In their crackdown on cryptocurrencies, regulators may have found their biggest target yet.

The New York Attorney General’s (NYAG) office today filed a case against cryptocurrency exchange KuCoin for an unregistered offering of securities. In its filing, the agency alleged that Ethereum’s ether, the world’s second biggest cryptocurrency by market capitalization, is a security.

Just yesterday, when asked about the cryptocurrency’s regulatory status, the head of the Commodity Futures Trading Commission (CFTC) Rostin Benham asserted that it was a commodity in his opinion.  

“This action is one of the first times a regulator is claiming in court that ETH, one of the largest cryptocurrencies available, is a security. The petition argues that ETH, just like LUNA and UST, is a speculative asset that relies on the efforts of third-party developers in order to provide profit to the holders of ETH,” the agency stated in its press release. It also mirrored the Securities and Exchange Commission’s (SEC) claim in an earlier case that UST, Terraform Labs’ stablecoin UST and its native token LUNA are securities.  

The price of ether, Ethereum’s native token, plunged 8% in 15 minutes after news came out about the lawsuit. As of this writing, the token is changing hands for $1434.84, down more than 7% from its price a day ago.  

The Ethereum Security Token  

There is a video clip on Twitter in which current SEC chief Gary Gensler discusses Ethereum when he taught a class on cryptocurrencies at the Massachusetts Institute of Technology (MIT).

“To my mind, there’s no doubt that Ethereum is a security,” he told students in 2018. Ever since he has become chief of the agency responsible for overseeing securities in 2021, he has insistently repeated the same assertion, albeit within the broader context of crypto tokens and minus bitcoin.

The NYAG office handed him an assist with its case against KuCoin today. While Ethereum itself claims to be decentralized, the agency identified the role of Ethereum Foundation, a Switzerland-based nonprofit, headed by Vitalik Buterin as key to their argument that its development and profits rely on third party efforts.

“Most relevant here, Buterin and the Ethereum Foundation played key roles in facilitating the fundamental shift of the transaction verification method from Proof-of-Work to Proof-of-Stake,” the agency wrote in its complaint and cited the instance of a developer being “granted permission” to work on the effort by the foundation.

That is not the only instance of the foundation’s central role in Ethereum’s development. Back in 2016, it orchestrated a hard fork, at the behest of investors concerned about losing their funds, that amounted to a fresh start for the blockchain.

Ether As a Wall Street Asset   

It is important to underscore that NYAG’s case against Ethereum is an allegation. But it is a strong one and will reverberate through the crypto ecosystem.

Staking is one area which will feel the impact of the NYAG’s lawsuit immediately.

As the SEC’s recent settlement with Kraken demonstrated, staking-as-a-service, a business model in which services aggregate tokens from customers to stake them at nodes, also makes a clear case for an unregistered securities offering. Other staking programs have become fair game for the SEC.

Even ether’s biggest staking platform Lido, which claims to be a decentralized lending platform but is actually a centralized setup, is in the firing range of regulatory agencies.

Investors are bidding up prices for ether, and hoarding it in their treasuries, in anticipation of the token’s conversion to a “Wall Street Asset” after staking withdrawals are enabled. Their argument is that a defined and rapid timeframe coupled with attractive yields will be a hit with Wall Street investors searching for returns.

But that investing thesis was based on ether’s status as a commodity. The NYAG’s case today introduces regulatory uncertainty – which hangs as a perpetual sword over cryptocurrencies – into the equation. Wall Street traders, already shackled to regulatory chains after the last financial crisis, will hardly be willing to venture into risky investments again.

Ether As a Crypto Asset

Meanwhile, the NYAG’s case also calls into question ether’s status as an asset within cryptocurrencies. It is used extensively in various financial applications, including as collateral for stablecoins like DAI, within the crypto ecosystem. The steep price drop indicates a rocky road and tumbling prices ahead.

By filing its case against KuCoin, NYAG has also taken aim at cryptocurrency exchanges that list ether. They could be charged with unregistered securities offerings and might choose to delist the token rather than spend money and time dealing with regulators. In turn, this might its trading to unregulated venues and dry up its liquidity. Illiquid tokens end up as zombie coins.