Why does it matter whether ether is a security or not? The SEC is clamping down on virtual currencies, and ether is in their headlights. The Commodity Futures Trading Commission (CFTC) considers Bitcoin to be a commodity, so it’s off the hook. In EY’s opinion, for accounting purposes, ether should be treated the same as Bitcoin.
Why it matters
If ether is considered a security, then two things will happen. Trading will dramatically reduce because exchanges will have to be authorized by the SEC to trade in ether in the US. Secondly the founders could be in deep trouble.
In late March venture capital company Andreessen Horowitz and a group of investors and lawyers met with the SEC. The aim was to persuade the SEC not to consider certain virtual currencies as securities or to create a ‘safe harbor,’ according to the New York Times.
In testimony to the US Senate in February, SEC Chairman Jay Clayton stated: “When investors are offered and sold securities – which to date ICOs have largely been – they are entitled to the benefits of state and federal securities laws and sellers and other market participants must follow these laws.”
There’s a significant difference between Ethereum and Bitcoin. Bitcoin never had an ICO event, whereas Ethereum did in 2014.
In March the SEC issued a statement describing crypto exchanges as ‘potentially unlawful online platforms for trading digital assets’.
The Howey Test
The US Supreme Court uses the 1930’s Howey case to determine whether a transaction is an investment. The case involved the sale of an interest in an orchard. Four criteria for classifying a security were defined in the case:
- It is an investment of money (or another asset)
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
Gary Gensler, former head of CFTC, in a recent MIT talk discussed cryptocurrencies and tokens. “You’ve heard this debate. Is it a utility token, it is a consumable token, or is it an investment? But kind of the answer is it’s both.”
He then addressed Ripple’s XRP and ether under the Howey test. In his opinion (he’s not a lawyer), XRP is a security, and ether is a little grayer. He argued in 2014, at the time of the ICO, ether probably was a security. The inference is that it may not be classed as a security if the test is applied today.
Andreessen Horowitz argued that no entity stands behind ether or is responsible for driving its value. The dramatic fall in the price of ether when there was a hoax about Buterin’s demise, may count against this. However, Buterin’s influence has declined since then.
One issue that leans away from ether being a security is the degree to which people use ether to run applications.
The EY approach
EY may not be lawyers, but they believe the accounting treatment of Bitcoin and ether should be the same.
The accountants acknowledge that Ethereum’s treatment is open to interpretation:
“We would emphasize the general-purpose nature of the Ethereum platform, and by extension ether, which contrasts with the more narrowly defined use cases seen among other tokens. This is underscored by the fact that ether is widely used as a means of payment for ICO tokens. It is strongly characterized by its role as a medium of exchange.”
“Therefore, although we acknowledge the technological distinction between bitcoin and ether, we deem it more appropriate to classify ether as a cryptocurrency for the purposes of an accounting discussion.”
It will be more than unfortunate if a visionary innovator such as Buterin is punished.
A group of senior regulators from the SEC and CFTC will meet to discuss the issue on Monday. It could be a big day for Ethereum either way.