What’s at Stake: Will the Merge Turn Ether Into a Security?
Adam Levitin’s argument
Levitin argues that a proof-of-stake system like Ethereum requires an investment of money (staking) in a common enterprise (Ethereum) with an expectation of profits (staking rewards) primarily from the efforts of others (other Ethereum participants).
He uses the phrase “primarily from the efforts of others” instead of Justice Murphy’s “solely from the efforts of the promoter or a third party.”
“Courts of Appeals have read ‘solely’ as being more like ‘primarily’ or ‘significantly,’” Levitin wrote.
However, Levitin acknowledges the significance of the latter part of Justice Murphy’s definition which references a “promoter” – the third-party entity shilling the investment contract and responsible for most of the profit-generating activity. Who would that be in the Ethereum ecosystem?
“None of this answers the trickier question of who the ‘issuer’ is when you’re dealing with a decentralized system. But that’s part of the broader problem of how to fit decentralized systems into a person-based legal system,” Levitin tweeted.
Counterarguments
Whodunit?
The most convincing counterargument to Levitin’s position may be the one he alluded to himself. If Ethereum is a truly decentralized network, who’s the third-party promoter? Former SEC regulator William Hinman’s comments in 2018 seem to undermine ETH’s risk of being branded a security on this basis.
“As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult, and less meaningful,” Hinman said. He was the SEC’s corporation finance director at the time. However, the SEC has not referenced nor acknowledged Hinman’s remarks since he made them.
What pool?
Levitin pointed out that proof-of-stake allows stakers to invest in validation pools where others perform the actual hashing, or processing transactions using a cryptographic algorithm. This goes back to his interpretation of the third and fourth prongs of Howey – expecting profits from the efforts of others.
Tim Beiko, who runs protocol support for the Ethereum Foundation, counter-tweeted to explain that Ethereum has no “validation pools” at the protocol level. More importantly, Beiko suggests that the proof-of-stake hashing Levitin referred to is nowhere near as computationally intense as proof-of-work hashing. Therefore, it shouldn’t be categorized as “efforts of others,” Beiko argued.