Yesterday blockchain development firm Consensys filed a Texas lawsuit against the Securities and Exchange Commission (SEC) and its Commissioners, arguing that the SEC is unlawfully claiming that Ethereum’s ETH token is a security. The lawsuit also seeks an injunction preventing the SEC from taking legal action against MetaMask, Consensys’ popular cryptocurrency wallet with more than 30 million monthly active users.
Some redacted parts of the text are worth exploring as they could imply that the SEC has issued some confidential ruling or internal guideline that ETH is a security. Apart from the redactions, the lawsuit explicitly states, “The SEC’s investigation into transactions in ETH is predicated on a determination that ETH is a security.”
Founded by Ethereum co-founder Joe Lubin, ConsenSys is backed by numerous traditional finance (TradFi) firms. These include HSBC, JP Morgan, Mastercard, Microsoft, Softbank and UBS.
MetaMask wallet
Consensys was first informed about the SEC’s interest in MetaMask in April 2022 and has provided considerable information since then. On April 10 Consensys received an SEC “Wells Notice” warning of an imminent enforcement action. This was on the grounds that the SEC believes the MetaMask Swaps and Staking services violate federal security laws because Consensys is not a broker dealer.
Consensys argues it is simply providing a user interface enabling access to other services such as decentralized exchanges (DEXs) and staking protocols. The SEC has also sent a Wells Notice to Uniswap, the leading DEX.
While it’s a different jurisdiction, Europe’s latest anti money laundering (AML) legislation imposes requirements on crypto asset service providers, but explicitly excludes self-hosted wallet providers such as MetaMask.
Did proof of stake make ETH a security?
Back in 2018 there was much debate about whether or not ETH was a security. One lawyer in the crypto space raised questions about the patterns in the ETH ICO and concluded it probably was*. However, just a few months later, SEC Director William Henman delivered a high profile speech in which he said ETH was a commodity.
Consensys is understandably unhappy that the SEC has flip flopped on this position. However, since then Ethereum has changed by moving from proof of work to proof of stake (the Ethereum Merge). This involves validators locking up cryptocurrency and earning a return in exchange for helping to secure the blockchain. Based on this, the SEC also targeted Consensys’ sales of ETH from its treasury and asked why Consensys considers these are not sales of securities. Additionally, Consensys received three subpoenas relating to the Ethereum Merge.
It’s not the only one that relied on the ETH being a commodity. The CFTC continues to say ETH is a commodity. As a result TradFi crypto players such as EDX Markets – founded by Fidelity, Citadel Securities and others – only trade Bitcoin, ETH and Litecoin. No license is required for spot trading of commodities.
What’s in the redactions?
Consensys’ statement that the SEC has taken the position that ETH is a security, combined with redactions in the text, indicates that the SEC’s stance appears to have formally changed.
Here’s one redaction: “The SEC’s self-aggrandizing about-face on ETH is notable for its lack of transparency. In April 2023, Gary Gensler, the Biden Administration’s crusading SEC Chair, appeared before the House Financial Services Committee. The Committee Chairman repeatedly asked Gensler: does the SEC now think ETH is a security? Gensler refused to answer this direct question from the Chairman of the Congressional committee charged with overseeing his agency. He did not want to admit that his SEC had already secretly cemented its power-grab by issuing an <redacted>.”
Elsewhere in the text it states, “ETH is not a security under the Securities Act, and therefore <redacted> exceeds the SEC’s statutory authority.”
On the basis of the first redaction, we quizzed ChatGPT to see if it could fill in any blanks. The suggestions it came up with were :
- internal memorandum
- directive to staff
- confidential ruling
- closed-door decision
- classification guideline
- enforcement action plan
- preliminary determination.
If, as Consensys implies, the SEC had already made some internal finding that ETH is a security, then given this is an about face, they should publicize it sooner rather than later. That said, Gensler has stated that proof of stake tokens should be regulated as securities for over a year.
What about an ETH ETF?
The crypto markets seem rather sanguine about the latest news of SEC’s position, perhaps because it’s already built in. ETH is up 1% during the past 24 hours. However, the SEC is also expected to approve an ETH ETF. If the SEC believes that ETH primarily trades on unauthorized exchanges, could this serve as grounds for rejecting the ETF? This reasoning differs from the grounds it used to reject previous Bitcoin ETFs, which courts threw out last year. Bitcoin is definitely a commodity, so its spot markets do not need to register.
* in response to the ICO blog post, high profile crypto techie Hasu penned another.
