Ethereum’s major software update on September 15 may have turned the second-largest cryptocurrency into a security in the eyes of a top US regulator.
Securities and Exchange Commission Chairman Gary Gensler said Sept. 15 that cryptocurrencies and intermediaries that allow holders to “stake” their coins could pass a key test used by courts to determine whether an asset is a security. Known as the Howey test, the test examines whether investors expect a return from the work of others.
“From the coin’s perspective…this is another indication that under the Howey Test, the investing public expects gains based on the efforts of others,” Gensler told reporters after a congressional hearing. He said he was not referring to any specific cryptocurrency.
Issuers of securities — a category of assets that includes stocks and bonds — are required to file extensive disclosures with the SEC under legislation passed in the 1930s. Exchanges and brokers that facilitate trading in securities must follow strict rules to protect investors from conflicts of interest. Cryptocurrency issuers and trading platforms face severe liability claims when they sell assets deemed securities by the SEC or courts.
Staking is one of two ways cryptocurrency networks verify transactions. Used by some of the biggest cryptocurrencies – including Solana, Cardano and, as of this week, Ether – it allows investors to lock their tokens for a period of time in order to receive a return.
When an intermediary like a crypto exchange offers staking services to its customers, according to Gensler, “it looks — with some labeling changes — very much like lending.” The SEC has repeatedly signaled over the past year that companies offering crypto lending products must register with the agency, and in February forced BlockFi Lending to pay $100 million for failing to do so.
Competition for crypto jurisdiction is intensifying among federal agencies and the congressional committees that report to them. On Sept. 15, while the Senate Agriculture Committee, which oversees the Commodity Futures Trading Commission, held a hearing to review a crypto bill, the Senate Banking Committee, which oversees the SEC, held a simultaneous hearing for members to review Gensler to question.
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The crypto bill proposed by leaders of the farming group last month would explicitly designate bitcoin and ether as digital commodities rather than securities. Under current law, such assets have no federal regulatory authority. The bill would give the CFTC, which oversees derivatives markets, the power to regulate digital goods.
Exchanges like Coinbase and FTX would have to register with the CFTC, monitor trading, protect investors from abuse, and only offer assets that are resistant to market manipulation, among other things. They would also be required to disclose some information about the assets they list, such as: B. the operational structure and conflicts of interest.
Consumer advocates fear the CFTC lacks the resources and experience to scout for retail investors in a market Gensler calls the Wild West. The CFTC’s staffing is a fraction that of the SEC, and the markets it oversees are dominated by sophisticated hedge funds, banks and corporations – not individuals saving for retirement.
To fund its oversight of the digital commodities market, the CFTC would need $112 million over the first three years for rulemaking, hiring, training and outreach, CFTC Chairman Rostin Behnam said during the hearing. He said the amount would be generated by crypto companies in the form of a usage fee. The agency has a current annual budget of $320 million, Behnam added.
Although she doesn’t communicate directly with individual investors, Behnam said the CFTC works closely with the National Futures Association and state regulators to ensure that the people and entities under its jurisdiction are complying with the law.
The crypto industry has shown a strong preference to be regulated by the CFTC rather than the SEC, which has a strict disclosure regime that crypto lobbyists say is expensive and impractical. Crypto firms have spent millions of dollars lobbying Congress for its interests.
Before Ether transitioned to the Proof-of-Stake model this week, Ether previously relied on an alternative model known as Proof-of-Work, which is used by Bitcoin. The model is often criticized for its high power consumption, as miners commit massive amounts of processing power to the network.
Under the bill, the CFTC would also need to work with other regulators with expertise in the energy space to produce a report on crypto projects’ energy use.
The agency would make recommendations to either create a disclosure system or provide incentives for companies to indirectly move from proof of work to proof of stake or other methods of reducing energy consumption.
Write to Paul Kiernan at firstname.lastname@example.org and Vicky Ge Huang at email@example.com
This article was published by The Wall Street Journal, part of Dow Jones