Letitia James.
That’s a name that probably won’t mean much to you, but it’s none other than one of the most powerful people in the United States, the New York’s Attorney General.
This woman, from this position of immense power, has filed a lawsuit against KuCoin for failing to register as a broker-dealer for securities and commodities.
But even though this is quite a common action against Crypto exchanges, the lawsuit is in fact a first-ever attack on the native currency of the second-biggest blockchain in the world by market capitalization.
An attack that could threaten not only its survival, but could also mean the demise of all staking blockchains.
Yes, you read that right.
When security became a cause for concern
There’s one word that is a cause for pride to Crypto enthusiasts, but used in a different context inspires extreme fear.
And that word is security.
Security, the crown jewel of Crypto
Of course, one of blockchain’s most revered features is the high security and integrity that the ledger guarantees for data stored in it, due to its decentralized nature and shared state.
In layman’s terms, once data is registered into a blockchain is really hard to modify by anyone except the owner of the private key that allows that data to be modified (for instance, if the owner of a Bitcoin decides to sell it).
But while Crypto enthusiasts pride themselves on how secure the technology is, no one in the industry wants that adjective to be linked to a cryptocurrency.
Put bluntly, there’s no bigger nightmare in Crypto than the native cryptocurrency of your blockchain being considered a security.
But why?
Crypto, an investment or a security?
For years, all Crypto projects issuing cryptocurrencies have relied on one assumption: that their native crypto token is a currency or, in the worst-case scenario, a commodity.
The reason is simple. Because the alternative is ‘no bueno’ or, to be precise, ‘muy malo’.
But why?
An investment security is a financial instrument that represents a claim on an asset, such as stocks, bonds, or options. In other words, it is a way for investors to invest their money and potentially earn a return on their investment.
From this we get the very first conclusion: If your token is considered a security, you’re automatically not a currency.
Indeed, some would argue that having your wealth in fiat currencies is just another form of investment, but we can all agree that investing in an inflationary-by-design asset tends to be a question of liquidity or investing ignorance, not a decision with the expectation of future returns.
Cryptocurrencies that aren’t currencies, wow. That’s certainly a stab in the back for Crypto bros.
But if you think that’s the only consequence, I have bad news for you.
Brace yourself.
A whole lotta regulation and scrutiny
If a cryptocurrency is categorized as a security, it means that it is subject to regulations under securities laws. Sadly, this has horrifying implications, among which are:
- Compliance Requirements: Companies issuing the cryptocurrency may be required to comply with regulatory requirements, such as registering with securities regulators, providing regular financial reports, and ensuring that their offerings are marketed only to eligible investors.
- Increased Required Transparency: Securities regulations may require companies to provide more information about their operations, financials, and risks to investors, which can increase transparency and help investors make more informed investment decisions.
These points alone are screaming centralization, and that puts Ethereum in a position of imminent death.
But how exactly is the Attorney General justifying categorizing ETH as a security?
Well, sadly for me, she kind of has a point.
Howey, Waldstein, and Vitalik Buterin walk into a bar
New York’s Attorney General (NYAG from now on) was very clear in its filing that she considered ETH to be security for three main reasons.
ICOs, Vitalik, and Proof-of-Stake
The first reason wielded by the NYAG is that Ethereum launched an ICO back in 2014, as the project team behind, Vitalik et al, required funding for the project.
The NYAG then describes how the Ethereum Foundation, that project team, is a “small number of developers who hold positions in ETH and stand to profit from the growth of the network and the related appreciation of ETH”.
This doubles down on the first point, as not only they raised funds while keeping an important share, but claims that to this day they remain in considerable control over the direction the Ethereum blockchain takes.
Can you hear that? Yeah me too, it’s centralization again.
Thirdly, and probably the scariest of them all, is that the NYAG implicitly considers the Merge, the transition of Ethereum from a Proof-of-Work (PoW) blockchain to a Proof-of-Stake (PoS) one, a major turning point to consider ETH a security.
