Coin Center Chips In: Is Proof-of-Stake Ethereum Suddenly a Security?

Coin Center Chips In: Is Proof-of-Stake Ethereum Suddenly a Security?

Not that anyone is asking, but Myntsenteret joined the debate. Is Post-Merge Ethereum a Security Now? Moving from Proof-Of-Work to Proof-Of-Stake without pausing operations was quite a feat, but it came with a cost. Many things are completely different at this stage, and the new features may put Ethereum in the regulator’s field of vision. Is staking a similar activity to mining or are they completely different?

Besides, what does this whole situation have to do with Coin Center? The organization defines itself as “the leading non-profit research and advocacy center focused on public policy issues facing cryptocurrency and decentralized computing technologies such as Bitcoin, Ethereum, and the like.” The Mint Center’s article “Does the merger change how Ethereum is regulated? (No.)” tackles the problem at hand.

“We do not believe that the technological differences between POS and POW warrant any different treatment,” sums up Coin Center’s position. “On the securities law side, the SEC has always emphasized that it looks at the economic realities of transactions rather than the terms or technologies used to create those realities. The approach is substance over form,” they say, summarizing the SEC position.

ETHUSD Price Chart for 09/16/2022 - TradingView

ETH price chart for 09/16/2022 on ForexCom | Source: ETH/USD on TradingView.com

Coin Center believes that mining and validation are basically the same

To soften the blow from the validation of this section title, Coin Center limits its scope to “the economic realities of validating.” We all know what they say.

“The economic realities of validating a chain through mining and validating a chain through staking are similar. In both cases, validators are an open set of participants, and the only prerequisite for participation is provably to suffer some costs. In proof-of-work that cost is energy and computing resources, in proof-of-stake it is the time value of money (e.g. the opportunity cost of holding an asset needed for effort rather than using it).

IN Bitcoinist’s First Article on Post-Merge Ethereum, we quoted Gabor Gurbacs, strategy advisor at VanEck, whose thesis was that “while not a security, Ethereum was bound to attract regulatory attention after the merger.” He recently tweeted:

“I’m not saying that ETH is necessarily a security because of its proof model, but regulators are talking about stakes in the context of dividends that are part of what securities law calls a ‘joint enterprise’. There are other factors in the Howey test as well.”

The Howey test, in turn, refers to these “four criteria for determining whether an investment contract exists:”

  1. An investment of money
  2. In a joint enterprise
  3. With the expectation of profit
  4. Being derived from the efforts of others

That leads us to…

Myntsenteret does not believe that the profit comes from the efforts of others

Now that we are all familiar with the Howey test, this paragraph makes more sense:

“Central to classification as a security is continuous dependence on profits derived primarily from the efforts of others. Both consensus mechanisms are explicitly designed to avoid such dependence by creating an open competition among strangers in which any self-interested participant can and will fill the gap left by any other unresponsive, corrupt or censoring participant.”

That may be true, but what about the efforts of all the companies and developers working on the Ethereum platform? They provide value that is converted into profit. And people who buy ETH are investing in them, in a sense. Chairman Gensler’s second example including an additional element. “If an intermediary such as a crypto exchange offers betting services to its clients, Gensler said, “it looks very similar – with some changes in labeling – to lending.”

Coin Center disagrees with extreme prejudice:

“However, our analysis of the technology suggests that there should be no discrimination between projects based solely on the choice of one permissionless consensus mechanism.”

Not only that, they go so far as to call them “goods”:

“Otherwise, decentralized cryptocurrencies that use proof of stake consensus are commodities, and therefore the CFTC has spot market policing authority and derivatives market oversight authority.”

Maybe, but is it a decentralized Proof-Of-Stake cryptocurrency? It is certainly up for debate. Especially considering Proof-Of-Stake’s inherent propensity for centralization.

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