a medium of exchange: Currency is used to facilitate transactions for goods and services.
2. It must represent a unit of account: Currency provides a common measure for valuing goods and services.
3. It must be a store of value: Currency can maintain its value over time, allowing individuals to save and retrieve value in the future.
4. It ought to be accepted as legal tender: Typically, currency is recognized by a government and is legally accepted for payment.

Now, let’s once again magnify Ether.

Medium of exchange: Ether is accepted by various merchants, online platforms and DApps for transactions.

Check. 

Unit of account: Ether is used to price goods and services within its ecosystem, establishing itself as a standard measure for these costs. 

Check. 

Store of value: Many individuals and institutions hold ETH as an investment, expecting its value to appreciate over time. This speculative aspect, combined with its use in decentralized finance (DeFi) applications, supports its role as a store of value.

Check.

Legal tender: Ether is not recognized as legal tender by any government. Legal tender status is typically reserved for state-issued currencies like the US dollar, euro or Japanese yen.

Uncheck. 

While Ether exhibits several characteristics of a currency, particularly within its ecosystem, it does not fully align with traditional definitions, primarily due to the lack of government recognition as legal tender. This means, for example, ETH cannot be used for settling public and private debts. 

However, it’s very probable that this could change. After all, in June 2021, El Salvador became the first country to adopt Bitcoin as legal tender. This was followed by the Central African Republic, which adopted BTC as legal tender in April 2022 (later to be reversed). 

Did you know? In 2021, the European Central Bank (ECB) stated that cryptocurrencies like Ether are not actual currencies but “crypto assets,” highlighting the ongoing debate about their proper classification.

Ether, the commodity 

While Ether is debated as a security or a currency, it is also classified as a commodity, particularly by the Commodity Futures Trading Commission in the US.

This might seem unusual at first glance, but it aligns completely with how the CFTC approaches certain digital assets, including Bitcoin. 

So, what’s the commodity checklist? 

1. Fungibility: Commodities are typically fungible, meaning that each unit is essentially identical and interchangeable with another. Ether, like Bitcoin, is fungible because one ETH is identical to another ETH, so it’s a “check” in that regard. 
2. Store of value and trade: Commodities often act as a store of value and are traded in markets. Ether holds value and is actively traded on various exchanges worldwide, as we’ve seen. So, check. 
3. Lack of central issuer: Unlike securities, which often involve a central issuer or entity that profits from the sale, commodities do not. Indeed, Ether now operates on a decentralized network, and no single entity controls its issuance or distribution in a way that would classify it as a security. 

A final “check” for Ether. 

Did you know? The Chicago Mercantile Exchange (CME) launched Ether futures contracts in February 2021, allowing institutional investors to trade ETH just like any other commodity, such as oil or gold.

Ether makes sense as a commodity. After all, the trading of Ether on futures markets and the existence of derivative products like futures contracts align with how commodities are traded. The CFTC regulates these markets to prevent fraud and manipulation, similar to other commodity markets.

Moreover, under the Commodity Exchange Act (CEA), the definition of a commodity is broad and can encompass a wide range of items, including digital assets. The CFTC has the authority to oversee and regulate commodities trading, and Ether fits within this regulatory framework.

By classifying Ether as a commodity, the CFTC can apply regulations to protect investors from fraudulent activities and market manipulation on trading platforms and futures markets.

However, it’s not a concrete definition. The widespread use and acceptance of cryptocurrencies could complicate the implementation of monetary policy by central banks. 

Additionally, the decentralized nature of many cryptocurrencies makes it difficult to apply traditional commodity regulations, which are typically designed for centralized markets and assets.

Because of these reasons, classifying not just Ether but all cryptocurrencies as commodities carries substantial challenges and, as such, could very well be subject to change.

What is Ethereum, then? 

In a sense, Ether can fit all or none of these definitions simultaneously. The core issue is the lack of a comprehensive global regulatory framework for cryptocurrencies, forcing jurisdictions and regulators to adapt existing frameworks to these new digital assets.

Given this context, it is essential to weigh the pros and cons of each classification as we approach a conclusion.

1. As a security

Pros:

• Investor protection: Ensures transparency, disclosures and fraud reduction, boosting investor confidence.
• Regulatory clarity: Provides clear guidelines and a stable investment environment.

Cons:

• Compliance burden: Imposes costly and time-consuming regulations, hindering startups.
• Stifling innovation: Heavy regulation can slow down development and discourage experimentation.

2. As a currency

Pros:

• Ease of use: Facilitates everyday transactions, enhancing its role as a medium of exchange.
• Regulatory simplicity: Fewer complex regulations compared to securities and commodities.

Cons:

• Monetary policy complications: Could complicate central banks’ monetary policies.
• Lack of legal tender status: Not guaranteed acceptance for all debts and transactions.

3. As a commodity

Pros:

• Market regulation: Well-regulated to prevent fraud and manipulation, protecting investors.
• Familiarity: Aligns with traditional market practices, increasing acceptance and integration.

Cons:

• Inadequate fit: Traditional commodity regulations may not suit digital assets, leading to gaps.
• Complexity: The decentralized nature complicates the application of centralized commodity regulations.

You likely reached a natural conclusion here — while not a perfect fit, classifying Ether as a commodity seems to be the most suitable definition, given the current regulatory landscape.

Think of Ether once more as a Swiss Army knife. Naturally, the knife blade is used the most frequently, while the hook sees the least wear. Nonetheless, they are all part of the same tool. Similarly, Ether’s functionality spans various domains, but its predominant use aligns with the characteristics of a commodity.

The future of Ethereum’s classification 

Until a complete, globally applicable regulatory framework tailored to the unique aspects of digital assets comes into force, classifying Ether as a commodity will have to suffice.

This approach provides a structured regulatory environment — though not without its challenges — and serves as a temporary measure until more comprehensive regulations emerge.

Did you know? According to a 2022 survey by the Pew Research Center, 58% of Americans believe that cryptocurrencies need more regulation to ensure their safety and security, reflecting growing public concern over the potential risks associated with digital assets.

The European Union’s Markets in Crypto-Assets Regulation (MiCA) is an example of such a novel regulatory framework that is only just coming into force. 

MiCA classifies crypto assets into different categories, such as asset-referenced tokens, e-money tokens and other crypto assets. Ether would typically fall under the category of “other crypto assets” not pegged to any specific asset.

The “other” category under MiCA provides a balanced regulatory approach for Ether, offering flexibility, encouraging innovation, ensuring market integrity and enhancing consumer protection. This classification supports the growth of the Ethereum ecosystem while maintaining necessary safeguards to protect investors and uphold financial stability.

It’s not perfect, but it’s a step in the right direction — one that other jurisdictions are likely to follow as time goes on.

Written by Bradley Peak