Published: September 21st, 2022
In a federal lawsuit filed Monday by the US Security and Exchange Commission against crypto influencer Ian Balina, market observers noted something unexpected in the fine print.
In a bold move hidden deep in the filing, the SEC claimed it had the right to sue Balina because the crypto transactions in question happened in the United States. It also claimed that the entire Ethereum blockchain falls under the regulatory purview of the US government.
Balina is being sanctioned because he allegedly failed to register a cryptocurrency as a security before launching an initial coin offering (ICO) back in 2018.
The SEC says that, because the ETH sent to Balina was validated by a network of Ethereum nodes which are clustered most densely in the USA, 'it's fair to conclude that those transactions took place on US soil.’
If experts are reading the SEC’s intentions correctly, the agency is saying that because most of Ethereum’s validating nodes are based in the United States, every global transaction made on the Ethereum blockchain should be treated as 'American’.
Fact check: numbers from Etherscan show that roughly 45.80 per cent of all Ethereum nodes are based in the US. The country with the second highest node density is Germany, which holds roughly 20 per cent.
The SEC has been filing civil suits against individuals and organizations for years when unregistered ICOs have been detected. What's changed in the Balina case is that the SEC is now saying that anyone doing business on the Ethereum blockchain ‘is effectively doing business on a US securities exchange,’ said University of Alabama law professor Brian Fayre in a recent blog post.
‘From the regulator's perspective, it would make taking action against individuals much easier.’
If the agency can re-classify Ethereum transactions in this way, it can claim jurisdiction over everything bought or sold on what’s meant to be a decentralized blockchain network.
That would constitute a major escalation in the SEC’s battle to oversee crypto financial services activity, Fayre says, ‘arguably vassalizing the world's second largest blockchain’.
Ethereum, he notes, is where the vast majority of NFT and DeFi activity happens.
Last week, just hours after the merge event that saw Ethereum move to a proof-of-stake (PoS) mechanism, SEC Chair Gary Gensler told the US Senate Banking Committee that the transition could re-define the blockchain in the government's eyes as something more akin to a security than a technology platform.
Gensler’s view is that the process of ‘staking,’ pledging assets to a crypto network in exchange for passive rewards, could be seen as proof under the so-called Howey Test that an asset qualifies as a security.
So far, the SEC hasn’t taken an official stance on Ethereum under Gensler’s reign, though leadership within the agency had previously suggested that Ethereum was so decentralized that it couldn’t be classified as a security.
That could all change if the commission can prove that Ethereum can act as an unregistered security.
Back in July the Financial Stability Board (FSB), a G20 entity charged with monitoring financial activity in the world’s top-20 economies, announced a coming proposal that will lay out new 'robust regulation and supervision’ for cryptocurrencies.
A report scheduled for October will be shared with G20 finance ministers with a proposed set of new rules to govern and supervise crypto assets, including so-called stablecoins.
An FSB press release said that digital currencies are evolving rapidly in a tumultuous environment marked by extreme volatility. 'Despite these worries, cryptocurrencies are becoming increasingly integrated into the traditional financial system, exposing investors to new risks.’
The FSB is worried, it says, about the potential for one market failure to negatively impact participants in the wider crypto ecosystem. ‘Investors can suffer huge losses while risks are transmitted to other parts of the system and market confidence is damaged.’
Crypto market watchers saw this as a veiled reference to Terra’s dramatic failure in early May of 2022. The collapse of the Terra ecosystem triggered a liquidity crisis and sent several well-known crypto finance firms and hedge funds into bankruptcy.
Though the organization monitors the financial services industry closely, the October crypto proposal will mark a new chapter for the FSB. Up until now it has played a background advisory role, and any recommendations to G20 ministers and bankers have been made outside the public sphere.
In May, pro-crypto Portugal became the latest country to reboot its financial services rules and clamp down on crypto activity. The shift from pro-crypto to crypto curious is significant, since Portugal had become a haven for blockchain and crypto innovation.
All that changed when the country's finance ministry did an about-face and announced that all crypto assets in the country would be subject to capital gains taxes.
Previously the government took a hands-off approach to cryptocurrency transactions, treating them as cash exchanges and effectively excluding them from capital gains taxes by definition.
Crypto trades are now taxable at 28 per cent. That quickly shredded Portugal’s reputation as one of the most attractive places on the planet for crypto projects and investments.
Given the level of tech and private investment crypto has attracted to the country, Portuguese finance officials were keen to avoid being seen as suddenly anti-crypto. The government said it was simply regulating crypto as it had always planned to. It simply wanted to see how other countries were adapting their tax and regulatory regimes and make sure Portuguese rules were coordinated with others.
In practice that would mean mimicking how other countries to treat crypto-trading profits as capital gains. Australia’s tax authority, for example, published a warning to crypto holders in April warning anyone who had not disclosed taxable earnings from the sale of crypto assets that they could be penalized under the law.