Notes 9/16: ETHW Crash, ETH As a Security

The effect of Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS) on the price of its native token ether has receded. Investors bid up ether’s price in the weeks leading up to the merge. It remained flat during the actual event. And now, it is in decline.

After reaching a high of $2,007 slightly more than a month ago, ether prices have fallen below the $1,500 mark. A possible catalyst for its fall could be a suggestion by SEC chief Gary Gensler that ether could be classified as a security. As of this writing, ether is changing hands at $1,445.98, down almost 3% from its price a day ago. Bitcoin is also down by roughly 1% and is trading at $19,646.62.

ETHW Takes Off and Crashes

The Ethereum Proof of Work (PoW) chain was riding high as Ethereum merged. IOUs for ETHW, its token, traded at more than $60 yesterday morning even as the price of ether remained flat. Investors snapped up the ETHW token in anticipation of…ok, let’s forget that sentence.

Launch of the Ethereum PoW blockchain this morning, a day after the Merge was finalized, has brought a shot of reality. Its token’s price crashed by almost 40 percent to $11.96.

The chain seems to be a mess. Miners and developers are complaining of difficulties in linking to it and former miner Chandler Guo, who spearheaded the fork, told Coindesk that it was beset by DDOS attacks.

IOU ETHW tokens from the chain, which has no practical applications and is doomed to die due to a “difficulty bomb”, are already trading on 25 exchanges, he said. According to Guo, 20 projects will be launched on the chain in the future. But the rewards are fewer for miners on the chain because of increasing difficulty levels and less support. In fact, he has warned that 90% of miners on the new chain will go bankrupt.

By then, Ethereum POW will have served its purpose. The blockchain is a backup repository for Ethereum PoS. It also boosts the overall valuation for crypto markets at a time when macro events like the Fed’s interest rate hikes have overtaken crypto narratives in investor analysis of the asset class.

And Guo is the perfect spokesperson for it. A hard-nosed businessman, his plain speak is refreshing in an ecosystem that has much jargon and little substance. “Even if [ETHPOW] is a zombie chain, it doesn’t matter because people coming into the crypto world for what…for making money,” he told Coindesk.     

Gensler Don’t Care  

Ethereum’s Merge may have slashed its energy emissions and set the stage for scaling its platform and significantly reduce transaction fees on its platform. But Gary Gensler, Chairman of the Securities and Exchange Commission (SEC), don’t care.

He gatecrashed Ethereum’s celebration party for the event by suggesting that the blockchain’s move from a Proof-of-Work (PoW) consensus mechanism to one that involved Proof-of-Stake (PoS) may have made ether – its native cryptocurrency – a security token candidate.

“From the coin’s perspective…that’s (a staking mechanism) another indicia that under the Howey test, the investing public is anticipating profits based on the efforts of others,” he told reporters after a Senate Banking Committee appearance yesterday.

After the Merge, Ethereum’s network consists of validators, instead of miners, that stake ether tokens to win the right to attest or confirm transactions and create new blocks. While no more than 32 ETH can be staked in a node, the system can be gamed by running as many nodes as possible to increase the staked amount.

Prominent crypto exchanges, such as Coinbase and Binance, are some of the biggest holders of staked ether tokens because they offer staking services that promise yields, or interest payments, to investors based on the amount of ether staked and its time duration.

Gensler told reporters that such services look “very similar – with some changes of labeling – to lending.” If ether is categorized as a security in such instances, then it could inflate costs of such services and increase disclosures required from exchanges.

A Question of Decentralization

Much of the debate about ether, and crypto, relates to the question of whether it is a result of common enterprise or a decentralized entity.

Two prongs of the Howey Test, which is used to evaluate whether a token is a security or not, are about profits that result from a common enterprise. Ethereum was deemed to be “sufficiently decentralized” by former SEC commissioner William Hinman in 2018.

But the move to PoS has concentrated ownership of tokens between relatively few holders. Under the Howey test, it should be relatively simple to classify ether as a common enterprise dominated by few players and one that produces profits.

But decentralization, at least on a cryptocurrency’s blockchain, exists on a spectrum. The number of developers working on a blockchain changes as does the number of nodes required to reach consensus. The center does not hold on a crypto’s blockchain and it transforms based on the cryptocurrency’s popularity and available funds.

That said, one could argue that a select group of developers and personnel, such as the blockchain’s founders, are responsible for most of the important decisions relating to it. For example, the Ethereum Foundation has shepherded its blockchain through important milestones.   

A Flexible Approach and CFTC’s Bill to Regulate Crypto  

Crypto advocates can take comfort from the fact that Gensler’s prepared statement stated that his agency was prepared to take a “flexible approach” to applying disclosure requirements for cryptocurrency projects. The approach will still enable the agency to pick winners from a crowded ecosystem of crypto projects. That is, if the SEC gets to regulate crypto.

As things stand now, the Commodities Futures Trading Commission (CFTC) is poised to regulate cryptocurrencies. A bipartisan August Senate bill, introduced by Sen. Debbie Stabenow (D-Mich.) and Sen. John Boozman (R-Ark.), proposes to put crypto tokens under the purview of the agency. That bill, called the Digital Commodities Consumer Protection Act, classifies bitcoin and ether as commodities.

CFTC Chairman Rostin Benham testified before the Senate Agriculture Committee yesterday regarding his agency’s expenses to regulate crypto. According to him, the agency plans to spend $112 million over the first three years for rule making, hiring, training, and outreach purposes. Crypto companies will finance the CFTC’s expansion through a “user fee.”

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