Continuing the regulatory crackdown on the cryptocurrency sector, the New York Attorney General has alleged that the ETH token on the Ethereum network is a security. He made the claim in a lawsuit filed against cryptocurrency exchange KuCoin, alleging that it is operating in New York state without licenses as a commodity broker-dealer and stockbroker.

Joe Lubin, the founder of ConsenSys, was a major backer of Ethereum in the early days and held a large chunk of ETH at the time of his initial coin offering (ICO). ConsenSys is heavily involved in Ethereum’s cryptographic and enterprise applications, including as maintainer of the Quorum enterprise blockchain. Ethereum was the first permissionless blockchain that showed potential for various applications beyond payment, including real-world solutions.

Antecedents: a value or a commodity?

Bitcoin is generally considered a commodity, partly because it did not have an ICO. But we will come back to that. ETH is considered a commodity by the CFTC, and a 2018 speech by SEC head William Henman hinted that ETH was likely a commodity as well.

The well-known Howey test analyzes an investment contract. To determine if it’s a value, ask if it’s:

• investment of money
• in a common company
• with a reasonable expectation of gains from the efforts of others.

Hinman (more or less) added a ‘sufficiently decentralized’ test: “If the network on which the token or coin will operate is sufficiently decentralized, where buyers would no longer reasonably expect a person or group to conduct business endeavors or essential management aspects, the assets may not represent an investment contract.”

So it was thought that ETH was probably a security at the time of the ICO, but by 2018, it might not be.

Is it about rethinking or new legal precedents?

NYAG’s court filing includes the following language, which interprets ETH as an investment and also references staking activities.

The court case states that “ETH satisfies the Waldstein test. The ICO was used to raise funds to develop the Ethereum network, as set out in the ICO Documents. And Vitalik Buterin and the Ethereum Foundation retained large ETH positions that they continue to use to fund ETH development. ETH was also designed as an investment. It continues to be referred to as an “investment” on the Ethereum Foundation website. And ETH is used to generate staking rewards for investors. Also, ETH was used to promote the Ethereum company because ETH is needed to process any transaction on the Ethereum network.”

There is much more in the document about the ICO and staking.

But NYAG’s filing also builds on a recent court case in late 2022 where a summary judgment ruled that the LBC token issued by LBRY was a security based on the Howey test. LBRY did not conduct an ICO and LBC was designed as a utility token for a video network.

One interpretation of the ruling highlighted that LBRY and the insiders retained significant amounts of the token, reinforcing the third prong of Howey’s test of an expectation of profit based on the efforts of others. However, the alignment of interests is also evidence of a common enterprise. Ropes & Gray argued that the case collapsed Howey’s points two and three into a single argument contrary to court precedent.

The law firm added: “There are numerous reasons for a project to hold onto parts of its own currency that would not relate to the expectation that the currency would increase in value. For example, a project may retain a portion of its own coins to facilitate transaction validation on a proof-of-stake network.”

Meanwhile, the trial between the SEC and Ripple over whether or not XRP is a security is yet to be concluded after beginning under the previous administration.