Ether Security Debate Heats Up as SEC ETF Deadline Nears

The discussion over whether Ether qualifies as a security has become a focal point in the cryptocurrency world as the United States Securities and Exchange Commission (SEC) approaches its deadline for determining whether to approve a spot Ether exchange-traded fund (ETF). The SEC is set to make its decision on VanEck’s spot Ether ETF application by May 23. Ether, which is the second-largest cryptocurrency following Bitcoin, faces a significant moment, and much of its future hinges on whether the SEC considers it a commodity or a security.

Earlier this year, the SEC approved spot Bitcoin ETFs on January 10, which confirmed Bitcoin’s status as a commodity. The same is not guaranteed for Ether. The SEC’s ongoing uncertainty about whether Ether is a security has led several analysts to adopt a more cautious outlook. Bloomberg ETF analyst Eric Balchunas, who previously estimated a 70% chance of approval for a spot Ether ETF, has recently lowered the odds to a “very pessimistic 25%.”

Much of the current debate centers around an investigation led by Gurbir Grewal, head of the SEC’s Division of Enforcement, into Ether’s status as a security. In April 2023, the SEC constituted a five-member commission to delve into the “Ethereum 2.0” project as part of these efforts. Adding to the complexity, Consensys, a prominent Blockchain and Web3 software firm, has sued the SEC, challenging its authority to classify Ether as a security.

Jamie Wright, a legal expert and CEO of the Wright Law Firm, weighed in on the potential outcomes of this conflict between the SEC and the Commodity Futures Trading Commission (CFTC). Wright believes that the SEC might hold the upper hand because its regulatory framework is more geared toward investor protection, which is a high priority: “The CFTC focuses on commodities, which traditionally face less direct oversight than securities. Since there is no specific cryptocurrency regulator, the SEC’s emphasis on investor protection and disclosure might make its position more influential.”

There are indications that SEC Chair Gary Gensler’s views could also play a pivotal role. Gensler approved the spot Bitcoin ETFs, which many consider a positive signal for Bitcoin. Internal SEC documents suggest that Gensler views Ether as a security, which might influence his stance against approving a spot Ether ETF. Finance lawyer Scott Johnsson pointed out that the SEC’s upcoming decision includes a “notice of the grounds for disapproval,” a clause absent in the Bitcoin ETF decision, suggesting that the SEC might deny the application based on categorizing the spot filings as improperly filed if they hold a security.

Senior legal counsel Adam Berker from Mercuryo commented that the SEC and Gensler have consistently treated all digital tokens aside from Bitcoin as securities. He explained that Gensler adopts a global perspective, using the Howey test to equate cryptocurrencies with securities. The SEC’s focus on regulating the rapidly growing interest in cryptocurrencies similar to traditional securities reflects this stance.

One of the significant factors that might weigh against the approval of an Ether ETF is staking. Financial instruments are generally considered securities if there’s an expectation of profit from a passive investment of money based on the work of others in a common financial project. Ether’s initial coin offering and its centralized Ethereum Foundation bring it closer to being seen as a security. Ethereum’s proof-of-stake (PoS) mechanism, where validators earn rewards based on the amount staked, introduces elements that could meet the Howey test criteria.

Peko Wan, CEO of PundiX, acknowledged that while Ethereum’s shift to PoS introduces factors that align with the Howey test, it doesn’t necessarily mean Ether will be classified as a security. Ethereum’s utility extends beyond investment purposes, facilitating smart contracts and decentralized applications, according to Wan. This utility might be an argument against classifying Ether solely as a security.

In anticipation of the potential challenges that staking could pose to the SEC’s approval, five ETF applicants recently amended their filings to remove any mention of staking. These amendments stipulate that the ETF’s Ether cannot be staked by anyone, aiming to address SEC concerns.

Some experts believe the upcoming U.S. presidential election could significantly impact the chances of spot Ether ETF approval. Kadan Stadelmann, CTO at Komodo, noted that cryptocurrency has emerged as a topical issue this election season, with former President Donald Trump’s favorable stance on crypto assets contrasting with the SEC’s current approach. A change in administration could usher in a more crypto-friendly era, although this remains speculative.

While some in the crypto community initially saw Gensler’s appointment as SEC Chair as a positive development for the sector, his hard stance has left many wondering about the future regulatory landscape. Jamie Wright added that a new administration could potentially change existing policies and regulatory priorities, making the regulatory environment for cryptocurrencies more dynamic and uncertain.