Ethereum’s Survival: The Decentralized Dilemma

On February 26, 2024, the Ethereum Foundation made a discreet modification to its website, deleting the footer and warrant canary. This suggested that the foundation was under a confidential investigation. Anonymous tips indicated that the United States Securities and Exchange Commission (SEC) was probing the foundation as part of an effort to classify Ethereum’s underlying asset, Ether (ETH), as a commodity. The timing of the investigation is crucial as SEC approval of Ether exchange-traded funds (ETFs) is approaching. The cryptocurrency market faces uncertainty if Ether is classified as a security, which could have a significant impact on Ethereum and other crypto projects.

The Ethereum Foundation cannot provide further details about the investigation due to confidentiality clauses. It is important to note that just because the foundation received an inquiry from a state authority does not necessarily mean it is the subject of the investigation. The SEC may believe that the foundation has information relevant to a different investigation and may request its cooperation. The foundation would likely cooperate to ensure Ether continues to be actively traded in U.S. markets.

If the SEC does determine that Ether is a security, it could have severe consequences for the crypto market. Other tokens that raised capital using a similar funding mechanism may also need to comply with registration processes and rules. This could lead to the downfall of many companies in the sector, as they may not have enough funds to sustain such a shock. Crypto exchanges listing Ether would be forced to either delist the asset or register as securities broker-dealers with the SEC. Most exchanges would likely choose to delist Ether rather than go through the extensive registration process.

While the SEC technically only has jurisdiction over companies in the United States, it can claim extraterritorial jurisdiction if the activity being challenged has a material impact in the U.S. The SEC has previously imposed worldwide injunctions on crypto companies based outside of the U.S. The Ethereum Foundation is not legally required to cooperate with the SEC, but the commission values cooperation and takes it into consideration when deciding on its actions.

If centralized exchanges in the U.S. were to shut down Ether trading, decentralized exchanges (DEXs) could become an alternative. DEXs are more difficult for regulators to target due to their decentralized nature, and they have a global reach. DEXs may still face compliance requirements in certain jurisdictions, and U.S. authorities have shown their ability to target platforms by going after developers and other participants in the ecosystem.

While the implications of the SEC classifying Ethereum as a security may initially be negative, there could be positive effects in the long run. A resolution could involve the Ethereum Foundation paying a fine and registering as a security in the U.S. market, bringing Ether trading under the same rules as stocks or bonds. This would provide clarity and regulation for the market participants, which could be beneficial for the long-term valuation of the crypto market. If the SEC takes the Ethereum Foundation to court, the outcome would have significant consequences for Ether’s market valuation and the entire ecosystem built on the Ethereum blockchain.