The Securities and Exchange Commission is waging an energetic legal campaign to classify Ethereum, the second-most popular cryptocurrency, as a security, according to U.S. companies that have received subpoenas related to an investigation. The news delivers a further blow to the crypto industry’s hopes the agency will approve applications by BlackRock and others for an Ethereum ETF following the SEC’s approval of a series of Bitcoin ETFs in January.
The SEC’s Ethereum investigation involves demanding companies furnish any documents and financial records they may have regarding their dealings with the Ethereum Foundation, a nonprofit group that oversees the governance and development of the blockchain by the same name.
According to a person at a company who received a recent subpoena request, the SEC’s probe of the Swiss-based Ethereum Foundation began shortly after the blockchain’s shift to a new governance model known as “proof-of-stake” in September 2022. Another person at a separate company that received a subpoena described it as narrow and focused on the Ethereum Foundation, and said they received the subpoena in the last few weeks.
That proof-of-stake event moved the blockchain away from the energy-intensive model used by Bitcoin in favor of one that relies on a trusted network of validators—and provided the SEC with a new pretext to attempt to define Ethereum as a security, according to people at three different companies familiar with the subpoenas. The people asked Fortune not to identify identify them or their firms for fear of retaliation by the agency’s chair, Gary Gensler, whom one described as “vindictive.”
The existence of an investigation into the Ethereum Foundation was reported on Wednesday by CoinDesk, which cited an update to the group’s Github code repository that reportedly provided evidence of a probe by an unknown state agency.
“The SEC does not comment on the existence or nonexistence of a possible investigation,” the agency said in response to a request for comment from Fortune.
A push to label Ethereum a security
The news of the subpoenas comes as the SEC and the Biden administration pursue an aggressive campaign to cut down the crypto industry, which they characterize as lawless. This campaign, however, has been frustrated at times by the vague legal status of cryptocurrencies, which has led to a series of court battles over whether the SEC even has jurisdiction over the industry.
This critical question of jurisdiction turns on whether a given cryptocurrency is a security, an issue that has not definitively been addressed by courts. While there is a consensus Bitcoin is instead a commodity, under the supervision of the Commodities and Futures Trading Commission, Gensler has signaled his agency regards the vast majority of other cryptocurrencies as securities that must be registered with the SEC.
The SEC has made this case in recent court cases, except when it comes to Ethereum, whose legal status is even murkier. The security status of Ether has long been a point of contention for the agency. Speaking at a conference in 2018, then-Director of Corporation Finance William Hinman said that Ether did not resemble a security. Emails published as part of the Ripple trial revealed that SEC staff deliberated on how clear to make the assertion and that one official wanted to say that the agency did “not…see a need to regulate Ether.”
That changed under Gensler, who took over the agency in 2021, and following Ethereum’s switch to proof-of-stake the following year.
At that time, Gensler said that any crypto assets produced by blockchains that use a proof-of-stake model could resemble investment contracts and therefore be classified as securities, although he was not speaking about any specific coin. In March 2023, he once again suggested that proof-of-stake tokens could be regulated as securities, although he’s since declined to comment specifically on Ethereum, including at SEC oversight hearings at the House Financial Services Committee.
The issue grew more complicated in October after the SEC approved nine ETFs that tracked the Ether futures market, which is overseen by the CFTC, suggesting the view Ether is a commodity. CFTC Chair Rostin Behnam has said on several occasions that his agency views Ether as a commodity.
But last month, the controversial crypto firm Prometheum, which has the approval to operate as a special purpose broker-dealer, announced its intention to offer custody services for Ethereum as a security under SEC oversight, once again adding uncertainty to Ether’s regulatory status. One of the recipients of the recent subpoena speculated that Gensler has sought to use Prometheum as a Trojan Horse to classify Ethereum as a security.
The recent race by major financial firms including Fidelity and BlackRock to gain approval for a spot Ether ETF has brought the issue into the spotlight, with all signs pointing to the SEC rejecting the applications by their May deadline. Bloomberg analysts have pointed out that agency staff have not gone back and forth with issuers on details about the potential, as they did with the spot Bitcoin ETFs, which were approved in January.
A potential declaration that Ether is a security could throw the process into further doubt, especially as it would raise questions over the CFTC’s supervision of Ether futures markets.
