In recent years, the cryptocurrency industry has been a prime target for regulators in the United States.
The legal battle between Ripple and the United States Securities and Exchange Commission (SEC), Nexo’s lawsuit with securities regulators in eight states, and the scrutiny directed at Coinbase’s Lend program last year are just a few examples of high profile. This year, even Kim Kardashian had firsthand experience with regulatory scrutiny after agreeing to pay a $1.26 million fine for promoting the dubious EthereumMax project.
While the developers of Ethereum intended to pave the way for key network upgrades in the future, it appears that the recent Merger has further complicated matters between crypto projects and US regulators.
Ethereum: Too Substantial for the Crypto Market?
On September 15, the same day the Ethereum merger took place, SEC Chairman Gary Gensler stated during a congressional hearing that proof-of-stake (PoS) digital assets could be considered securities. Gensler said his reasoning was that holders can earn income by staking PoS coins, which could mean there is an “expectation of profit from the efforts of others.” The latter is one of the essential parts of the Howey test, used by the SEC and other US authorities to determine whether an asset is an investment contract and is subject to federal securities law since it became a law in 1946.
As you may already know, Ethereum has moved from mining-based proof-of-work (PoW) to PoS, which requires validators to stake Ether (ETH) to add new blocks to the network. In other words, this means that Ether could fall under the Securities Act of 1933, which would require the project to register with the SEC and meet strict standards to protect investors.
Gensler argued that intermediaries such as cryptocurrency exchanges and other providers offering staking services “are a lot like” lending. And, cryptocurrency lending is a sector that has come under intense scrutiny from the SEC, especially considering the agency’s $100 million fines against BlockFi in February.
In fact, Gensler’s last argument is highly relevant in the case of Ethereum, where one has to stake 32 ETH (worth $42,336 at the current price of $1,323 per coin) to become a validator. Since this is a hefty sum for many, most users turn to staking providers to stake their digital assets on their behalf to avoid this capital requirement for a fee.
At the same time, this could mean that, at some point, the large centralized providers will increase their control over the network. Therefore, being under the supervision of the SEC, there is a possibility that the agency will prohibit them from validating individual transactions (censorship), which will lead to the fact that such transactions will take longer to confirm. That being said, confirmation speed should be the most important issue here, as there will always be some validators that will subsequently confirm the transaction.
In this scenario, Ethereum, as one of the main decentralized finance (DeFi) networks, would be the main lever of regulatory policy. Tokens like USD Coin (USDC) and many others contain blacklisting and blocking mechanisms at the development level, unlike the DeFi market in general, so it makes sense for validators and the MEV market to play the role of enforcement tools. leverage. However, in the short term, this is more of a scare as there are too many validators and no one can control this process at a reasonable cost.
With regard to the above, US regulators may intend to force node validators under their jurisdiction to implement Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures to validate transactions.
The Ethereum merger provides opportunities for the SEC to act. How?
In addition to the Howey proof argument, the SEC also asserts that ETH transactions are under US jurisdiction due to the high concentration of network nodes in the United States. If this statement proves to be accurate and finds further development across the country, this would mean that the US Treasury’s Financial Crimes Enforcement Network (FinCEN) will require that all companies operating on the blockchain Ethereum are KYC and AML compliant.
In practice, this means that customers will need to verify their identities and residences, as well as provide more information to service providers before they can start using a DeFi service. This significantly increases the burden on crypto projects (and it could be argued that this process would go against the idea of decentralized finance). However, regulatory compliance will facilitate trust between investors and providers, which will help attract investment from institutional clients.
With that said, it is vital to mention the SEC controversy regarding its approach, communication, and decisions on crypto regulation, which has been heavily criticized by digital asset market players. The case of BlockFi is an excellent example. The SEC announced actions against the company for failing to register high-yield interest accounts that the commission classified as securities. According to case documents, one of the agency’s requirements was to bring BlockFi’s business into compliance with the Investment Company Act of 1940.
As a result, BlockFi ended up on the auction block, and two other companies with similar businesses went bankrupt – these were the words of Ripple General Counsel Stu Alderoty.
Thus, a situation has arisen where the SEC used the 1940 legislation to regulate modern and not yet fully developed technology, which is absurd.
Furthermore, the SEC statement that all Ether is under US jurisdiction is, to put it mildly, false. (If it were, it would be convenient for the agency). The SEC’s logic here is that the Ethereum blockchain node network is more densely clustered in the US than anywhere else, so all ETH transactions around the world could be seen as If they were Americans. source.
But according to Etherscan, the US currently hosts just over 46% of all Ethereum nodes, not even a simple majority. According to the SEC statement, it could be argued that only the European Union should regulate Bitcoin (BTC). Of course, this last argument is as absurd as the agency’s claim.
I believe that these statements are the result of the SEC lawyers’ very rough understanding of cryptocurrencies. But we can’t rule out the SEC’s past tendencies to regulate through enforcement.
Regulatory compliance will come at a great sacrifice for Ethereum
US regulators are increasingly expressing concern about the huge sums circulating in DeFi without any controls. Since the Ethereum blockchain serves as the main chain for most tokens, its recent switch from PoW to PoS can be used as an argument for its attempts to influence (at least part of) the decentralized market.
If the SEC and other US regulators succeed in the latter, it could restructure DeFi so that another evolving blockchain becomes the leader. But, what is certain in the case of the complete regulation of Ethereum is that traditional banks and investment funds will push the use of ETH as an asset for investments and means of payment.
Given all of this, providing any timeline is challenging, as such SEC statements are fairly recent and raw at this point. Let’s wait and see what other actions the US regulators will take in the near future and if they will also affect the KYC and AML procedures of the crypto space.
Slava Demchuk is the CEO and co-founder of AMLBot, a company that monitors a global database of cryptocurrency addresses to help businesses and private users with compliance requirements.
This article is for general information purposes and is not intended to be and should not be taken as investment or legal advice. The views, thoughts and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.