Ethereum is most likely not a security under existing United States laws, as previously said by U.S. Securities and Exchange Commission (SEC) Division of Corporate Finance head William Hinman.
"Based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions,” Hinman said on June 14, 2018.
Indirect comment on Ethereum
In a letter, Clayton said that he agrees with Hinman’s explanation when a cryptocurrency transaction does not represent an investment contract or the transfer of a security.
“I agree with Director Hinman’s explanation of how a digital asset transaction may no longer represent an investment contract. If, for example, purchasers would no longer reasonably expect a person or group to carry out the essential managerial or entrepreneurial efforts. Under those circumstances, the digital asset may not represent an investment contract under the Howey framework.”
However, according to Marco Santori, the president of Blockchain.com, one of the largest cryptocurrency wallet operators in the global market, the statement by Clayton does not directly confirm the regulatory nature of Ethereum to Congress.
Clayton said that he agrees with Hinman’s explanation on the point in which a token can no longer be accurately characterized as a security but did not directly and conclusively state that Ethereum is not a security under existing laws, Santori explained:
“Clayton didn't say that ‘Ether is no longer a security.’ He said he agreed with Hinman's explanation of when a token is no longer a security. Hinman can say stuff like that but for the Chairman to say it in a letter to Congress is another matter entirely. It would be construed as binding, and the SEC isn't trying to have that.”
Although Santori said that he does not think Ethereum is a security — and so did other industry executives and regulators, including Hinman — there is a gap between an SEC official offering his thoughts on the regulatory nature of the SEC and the chairman of the commission stating it to Congress.
“Okay but is Ether a security? No, I don't think it is,” Santori said.
Does it change the ICO market?
As such, most SAFT contracts, which are considered an issuance of security, do not allow investors based in the U.S. to participate in token sales, due to the ambiguity surrounding ICO regulation.
More importantly, unless it obtains the approval of the SEC, an ICO project prefers to not risk being classified as a security within the U.S. and run into conflict with U.S. regulators rather than target U.S.-based investors.
Santori emphasized that the SEC Chairman did not endorse the SAFT framework in any manner nor reject Ethereum as a security:
“Did Clayton endorse the SAFT framework? Lolno [sic]. Nor did he say that Ether is not a security. Words have meaning, though, and so does diction. It's tough to ignore these letters and everything that goes into them. Best predictive value we have, for now.”
Clayton’s recent statement, which could be viewed as a positive step toward cryptocurrency and ICO regulation, does not provide enough clarity on the regulatory nature of most tokens and does not definitively show that Ethereum is not a security.
Why governments will likely back away from characterizing Ethereum as a security
As SEC official Hinman said last year, the definition of a token as a security will continue to be a case-by-case scenario that could differ based on time frames. The official noted that systems that directly rely on central actors or a centralized institution for success are considered securities.
Even if an ICO or a token sale starts off as a non-security, if the token begins to rely on a central institution, Hinman suggested that securities laws could be applied.
“Over time, there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required. And of course there will continue to be systems that rely on central actors whose efforts are a key to the success of the enterprise. In those cases, application of the securities laws protects the investors who purchase the tokens or coins.”
Cryptocurrencies and public blockchain networks like Bitcoin and Ethereum are unlikely to be considered securities because there always have been open-source developer communities working to improve and develop the codebases of the two crypto assets.
But, once a token or a blockchain project begins to rely on a central group of developers or authorities, it could run into the risk of being described as a security in the U.S.
Characterizing Ethereum as a security could be detrimental to the growth of the global blockchain sector. Most blockchain projects and tokens are based on Ethereum in the form of ERC-20 tokens and utilize the smart contract standard to execute transactions and process information.
As such, industry executives do not expect the regulators in the U.S. or other key governments to consider Ethereum as a security.
How is the overall regulatory landscape in the U.S.?
With companies the likes of Gemini putting in the efforts of maintaining strictly regulated cryptocurrency trading platforms that are compliant with both federal and state-specific regulations, the infrastructure of the U.S. cryptocurrency market is strengthening at a rapid pace.
However, it is not likely to see an ICO-supportive and token-sale-adopting market in the U.S. anytime soon. Similar to Japan, where ICOs to the public are banned but are set to be opened to institutional investors and potentially accredited investors, the SEC is expected to continue encouraging blockchain projects to cooperate with the agency by receiving an approval.
In December 2018, as Cointelegraph reported, Chairman Clayton said that ICOs could be an effective way for entrepreneurs and teams to raise capital, but it has to be done in the right way — i.e., following the securities laws of the U.S.
“I believe that ICOs can be effective ways for entrepreneurs and others to raise capital. However, the novel technological nature of an ICO does not change the fundamental point that, when a security is being offered, our securities laws must be followed.”
The state of the ICO market in the U.S. remains more or less similar to the time before Clayton released his statement and the securities laws remain ambiguous for projects.
Could it change at all?
The SEC is an enforcement agency that interprets the existing securities laws in the U.S. If changes are made to the securities laws, it may alter the way the SEC characterizes tokens and cryptocurrencies in general.
In late 2018, a bipartisan bill entitled “Token Taxonomy Act of 2018” was introduced, which proposed the exclusion of cryptocurrencies from the securities laws because of the limit in which the laws govern or characterize cryptocurrencies:
“Direct the Securities and Exchange Commission to enact certain regulatory changes regarding digital units secured through public key cryptography, to adjust taxation of virtual currencies held in individual retirement accounts, to create a tax exemption for exchanges of one virtual currency for another, to create a de minimis exemption from taxation for gains realized from the sale or exchange of virtual currency for other than cash, and for other purposes.”
The time frame for a vote on the the bipartisan bill still remains unclear, and it remains highly unlikely that changes will be made to the existing securities laws in the U.S. in the near-term.
In the foreseeable future, the SEC is expected to go over ICOs and token sales in a case-by-case basis, evaluating whether certain tokens or crypto assets represent potential security transactions within the regulatory framework of the U.S.