Ethereum: Security or Not? Analysing the Regulatory Perspective

Ethereum security
To be or not to be: Is Ethereum a security or not?


Is Ethereum a security? If you are not familiar with this cryptocurrency, you can find more about it here on our website. Save some time to read “Will ETC Replace ETH After the Merge?” and “Will The Price of Ethereum Hit $2,000 after The Merge?“.

Some people say (mainly mathematicians) that the only science capable of using the word “truth” is Mathematics since they need to undoubtedly prove a theorem prior to its acceptance.

There can’t be a “maybe” for Mathematics. Simple as that. All other sciences either catch a hide on Mathematics or rely on every man’s head and understanding. Like a famous old saying: “From a judge’s head or a toddler’s butt you never know what will come.”

We will not talk about a Judge, but Garry Gensley, a chairperson that works in the U.S. Securities and Exchange Commission (SEC) since 2021. He has some “interesting” thoughts here. It’s a long text, but save some time to take a read. Can we be able to answer if Ethereum is a security? Let’s find out.

Judge's head and toddler's butt
Figure 1 – Judge’s head and toddler’s butt. Source: Pictures taken from the internet. The baby’s face has been preserved.

Definitions of security

Strict definition

First of all, we need to understand the technical terms that define a security. Then, we can decide if Ethereum can be considered a security or not. There are thousands of sources that can be used to define what a security is, but let’s keep it simple by quoting the Corporate Finance Institute (CFI) :

“In the United States, the term broadly covers all traded financial assets and divides such assets down into three primary categories”:

  1. Equity securities (e.g.: Stocks – common and preference shares): represents either the ownership of a company (common) or the preference for its dividends distribution (preference).
  2. Debt securities (e.g.: Bonds and commercial paper): These represent a debt obligation between two parties.
  3. Derivatives (e.g.: Future and swaps): These represent a financial contract between two parties.

All of these must be fungible and tradable in public and private markets.

Broader definition

Do you remember the judge’s head and toddler’s butt? Now it’s the right time to use it to go beyond the strict definition of security. The U.S. Supreme Court is the guardian of the Constitution and they have a much broader interpretation of what security is.

In the case of Howey vs SEC (1946), known as the “Howey test”, the understanding is that an investment can be regulated as a security if:

  1. Money is invested;
  2. The expectation of Profits to be derived from the efforts of others;
  3.  Common enterprise.

So, according to SEC itself here,  we can combine all of these definitions and say that: “an investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Does Ethereum passes the “Howey test”?

1. Are you investing your money?

Do you need to invest money in order to buy Ethereum? If we had the old PoW (Proof Of Work) system, this wouldn’t be true. You could get a fancy VGA (Video Graphics Adaptor), probably from NVidia, and start mining to receive Ethereum as a reward. But it’s not the same under a PoS (Proof of Staking) model. It’s clear that Ethereum complies with definition #1, since you need to buy Ethereum in order to take part in staking.

2. The “others”

The expectation of profits is derived from the efforts of others. Is there an expectation of profit when buying Ethereum? No doubt about it. The problem is the term “others“.

Ethereum is a security?

When we talk about securities considering a strict definition, all of them (equity, debt, and derivatives) undoubtedly rely on the effort of others. A company, for example, needs to be well managed in order to generate profits. A debt will require an effort to be paid and the same applies to derivatives.

There are different views here that need to be analyzed. The first one comes from here, the website, and the second one comes from SEC.

Argument #1: Ethereum doesn’t meet this criteria

According to the website, the profits from trading Ethereum must not be derived from the efforts of others. The main argument is defended by “In the Ethereum network, you as a validator are not rewarded on the basis that the Ethereum developers continue to develop.”

Argument #2: Ethereum does meet this criteria

The main argument of SEC is that, despite its decentralization, the value of the Ethereum network will be undoubtedly linked to the success of the projects (AP – Active Participant) building on it. So, even though the profits may not derive only from this particular aspect, it’s clear that the development, promotion, and operation can’t be done by ghosts.