And considering that the majority of blockchains today are PoS blockchains, this is a statement that can be easily interpreted as a warning that all PoS cryptocurrencies could be considered securities in the near future.
That’s absolute chaos.
But why such an aggressive stance over Proof-of-Stake?
The dichotomy of PoS
The NYAG draws a clear line between PoW and PoS.
While PoW blockchains decide what node introduces the next block of transactions (receiving the reward for doing so) by a mathematical guessing competition, PoS decides the next node by random choice, in which the nodes stake their tokens to have a higher chance of being chosen.
To the NYAG, this sole difference is fundamental, as she claims that the sole concept of staking incentivizes ownership and staking of the crypto token in expectations of future profits.
Therefore, using these arguments, the NYAG claims that ETH passes the Howey Test, the procedure used in the United States to define what’s a security.
But what is the Howey Test and why it matters so much?
70-year-old Howey is alive and strong
The decades-old Howey Test consists of three criteria:
- Investment of Money: The first requirement is that the investment involves an exchange of money or something of value.
- Expectation of Profit: The second requirement is that the investment is made with the expectation of earning a profit.
- Common Enterprise: The third requirement is that the investment is made in a common enterprise.
The first point is clear, buying ETH requires an investment of money or a valuable asset.
For the second criterion, the NYAG targets the concept of staking, as she argues that staking alone incentivizes people to buy ETH with the sole purpose of staking it to earn passive interest.
Regarding the third, for sure the most controversial point, she argues that the people in the Ethereum Foundation have considerable power over the network and a clear interest in heading the blockchain in a direction that favors them, as they allegedly own considerable amounts of ETH and thus have a clear interest in accruing the value of the token.
And here’s the real issue. If ETH really meets the third criterion, then ETH is unequivocally centralized. And there’s no other way to put it… centralization means death.
Being a security is the worst possible outcome
Common enterprise.
The two words that all Crypto projects should avoid.
Put simply, if ETH is considered a security, it automatically becomes a centralized asset to the eyes of the world.
Whether is it really centralized or not — the power and the control attributed by the lawsuit to the Ethereum Foundation is probably overstated — it really doesn’t matter, as the impact this categorization alone would have over the token and the overall industry is devastating.
As I’ve said many times, any indication that a Crypto project is centralized automatically makes it completely worthless, because the sole concept of blockchains is intrinsically related to the concept of decentralization.
Without decentralization, high security and integrity of data are no more, as the ledger relies on its distributed nature to guarantee the high-security thresholds it claims to have.
In short, public ledgers in this scenario provide absolutely zero reasons to be used.
But the question is, if ETH is considered a security, will there be an option for it to stop being one eventually, becoming a commodity or even a medium of exchange?
How do we survive this?
Personally, I think the concept of “you made an ICO, you’re a security” is a rather poor argument by itself, so US regulators will probably double down on the alleged power the Ethereum Foundation holds to guide the decision-making of the project as the main argument to consider ETH a security.
In that scenario, the Ethereum Foundation must focus on undermining such claims, with a few options, like:
- Burning their ETH — render them unusable — to eliminate their economic incentive
- Proving a continuous track record of protocol improvements not pushed forward by them — this is not probable in my view
- Reducing Vitalik’s influence over the project’s direction
However, all these three are potentially very negative for the prospects of the project, so decisions aren’t going to be easy.
But one thing is for sure, there’s no way to put in good light the fact that ETH could be soon considered a security and thus, tell the world that what was once considered decentralized, was actually not.
And if this precedent extrapolates to the rest of PoS in the industry, that’s complete Armageddon.
A final word
When it comes to Crypto, knowledge is everything.
And by subscribing to my weekly newsletter, you’ll gain free access to such knowledge much earlier than everyone.
But I won’t lie to you, even though Crypto assets are potential investments, I can’t promise you success in venturing into Crypto, let alone profits; that would be me deceiving you.
That being said, I can promise you knowledge, and there is no wealth without knowledge.
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