The SEC Has Ethereum in Its Sights. Here's What It Means for Investors

The Securities and Exchange Commission (SEC) has issued subpoenas to various companies about their dealings with the Ethereum Foundation, according to Fortune and Bloomberg. The probe has sparked speculation that the SEC may want to label Ethereum as a security.

It is early days, and the SEC has refused to comment. However, this question of how Ethereum is classified could have a huge impact on the whole crypto industry.

Cryptocurrencies: Commodity or security in 60 seconds

Right now, most cryptos are classed as commodities and come under the purview of the Commodity Futures Trading Commission (CFTC). The SEC insists that many cryptocurrencies -- including Solana (SOL), Cardano (ADA), and Polygon (MATIC) -- are, in fact, unregistered securities.

Here's how commodities and securities differ:

• Commodities: These are physical goods like oil, gold, silver, wheat, and corn. They are often traded as futures contracts on commodity exchanges.
• Securities: These are investment products like stocks, bonds, and mutual funds. Investors can buy and sell them at stock brokers registered as broker-dealers with the SEC.

If a product is a security, there are strict rules about what information it needs to report and how it can be bought and sold. Hence, a slew of SEC charges against top cryptocurrency exchanges for trading what it's dubbed "crypto asset securities."

Why the SEC may think Ethereum is a security

The SEC uses what's known as the Howey test to determine whether a product could be classed as a security. It says, "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."

The SEC doesn't consider Bitcoin (BTC) to be a security. The decentralized nature of Bitcoin means it does not meet the common enterprise requirement of the Howey test. Plus, it has an anonymous founder who is not involved in the foundation behind it.

In contrast, Ethereum's figurehead, Vitalik Buterin, is far from anonymous. On top of this, the Ethereum Foundation takes an active role in promoting and supporting activity on the blockchain. If the SEC's investigators decide this constitutes a common enterprise, it could check one of the four Howey boxes.

The SEC also argues that proof-of-stake (PoS) cryptos offer a reasonable expectation of profits. Staking means participants can tie up their coins and earn rewards for contributing to the network. Ethereum moved to PoS in 2022, which was an extraordinary technological feat. But the fact that investors can now expect to profit from staking their ETH could check another Howey test box.

Why Ethereum's classification matters

All this talk of commodities and securities may feel like semantics. After all, if you own Ethereum, why does it matter who has oversight? Unfortunately, the answer could transform the crypto industry in the U.S. Here are just two potential impacts.

1. It could change how you buy or sell Ethereum

If Ethereum is classed as a security, we'd see much stricter controls on how you can buy and sell Ethereum. One crypto attorney told CoinDesk it would be "devastating" for American investors. For example, centralized cryptocurrency exchanges are not registered with the SEC. They may have to delist Ethereum, which accounts for almost 20% of the crypto market.

Moreover, it isn't clear what it would mean for the many cryptocurrency projects and NFT markets that are built on the Ethereum blockchain. They rely on ETH for gas fees and payments. It's hard to imagine how you'd use a registered security to pay gas fees. Securities aren't set up to work that way. Imagine you own Apple stock and try to use a fraction of it to buy a coffee or pay a bank fee.

What crypto investors can do

If the SEC decides to pursue a case against Ethereum, be prepared for fallout in both the short and longer term.

• If you are a buy-and-hold investor, consider how the regulatory issues fit with your long-term investment thesis for ETH. Not only could it make it a riskier investment, regulatory changes could affect the functionality of the Ethereum blockchain.
• If you want to hold your ETH, irrespective of any SEC actions, think about storage. In a worst-case scenario, your crypto exchange or broker may restrict ETH trading. How will you manage that? For example, if you'll move your ETH to a crypto wallet that you control, make sure it is set up and you know it works.

2. Spot Ethereum ETFs look less likely

The more immediate impact of the recent news is that a spot Ethereum ETF is less likely to get the green light. The SEC recently approved several spot Bitcoin ETFs, sparking an influx of institutional money and pushing BTC to a new high. Hopes of a similar Ethereum ETF approval are fading fast.

Bottom line

This isn't the first time regulators have shaken the security stick at Ethereum. Even so, it's unlikely, but not impossible, that it will take further action. All we know is that the regulator is asking questions about how the foundation works. That's a long way from bringing charges and even further from any court ruling, which could take years to play out.

The biggest takeaway for investors is that regulatory uncertainty makes cryptocurrency a more precarious investment. Don't forget that countries like China have all but banned crypto altogether. Keep your ear to the ground and have a plan so you can act fast if anything changes.