Why Ethereum, per the SEC, now falls under securities law

Right now, Ethereum isn’t officially classified as a security by the U.S. Securities and Exchange Commission.

Right now, Ethereum isn’t officially classified as a security by the U.S. Securities and Exchange Commission. Like Bitcoin, Ethereum is currently treated as a commodity. That means ETH isn’t under the SEC’s jurisdiction for now. If Ethereum were ever classified as a security, it would fall under the Securities and Exchange Commission’s oversight.

Under the SEC’s view, all cryptocurrencies with a proof-of-stake based consensus model should fall under the U.S. securities laws. Legally, though, applying that would be incredibly tricky. The SEC’s core argument hinges on the so‑called Howey test, which determines whether a financial product in the U.S. counts as a security.

The Howey test is a framework established by the Supreme Court that weighs whether a transaction represents a capital investment and thus qualifies as a security.

Is Ethereum a security?

Under the U.S. Securities Act of 1933, all issuers of securities must register offers or sales with the SEC. The only exception is if there’s a specific SEC exemption. Whether an asset in the U.S. counts as a security has to meet the Howey criteria:

• Is money invested?
• Is the invested money put into a joint venture?
• Is profit expected?
• Are third parties or the operators themselves responsible for generating the profit?

Only if all four points are met can an asset, a security interest, or a transaction in the U.S. be deemed a security.

But in Ethereum’s case, the SEC interprets the Howey test differently. It also ignores the fundamental goal of securities law, which is to remove information asymmetries. So the SEC isn’t acting in the interest of American citizens and seems to be overreaching its jurisdiction.

Applying the Howey test to Ethereum

Before Ethereum switched to Proof of Stake, the SEC believed Ethereum wouldn’t pass the Howey test. With PoS, the agency now argues validators (staking operators) can meet the Howey definition of a security. Their argument goes like this:

• Ethereum validators put in money because they have to stake ETH.
• Validators pursue a "common enterprise" since they participate in validating transactions on the Ethereum network.
• Validators hope to earn profits in the form of staking rewards.
• These profits come from validators or third parties who participate in Ethereum’s consensus mechanism.

On the first and third points, the SEC might be right. Stakers do need capital, convert it to ETH, and lock it into a smart contract (money is invested) with the expectation of rewards. But, per the Supreme Court, meeting two points isn’t enough to deem something a security.

By definition, a security must involve a "common enterprise"—a venture where an investor’s returns are tied to the efforts and success of those running the investment (the validators) or third parties (the users). That’s not the case with Ethereum.

Staking doesn’t make Ethereum a security

To become a validator on the Ethereum network, you must deposit 32 ETH into a smart contract address. This address isn’t controlled by any single institution. ETH validators are therefore at all times fully in possession of their Ether.

Moreover, ETH can’t be used by others for specific purposes (no money flows into a joint venture), and validators can pursue different goals. Staking as a consensus mechanism is meant to make the Ethereum blockchain more decentralized and secure. All validators can participate autonomously and without third-party dependency.

Additionally, staking gives validators some influence over the network so they can penalize bad behavior to protect the Ethereum blockchain’s security. If they do their job correctly under the network’s rules, they’re rewarded according to those rules, not based on other validators’ efforts (profits don’t come from other validators).

Also, individual staking validators don’t have a claim to specific profits generated by a company. In fact, staking rewards can vary for each validator and depend on their own performance. Whether their profits rise or fall isn’t tied to other validators’ entrepreneurial results, since the network’s consensus mechanism is decentralized and validators are independently organized.

In other words, validators maximize their stake by delivering the greatest overall benefit to the network. Of course, the situation changes if a particular company, like a crypto exchange, offers staking as a service to its customers. A judge could then rule that at least one element of the Howey test is met.

A validator’s reward is largely set by the amount of ETH they’ve staked and the random chances they get to validate a block. Both factors vary for each validator and aren’t dependent on a third party. In short, ETH stakers still retain the ability to control their investment’s return.

Earlier court decisions in the U.S. treated this arrangement as a reason to deem securities law unnecessary, since there’s no transfer of control or ownership to a third party, unlike in comparisons to securities like stocks.

Crypto exchanges could fall under SEC oversight

For this reason, it’s highly unlikely the SEC would win in court if private or decentralized staking were deemed securities.

But the landscape would likely be different for centrally organized providers like Coinbase, Binance, Celsius, and others that offer staking services and require customers to relinquish control of their deposits. Those firms would probably fall under SEC securities laws to prevent abusing customer funds for other uses.

Sensible crypto regulation is crucial

Thoughtful regulation of centralized crypto firms—whose machinations are often outside disclosure rules—could have protected thousands of customers from losing their capital.

When you look at individuals running their own, sufficiently decentralized and transparent validators, it’s clear how absurd it is to apply securities law to ETH staking in the U.S. Would validators be forced to share information that’s already public? What information would they need to disclose? How would that help close information gaps and serve the public interest?

All of these questions illustrate the imperfect logic of many supporters of U.S. securities regulation with respect to some crypto networks. It’s not the breakthrough, transparent, secure, decentralized consensus mechanisms of many blockchains that create the risks U.S. regulators are focusing on right now.