If there’s one way to raise the hackles of cryptocurrency and blockchain enthusiasts, it’s mentioning regulation.
Why? For starters, the first successful implementation of blockchain technology, bitcoin, is embedded in a libertarian ideology that’s averse to not just government oversight, but to the participation of any third party, trusted or not, in a transaction.
And, sure, some cryptocurrency groups have decided to play nice with big banks, and others actively seek validation and legitimacy from the government. But, in general, the early adopters and true believers in the community continue to view regulation in the same way most cats regard bathtime: uncomfortable, unwanted, but perhaps inevitable if they keep stinkin’ up the place.
But the regulation of ethereum and other blockchains is the proverbial talk of the town, or at least the wonkier blocks around SEC headquarters.
Bitcoin Is A Commodity
So far, in the United States, the Securities And Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) are on the record as taking a “do no harm” approach to regulating the emerging blockchain sector. This very similar to Clinton-era verbiage concerning regulating the then-nascent web and e-commerce. (The archived Clinton-era federal website describing that particular regulatory framework is a real treat for fans of vintage web design.) As tech policy researcher Adam Thierer characterized the Clinton policy, it’s “a high-tech Hippocratic oath.”
And, for the most part, that’s the tack taken by contemporary regulators with bitcoin, the highest-value cryptocurrency in the market today. For exchange purposes, it’s been treated like a commodity by the CFTC since 2015, and its users have been largely free of a government crackdown, provided that tax payments are up to date, and there’s no evidence of flagrantly illegal activity.
Is Ethereum A Commodity?
But an emerging class of blockchain assets built on the ethereum blockchain is leading some in Washington to consider regulating the second most valuable cryptocurrency, which has a total market value of nearly $65.5 billion at time of writing, in a way that’s different from bitcoin. Why regulate ethereum? According to recent reporting by the Wall Street Journal, it’s because ethereum tokens (referred to as “ether”) exhibit many characteristics of securities.
Being classified as a security instead of a commodity would subject ethereum and its trade to much stricter regulatory oversight. If, as the WSJ’s sources suggest, regulators continue to use the “Howey Test”—a 1946 legal rule which says assets in a “common enterprise” whose value is tied to the efforts of managers or promoters are “investment contracts” and thus securities—then ethereum and other protocols like ripple may fall under the regulatory purview of securities, rather than commodities.
WSJ’s sources cite a number of factors, leading with the Ethereum Foundation’s initial fundraising event, which raised over 31,000 bitcoins in mid-2014. They also mentioned the ongoing and active management of the technology’s development, and forward-looking statements by Foundation leadership about the technology as reasons why ethereum acts more like a security in substance, if not always in form.
ICOs Are Probably Securities, But Is Their Most Popular Blockchain Infrastructure A Security Too?
The discussion of whether to regulate ethereum as a security is intertwined with a broader discussion of regulating initial coin offerings (ICOs). At this time, the SEC treats tokens sold in an ICO as securities, and accordingly holds their issuers to a set of standards around truthfulness in financial reporting, fiduciary responsibility, operational integrity, and the like.
On the other hand, treating ether itself like a security may not be the right approach. For one, the goal of ethereum is to create a reasonably open platform and protocol for decentralized applications, ERC20 tokens being the most popular example today. So it feels a bit like if a government went in to regulate, say, the Linux Foundation in a restrictive way. But here’s where that analogy breaks down: although Linux boxes facilitate untold amounts of economic activity, its price (generally free) isn’t tied to the number of other Linux users out there. While in the case of ethereum, the more applications that are built on top of its code, the more ether tokens may be worth.
But unlike bitcoin, the design of which doesn’t easily allow for many blockchain use cases like smart contracts, ethereum is the beneficiary of “platform economics” akin to Metcalfe’s Law insofar as it becomes more valuable as more projects use it as foundational infrastructure. Ethereum, as a platform, benefits—in the form of price appreciation and being seen as a default option for new tokens—from network effects in a way that bitcoin doesn’t.
There Is No Good Answer Here
This is all to say that the question of whether ethereum is a security or a commodity is particularly thorny. CTFC chairman Christopher Giancarlo recently said on CNBC that bitcoin has “elements of all of the different asset classes,” and so does ethereum, perhaps even more so. How to treat these emerging assets is a tough regulatory nut to crack.
The Clinton administration labeled the internet a “global free-trade zone,” but not an anarchy. Bill Clinton said in 1997 that “[i]n many ways, electronic commerce is the Wild West of the global economy.” Replace “electronic commerce” with “blockchain technology” and that statement could apply just as well today. However, he followed up with “our task is to make sure it’s safe and stable terrain.”
Over two decades later, the attitude of financial regulators toward ethereum is a chip off the old blockchain.
Illustration: Li-Anne Dias