Is Ether a security?

Last Thursday morning, I wondered if I needed to write a follow-up article about Silvergate Bank. Thursday night I wondered if my main topic should instead be about ether potentially being a security. And then, apparently, some things happened.

You’re reading State of Crypto, a CoinDesk newsletter that looks at the intersection of cryptocurrency and government. click here to sign up for future issues.

Last week, the New York Attorney General’s office sued KuCoin for operating an unregistered securities/commodity brokerage in the Empire State. Most of the complaint is pretty straightforward – NYAG claims that KuCoin offered tokens that are securities under New York’s General Business Law (the Martin Act, which we’ve seen a few times before). More intriguingly, the lawsuit alleged that ether (ETH), the second largest cryptocurrency by market capitalization and one that has futures products built on top of it, was also a security listed by KuCoin.

Other details include the fact that KuCoin apparently did not bother to respond to a subpoena from the NYAG.

If ether is truly a security, it means that every crypto exchange in the US must register as a securities trading platform with the US Securities and Exchange Commission (SEC) and adhere to a strict disclosure regime that is likely to make it difficult for many, if not all, of these exchanges to continue operations. But that’s a very big if.

The NYAG sued KuCoin last week under state law, alleging that ether, after merging, is a security under the Ethereum blockchain’s proof-of-stake consensus mechanism. NYAG also alleged that terraUSD (UST) and luna (LUNA) are securities, as well as KuCoin’s Earn platform. I won’t go into the last two – regulators have been claiming for some time now that “earn” products are securities, and have settlements with various lenders to support that claim, and there are other issues looking at the terraUSD/luna ecosystem .

And not to pull a bait-and-switch on you, but I have no answer to the question posed in the title of this section. However, I wanted to find out what the outcome of the New York Attorney General’s case against KuCoin might be.

Matthew Blaine, a New Jersey-based partner at the law firm Davison, Eastman, Muñoz, Paone, doesn’t think much will come of it.

The case will probably end with a verdict, he said in a telephone conversation.

“If there is any judgment [ether] is an unregistered security, it’s not binding on any issue or things of that nature,” he said. “It really only has to be seen in the narrow lens through which this case passes.”

He compared the NYAG lawsuit against KuCoin to the US Securities and Exchange Commission’s (SEC) lawsuit against former Coinbase CEO Ishaan Wahi. In that case, the SEC alleged that a number of tokens were securities, but did not sue Coinbase for listing the tokens, or the token issuers themselves.

Similarly, KuCoin has not sued the Ethereum Foundation, only the one exchange, Blaine said.

It is also unclear whether the NYAG is seeking registration from these other types of entities, or indeed from other crypto exchanges operating under the New York Department of Financial Services’ BitLicense.

The NYAG did not return multiple requests for comment, including a question about whether it would require licensed crypto exchanges to also register as securities trading platforms.

The NYDFS is, of course, the state’s banking and financial regulator that oversees all crypto companies, but the regulator’s authority could be challenged by the lawsuit.

A former NYDFS official told CoinDesk that the New York Attorney General’s office and the banking regulator did not have good relations while at the NYDFS, describing those relations as an “enduring power struggle.”

The other factor is of course the SEC. SEC Chairman Gary Gensler has been known (a few times now) to say that he believes proof-of-stake cryptocurrencies are similar to securities. The NYAG lawsuit against KuCoin may not set much precedent for the SEC, but it’s still a sign that regulators are starting to figure out what they’re thinking.

However, at least one judge has very little patience with how the SEC currently approaches these questions of whether something is a security. Judge Michael Wiles, of the New York Southern District Bankruptcy Court, wrote a rather scathing order explaining his approval of Voyager Digital’s restructuring plan to sell itself to Binance.US, saying the regulator did not provide any clarity for industry operators.

