SEC investigating Ethereum Foundation in bid to declare ETH a security

Cracks are appearing in the Ethereum Foundation following reports that the U.S. Securities and Exchange Commission (SEC) is probing the group ahead of plans to label the ETH token an unregistered security.

On March 20, sharp-eyed observers noticed a small but significant change in the Ethereum Foundation’s GitHub repository that was made on February 26. Gone from the site was a block of text declaring that the Foundation “has never been contacted by any agency anywhere in the world in a way which requires that contact not be disclosed.”

The change was made by developer Pablo Pettinari, whose description of the revision stated that the change was necessary due to the Foundation having “received a voluntary enquiry from a state authority that included a requirement for confidentiality.” A ‘warrant canary’ was also quietly removed from the Foundation site, indicating that it had been served with a subpoena or other secret government request.

Fortune subsequently reported that the SEC had served subpoenas on multiple companies seeking financial records and other documentation regarding their dealings with the Foundation. One of these companies told Fortune that the SEC had launched a probe into the Foundation following the Ethereum network’s September 2022 transition
from a consensus mechanism based on proof-of-work (PoW) to one based on proof-of-stake (PoS).

PoS requires Ethereum transaction validators to post a ‘stake’ of 32 ETH tokens, a sum worth around US$51,000 at the time (currently worth over US$100,000), making it a prohibitive barrier for most ETH holders to clear. The net result of this shift was that a handful of ETH whales—including many Foundation insiders who claimed large portions of the ETH distributed via the network’s controversial pre-mine—are now reaping most of the rewards for keeping the network humming.

Fortune claimed that individuals at three companies that received SEC subpoenas said that the shift to PoS had offered the agency ‘a new pretext’ to define ETH as a security. This isn’t much of a revelation: SEC Chairman Gary Gensler commented at the time that entities offering PoS-based ‘staking services’ represented “another indicia that under the Howey test, the investing public is anticipating profits based on the efforts of others.”

Gensler wasn’t alone in making this observation. In March 2023, the New York Attorney General’s Office filed charges against the KuCoin exchange for failing to register as a securities broker-dealer. The NYAG called the complaint “one of the first times a regulator is claiming in court that ETH, one of the largest cryptocurrencies available, is a security.”

The NYAG explained that “ETH’s development and management is largely driven by a small number of developers who hold positions in ETH and stand to profit from the growth of the network and the related appreciation of ETH … [Ethereum Co-Founder Vitalik Buterin] and the Ethereum Foundation retain significant influence over Ethereum and are often a driving force behind major initiatives on the Ethereum blockchain that impact the functionality and price of ETH.”

Prior to the network’s launch, Buterin himself stated publicly that “if you’re investing in Ethereum, I would say you’re investing in the team and community.” More recently, former Ethereum insider Steven Nerayoff offered evidence showing that Ethereum Foundation members understood from the start that ETH was a security.

Nerayoff released emails showing Ethereum Co-Founder Joseph Lubin asking lawyers for a legal opinion that would leave insiders “well insulated from criminal liability regarding securities laws.” This acknowledgment of ETH’s security status helps explain why Lubin and other insiders did such a full-court press on Gensler’s predecessor, William Hinman, who in June 2018 controversially declared that ETH was originally a security but then “become something other than a security.”

(g)ETF(*cked)

The SEC has yet to comment publicly on the Fortune report other than to say it doesn’t comment on possible investigations, whether they exist or not. The ETH token suffered a momentary plunge as the story broke, but has since recovered its losses and then some.

Regardless, the Ethereum community is up in arms over the mounting suspicion that the SEC wants to label ETH a security in order to justify the SEC’s refusal to authorize new ETH-based exchange-traded funds (ETFs). Rightly or wrongly, the launch of multiple BTC-based ETFs in January has been credited with that token’s otherwise unwarranted spike in fiat value, and ETH holders want to artificially pump their own bags in the same fashion.

Foundation members decided they wanted in on the ETF spoils once they learned that their developer counterparts at BTC Core had been promised a share of the profits—anywhere from 5-10% for a decade—by at least two of the BTC ETF issuers.

So far, the SEC has refused to play ball, using all the procedural options at their disposal to avoid having to issue a formal decision on any of the multiple ETH ETF applications. Just this week, the SEC told an ETF applicant to cool their heels while asking the public to submit further comments.

The SEC has until May 23 to issue a decision one way or the other, but the reported lack of communication between the SEC and applicants regarding the finer points of their paperwork has been taken as a sign that ETH won’t be getting the BTC treatment.

Labeling ETH a security could set up a regulatory turf war between the SEC and the
Commodity Futures Trading Commission (CFTC), which currently regulates ETH-based futures contracts. One year ago, CFTC Chair Rostin Behnam told Congress that “we would not have allowed the Ether futures product to be listed on a CFTC exchange if we did not feel strongly that it was a commodity asset.”

This interagency slap-fight could provoke Congress to finally set some firm boundaries between the two regulators when it comes to digital assets. But given the current Congress appears infinitely more interested in performative stunts than actually legislating, don’t hold your breath.

Meanwhile, as everyone focuses on the ETF question, there is also the possibility that Gensler will use whatever information he may have gleaned via the SEC’s subpoenas to file a complaint against the Ethereum Foundation, Buterin, Lubin and countless others connected with that centralized mothership.

It’s not like there aren’t plenty of options—in terms of both the number of targets and the type of charges—to choose from.

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