SEC v. Ripple: Will the lawsuit turn against Ethereum?

Rick Steves

Once Ethereum’s upgrade (ETH2) goes live, the US regulator might be inclined to clarify the blockchain network’s status in order to be more coherent with its own legal arguments in the SEC v. Ripple case. 

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The ripple effect stemming from the SEC v. Ripple Labs lawsuit could eventually lead the SEC to officially determine the nature of Ethereum, especially its upgrade, Ethereum 2.0, which should come into force in the coming weeks.

William H. Hinman, former Director of the SEC’s Division of Corporate Finance, has publicly stated that Ethereum, as well as Bitcoin, are not securities.

“And 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.”

He then went on to emphasize that the analysis of whether something is a security is not static and does not strictly inhere to the instrument, which paves the way for the US financial watchdog to revisit the analysis on Ethereum, especially with the upcoming upgrade.

A lot of questions have emerged from his statements, including the criteria used to make those assessments. That is why Ripple Labs subpoenaed Mr. Hinman to offer his deposition and clarify the SEC’s internal views and policy decision-making, among other issues.

The SEC filed a motion to quash the subpoena, arguing that Mr. Himan was of critical importance to the SEC’s operations, has no first-hand knowledge of the facts underlying this action, and defendants cannot meet the burden of “exceptional circumstances”.

Earlier this month, the blockchain company and its co-founders sent a letter to Judge Sarah Netburn to oppose to the SEC’s motion. Its main points in favor of the deposition are that the ex-SEC Director never was a high-ranking official and that he has a unique, first-hand knowledge relevant to the claims and defenses in the case.

In regard to the speech Mr. Hinman gave on Ethereum’s nature, Ripple and its co-founders argued he “himself described the speech as newsworthy. And those watching and listening agreed. The price of ether skyrocketed immediately after the speech”, the letter stated.

“Many have since described the speech as setting forth a new standard separate from, or additional to, Howey. Multiple currency exchanges decided to list XRP after the speech, suggesting it gave comfort that offers and sales of XRP did not run afoul of the securities laws.”

Although the US Securities and Exchange Commission insists that Mr. Hinman’s words were his own and did not represent the regulator’s policy on crypto, the SEC could feel enough heat to clarify Ethereum’s status, especially now that the upgrade, ETH2, is about to go live and will transition from a proof of work to a proof of stake model.

On that, attorney Jeremy Hogan took a shot at analyzing a few of the top cryptocurrencies regarding the likelihood of finding themselves in a similar spot that Ripple is now with the SEC.

We transcribed the two videos that comment on Bitcoin, Ethereum, Ethereum 2.0, Tether, Binance Coin, Cardano, Dogecoin, Polkadot, and Uniswap. You can read the whole article here.

 

SEC v. Ripple: Why is the lawsuit taking so long?

 

Ethereum (ETH)

The blockchain network is different from Bitcoin in that it is overseen by a centralized organization that has also raised money to fund the project.

Ethereum was funded through a pre-sale in 2014, where coins were sold before being in existence: “That tends to suggest that the common enterprise prong of the test is met because pre-sale purchasers were relying on the developers for the value of the coins they bought”.

The centralized management structure of Ethereum can affect price, Mr. Hogan continued, using the DAO hack as an example, which led to a hard fork of the ledger (which indicates lack of decentralization). Prices moved on both events.

“That is consistent with an investment contract – a common enterprise for profit. That’s problematic.”

While former SEC director Hinman – who is being summoned by Ripple Labs to testify in the lawsuit – said Ethereum is not a security, it might not be legally binding as the SEC argues in the SEC v. Ripple Labs.

“So, Ethereum has some serious problems with its initial fundraising which, although not called an Initial Coin Offering, sure does look like one”, Mr. Hogan said.

So, the price moves in correlation with the Ethereum Foundation’s actions and the centralized nature of the management group – although loosely formed – makes it easier for the SEC to sue, but being a non-profit organization could save Ethereum from the US financial watchdog.

Ethereum 2.0, however, changes the network’s model to a proof-of-stake system and this also changes the securities analysis.

 

Ethereum 2.0 (ETH2)

“The change to staking creates a problem first because the validators who stake their Ethereum do so with an expectation that their stake will earn them a return – that’s the whole point. So that goes to the “Expectation of profit” prong.”

The SEC’s 2019 guidance for digital assets said “An Active Participant” is responsible for the development, improvement (or enhancement), operation, or promotion of the network, particularly if purchasers of the digital asset expect an AP to be performing or overseeing tasks that are necessary for the network or digital asset to achieve or retain its intended purpose or functionality, Mr. Hogan explained.

“Well, isn’t the upgrade to Ethereum 2.0 exactly the type of thing that would raise the SEC’s alarm system – get the old death star fully functional and ready to destroy? Definitely seems like the SEC might see a “promotion” and “improvement” of the network by a semi-centralized entity with the rollout of 2.0. And now you have the profit to stakers added to the equation”.

According to Mr. Hogan, the upcoming Ethereum upgrade gets even closer to a security status in the Howie test and the SEC’s past enforcement actions.

 

Once Ethereum’s upgrade (ETH2) goes live, the US regulator might be inclined to clarify the blockchain network’s status in order to be more coherent with its own legal arguments in the SEC v. Ripple case.

Ripple General Counsel Stuart Alderoty said in June that Ripple is fighting for the crypto industry, but it seems that Ethereum may get caught in the middle of it.

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