3. Common enterprise

SEC has a short answer about this one: Yes. According to the understanding of the Federal Court, the characteristic of a “common enterprise” is consistent with digital assets since it satisfies both the “horizontal commonality” and “common enterprise”. Let’s take a look at them:

  1.  Horizontal commonality: This refers to the horizontal relationship among Ethereum’s investors. Is the fortune of each investor depending on the success of the network?
  2. Vertical commonality: This refers to the vertical relationship between Ethereum’s investors and the “efficacy of the manager’s efforts“. Since we don’t have a “manager”, we can understand this as “efficacy of the developer’s efforts”.

The website defends that there is no horizontal commonality, since “Ethereum is not pooled and a validator’s profit or penalty is derived solely from their performance“. Also, the website mentions “Revak v SEC Realty Corp” and that the court looks for “the pro-rata distribution of profits” that doesn’t apply to Ethereum.

Actually, according to this article, this is not totally true: “Some courts require a “pro rata sharing of the profits and losses derived from the pooled funds” (attention to the bold word). This means that not all courts need this to be true for digital assets.

Is Ethereum a Security?
Figure 2 – “Investment Contracts” Article. Source: Gordon III, James D. “Defining a Common Enterprise in Investments Contracts.” Ohio St. LJ 72 (2011): 59.

In relation to vertical commonality, the website defends that the fortune of the developers (if they are considered the “promoters” of Ethereum) can’t be directly tied to the fortune of the investors and therefore Ethereum doesn’t fulfil this criterion.

Before jumping to our Conclusion, let’s take a look at what is going on right now. We should ask ourselves what could be starting the eagerness of the Government to regulate Ethereum.

Latest news

Let’s do the following exercise: you are the government. From a government perspective, read the following news:

Is Ethereum a security?
Is Ethereum a security?
Is Ethereum a security?
Is Ethereum a security?

“What if” Ethereum becomes legally defined as a security?

What would happen with your investments after all? It seems there is a lot of hype around the debate whether Ethereum is a security or not, but do they know what would happen in the case of Ethereum becoming a security?

The following text was taken from the website of Avenue Securities LLC, a securities distributor. Read carefully:

Cryptocurrency trading on Avenue’s platform is made available by Avenue Digital Assets LLC and offered and served through Apex Crypto LLC. Neither Apex Crypto LLC nor Avenue Digital Assets LLC are members of SIPC or FINRA.”

One more from Avenue’s website:

“Cryptocurrencies are not securities and are not FDIC or SIPC insured. Cryptocurrency execution and custody services are provided by Apex Crypto LLC (NMLS ID 1828849) through a software licensing agreement between Apex Crypto LLC and Avenue Digital Assets LLC. Please ensure that you fully understand the risks involved before trading:”

SIPC stands for Securities Investor Protection Corporation and FINRA is the Financial Industry Regulatory Authority.  Here are my thoughts on what could happen:

  1. DEXs would be obligated to inform to IRS of every Ethereum’s transaction along with the name of the investors;
  2. No more anonymous transactions;
  3. Ethereum could face a huge price drop if investors decide to move their funds to other cryptocurrencies that aren’t considered securities (yet);
  4. Similar to stocks, trading Ethereum could have a monthly limit and the DEX would be obligated to retain a percentage of profits just like it happens to stocks;
  5. Not declaring your Ethereum to IRS would be considered a serious offense (probably foreign exchange fraud).


IMHO, it doesn’t matter if Ethereum is a security or not. You’ll need to pick a side. I’d like to tell you that Statistics has a dark side. Some might say that if you strangle the data, they’ll confess. We know that 2+2 equals 4 unless you want it to be something else. This is why a debate like this will be endless. To regulate Ethereum goes much beyond technical, regulatory, economic, or legal perspectives. The government will make Ethereum a security if they need to. Simple as that.

The government’s revenue comes mainly from taxes, rates, and fees. Your expenditures are going up, inflation is acting like a wild horse, energy prices are surging, a war is going on and a recession is imminent (if not yet here). On the other hand, big players like Nasdaq and Blackrock are making moves toward cryptocurrencies and mainly Ethereum.

I don’t have any doubt that a judge, economist, lawyer, or any other professional related to the government is ready to make 2+2 equal anything they like. They’ll change the law if they have to and we will never know for sure if Ethereum is a security or not. The only certainty you’ll ever have, even though you may not be a mathematician, is that nothing is certain except death and taxes.