Everything initially seemed routine when the SEC filed a federal lawsuit against crypto influencer Ian Balina on Monday for his failure to register a cryptocurrency as security prior to launching an initial coin offering (ICO) in 2018. After all, the SEC has been bringing civil lawsuits against people and organizations for launching unregistered ICOs for years.
Observers with keen eyes then read a little deeper into the fine print. The SEC today claimed, in a bold and potentially unprecedented move buried in the lawsuit’s 69th paragraph, that it had the right to sue Balina not only because his case involves transactions made in the United States, but also because the entire Ethereum network falls under the purview of the US government.
The ETH sent to Balina was “validated by a network of nodes on the Ethereum blockchain, which are clustered more densely in the United States than in any other country,” according to the regulator’s complaint. “As a result, those transactions took place in the United States,” the SEC concludes.
The SEC seems to be arguing that since there are currently more validating nodes for Ethereum operating in the US than any other nation, all Ethereum transactions worldwide should be regarded as coming from the US. According to Etherscan, the United States currently hosts 45.85% of all Ethereum nodes. Germany has only 19% of the second-highest node density, in contrast.
“Saying that enables [the SEC] to characterize doing business on the Ethereum blockchain, as doing business on a US securities exchange,” University of Kentucky law professor Brian Fyre said. “Which, from their regulatory perspective, is convenient. It makes things so much simpler.”
If the SEC is successful in classifying Ethereum activity as similar to that on an American securities exchange, the regulatory body will have jurisdiction over all activity on the ostensibly decentralized Ethereum network. Such a development would represent a significant increase in the SEC’s role in overseeing both Ethereum, specifically—where the vast majority of NFT and DeFi activity occurs—and crypto in general.
Fyre pointed out that the language of today’s complaint carries no legal weight, and that given the nature of the SEC’s suit against Balina, the court, in this case, is unlikely to rule on this specific issue. But that doesn’t mean the statement is meaningless.
“I think they may be trying to get their vision of what Ethereum is, and how it works, out into the judicial ecosystem,” Fyre explained “It’s the SEC saying, ‘This entire body of financial activity is within the scope of the stuff that we regulate, and therefore we’re going to regulate all of it.’”
Fyre believes that such a vehement claim to jurisdiction over the entire Ethereum ecosystem is unprecedented.
“It’s the first time I’ve seen the SEC really lay out how it understands the Ethereum ecosystem to work, and why it thinks it falls within the scope of what the SEC regulates,” he said.
In the hours following Ethereum’s successful transition to a proof-of-stake consensus mechanism last week, SEC Chair Gary Gensler made the suggestion that the change might move the network closer to the government’s definition of security.
Gensler gave his opinion on how “staking,” or pledging assets to a cryptocurrency network in exchange for passive rewards, could be interpreted as a sign that an asset meets the requirements to be considered a security under the so-called Howey Test, though he avoided mentioning any particular cryptocurrency or network by name. This was done after testifying before the Senate Banking Committee. The proximity of that statement to the present, in Fyre’s opinion, is no coincidence.
Fyre stated, “seems perfectly consistent with what Gensler was getting at in his statement […] that the SEC sees all of this as securities and therefore is going to make regulatory decisions in relation to the entire ecosystem.”