Ethereum Announcement Rings Bell for Unregistered Securities

The big news this week is that the Securities and Exchange Commission (SEC) declared that Bitcoin and Ethereum are not securities.

The long-awaited decision brings a lot of clarity to investors as to what will be considered a security going forward and why. The principle factor in determining whether a crypto-asset is a security seems to be its level of decentralisation. The Director of the division of Corporation Finance William Hinman:

“…putting aside the fundraising that accompanied the creation of Ether, 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.”

There’s an implication here that Ethereum was likely a security at the time of its ICO, but now is not because it’s decentralised. This is in line with past comments by the SEC which has emphasised the possibility of definitional change over time. SEC Chairman Jay Clayton:

“If the network on which the token or coin is to function is sufficiently decentralized — where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts — the assets may not represent an investment contract.”

At what point is a crypto-asset sufficiently decentralised to be exempt from securities regulation? Many ICOs are no doubt biting their nails thinking about this question. And none more than Ripple, whose XRP was notable in that Hinman didn’t mention it at all. This omission rang loudly, but the SEC’s silence will not last long. Based on the 13 criteria outlined as guidance, it’s hard to see how XRP could go the same way as Bitcoin and Ethereum and be spared the fate of securities regulation. From our perspective, XRP isintimately connected to Ripple Labs.

What will happen when regulators come down heavily on unregistered securities masquerading as decentralised crypto-assets? There are arguments to be made that several of the top 10 cryptocurrencies by market capitalisation are securities. This list may include not just XRP, but also EOS, Stellar, Cardano, IOTA, and TRON. If the SEC begin to enforce, which seems likely, the impacts could be immense. Legal battles between the SEC and Ripple Labs and the attempted closure of exchanges that have been selling unregistered securities would just be the beginning. All this would create uncertainty in the market. Projects that are not securities (i.e. Ethereum and Bitcoin) may benefit from a flight to quality. But there’s also the possibility that investors simply panic and sell back into fiat.

Nothing is certain, but expect this announcement to have consequences for the whole crypto-asset ecosystem going forward. A close reading of the announcement implies that many other projects will be considered a security going forward. The announcement was more interesting for what was unsaid and implied than what was stated overtly.

For more information, read the full transcript of Director of the division of Corporation Finance William Hinman’s speech here, along with Fred Wilson’s take.