Over the last few years, the cryptocurrency industry has been a primary target for regulators in the United States. The legal battle between Ripple an
Over the last few years, the cryptocurrency industry has been a primary target for regulators in the United States.
The legal battle between Ripple and the United States Securities and Exchange Commission (SEC), Nexo’s lawsuit with the securities regulators of eight states, and the scrutiny targeting Coinbase’s Lend program last year are only a few high-profile examples. This year, even Kim Kardashian had first-hand experience with regulatory scrutiny after agreeing to pay a $1.26 million fine for promoting the dubious crypto project EthereumMax.
While Ethereum developers intended to pave the way for key network upgrades in the future, it seems like the recent Merge has further complicated matters between crypto projects and U.S. regulators.
Ethereum: Too substantial for the crypto market?
On Sept. 15 – the same day Ethereum’s Merge took place – SEC Chairman Gary Gensler stated during a congressional hearing that proof-of-stake (PoS) digital assets could be considered securities. Gensler said his reasoning was that holders can earn revenue by staking PoS coins, which could mean that there is an “expectation of profit to be derived from the efforts of others.” The latter is one of the essential parts of the Howey test, used by the SEC and other U.S. authorities to determine whether an asset is an investment contract and falls under federal securities law since it was passed into law in 1946.
As you may already know, Ethereum has shifted from the mining-based proof-of-work (PoW) to PoS, requiring validators to stake Ether (ETH) to add new blocks to the network. In other words, this means that Ether could fall under the Securities Act of 1933, which would require the project to register with the SEC and comply with strict standards to safeguard investors.
Related: Federal regulators are preparing to pass judgment on Ethereum
Gensler argued that intermediaries like crypto exchanges and other providers offering staking services “look very similar” to lending. And, cryptocurrency lending is a sector that has been under heavy SEC scrutiny, especially if we consider the agency’s $100 million fines against BlockFi in February.
In fact, Gensler’s latter argument is highly relevant in the case of Ethereum, where one has to stake 32 ETH (worth $42,336 at the current price of $1,323 per coin) to become a validator. Since this is a considerable sum for many, most users are turning to staking providers to stake their digital assets on their behalf to avoid this capital requirement in exchange for a fee.
At the same time, this could mean that, at some point, large centralized providers will increase their control over the network. Thus, by falling under the SEC’s supervision, there’s a chance the agency could prohibit them from validating individual transactions (censorship), which will lead to the fact that such transactions will take more time to be confirmed. That said, confirmation speed should be the most significant issue here, as there will always be some validators that will subsequently confirm the transaction.
In this setting, Ethereum, as one of the major networks for decentralized finance (DeFi), would be the main lever for regulatory policy. Tokens such as USD Coin (USDC) and many others contain blacklisting and blocking mechanisms at the development level, as opposed to the DeFi market in general — so it makes sense that validators and the MEV market will play the role of leverage tools. In the short term, however, this is more of a scare since there are too many validators, and no one can control this process at a reasonable cost.
Regarding the above, U.S. regulators may intend to oblige those node validators under their jurisdiction to implement Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures for validating transactions.
Ethereum’s Merge gives opportunities for the SEC to act. How?
In addition to the Howey test argument, the SEC also claims that ETH transactions fall under U.S. jurisdiction due to the high concentration of the network’s nodes in the United States. If this statement turns out to be accurate and finds further development across the nation, this would mean that the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) will require all businesses operating on the Ethereum blockchain to comply with KYC and AML requirements.
In practice, this means that customers will have to verify their identities and residencies, as well as provide further information to service providers before they can start using a DeFi service. This significantly increases the burden for crypto projects (and one could argue that this process would go against the idea of decentralized finance). However, regulatory compliance will facilitate trust between investors and providers, which will help attract investment from institutional clients.
That said, it’s vital to mention the SEC’s controversy regarding its approach, communication and decisions about crypto…
cointelegraph.com