“If the current regulatory environment can be characterized as uncertain, in my view the future regulatory environment can only be characterized as virtually unknown,” the judge wrote. “There have been various proposals in Congress to adopt different types of regulatory regimes for cryptocurrency trading. Meanwhile, the SEC has filed some lawsuits against specific firms with respect to specific cryptocurrencies, and these actions suggest that a broader regulatory attack may be in store.”

The judge reiterated his oral order from March 7, saying that the SEC’s arguments were vague and that the regulator did not provide any evidence to support the arguments that Binance.US can operate an unregistered securities exchange or that the VGX token can be a security.

“Although the SEC argued that the Debtors somehow had to prove a negative — ie, that the Debtors did not violate securities laws and that Binance.US is not in violation of broker-dealer registration requirements — the SEC had not even affirmatively asserted that the Debtors did anything wrong, or that Binance.US did something wrong,” the judge wrote. “Also, the SEC had provided no guidance at all as to what the Debtors allegedly had to prove on these issues, or how the Debtors could possibly prove what the SEC wanted them to prove without to receive any explanation at all from the SEC as to why the debtor’s operations, or Binance.US’s operations, may raise legal questions.”

So the crypto industry just lost three banks that actually brought crypto companies: Silvergate, Silicon Valley and Signature. Their collapse has been seen by some as part of a coordinated conspiracy to de-bank crypto in the US, due to the timing and explosiveness of the near-simultaneous failures.

In the aftermath, crypto companies are looking for alternatives (including CoinDesk, which tapped SVB). While this is going to be an interesting timeline in itself, another question could be what happens with the loss of the Silvergate Exchange Network and Signet, two tools created by Signature and Silvergate to allow crypto companies to process transactions 24/7.

A Coinbase spokesperson said the exchange had preparedness in place should Signet be shut down.

“In that hypothetical situation, there are other players in the market who could step up to fill the void. As we saw over the weekend, crypto is resilient and we would absorb this and move forward just as we have in other events,” the spokesperson said .

Dante Disparte, chief strategy officer and head of global policy at stablecoin issuer Circle, said the two services helped build crypto, though he noted that ACH transactions and wire services also remain important.

“While [Signet and SEN] may go down in history as abject failures, they demonstrated that banks can innovate, he said.

Another result could be that larger banks continue to gain new business while smaller community or regional banks and credit unions lose out, Disparte said.

One such company forced to make changes was Circle, whose USDC stablecoin lost its dollar peg for an entire weekend as a result of SVB’s collapse, which began on Friday and continued after Circle acknowledged it had $3.3 billion, or around 8%, of the USDC reserves. in the bank. The stablecoin finally regained its tether earlier this week.

There is also the question of whether or not bank regulators force banks to remove crypto clients. It’s a conspiracy theory that has been revived in recent weeks, with everyone from lawmakers to industry participants saying “Operation Choke Point 2.0” is real.

Recent guidance from banking regulators, suggestions that Signature and Silvergate were forced to fold due to anti-crypto animus, and news of the FDIC’s demand that Signature’s bidders not buy the crypto business have bolstered these claims.

However, Disparte doesn’t think so.

“I categorically reject the idea that this is Choke Point 2.0,” he said. “For one thing, [the original, Obama-era] Choke Point was hidden, [but] this is blatant … some companies are creating an asset that can’t be banked.”

Other people CoinDesk spoke to, including legal counsel at a stock exchange and a member of a lobby group in Washington, DC, also do not believe in Choke Point 2.0.

Austin Campbell, adjunct professor at Columbia University and former Paxos official, told CoinDesk that we may get an answer to this question of whether Choke Point is real within the next six months.

“What I would look at is that there is an obvious commercial voice for banks that can control risk. The crypto community should watch to see if it is allowed, or if sources step in and block this, he said. “If new banks come in and start serving all these customers and bring them on board, then it’s probably just a risk failure story.”

If you have thoughts or questions about what I should discuss next week or any other feedback you’d like to share, feel free to email me at [email protected] or find me on Twitter @nikhileshde.

You can also join the group conversation at Telegram.