Bracing for Uncertainty: SEC PoS Regulations and The Impact on Projects That Use It

Bracing for Uncertainty: SEC PoS Regulations and The Impact on Projects That Use It


May 22, 2024

The status of Ethereum and other Proof of Stake (PoS) ecosystems is uncertain. As the industry braces for a showdown with the Securities and Exchange Commission, the projects using Ethereum smart contracts may also be at risk and need to realign themselves with another ecosystem to continue operating. On the other hand, Proof of Work (PoW) ecosystems have been relatively safe from a compliance standpoint.

The SEC and Ethereum’s History

The trajectory of the SEC’s comments on Ethereum has changed over time. Starting with the government agency's first comments in 2018, which surfaced when Ether utilized Proof of Work, it seemed Ether was in the clear. However, now, Proof of Stake’s future is not as straightforward.

“And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions.” - Former SEC Director William Hinman

However, in late 2020, Ethereum switched from a Proof of Work to a Proof of Stake during a transition known as ETH 2.0. Since then, the story has changed from the “Hinman Standard” days.

Fast-forward to February 2024, when the warrant canary was removed from the Ethereum Foundation’s website after a “voluntary inquiry from a state agency” (Blockworks).

Warrant Canary Removal

A warrant canary on a website indicates that an organization has not been served a government subpoena or document request (CoinTelegraph). Thus, removing a warrant canary indicates receiving a subpoena or inquiry from a state agency. The timing of the warrant canary’s removal from the Ethereum Foundation’s website comes 4 years after Ethereum switched from Proof of Work to Proof of Stake.

Fortune reported that the SEC issued a subpoena against the Ethereum Foundation.

Then, in April 2024, Consensys filed a lawsuit against the SEC, alleging that Consensys received its fourth document subpoena in March and a Wells notice in April. In the lawsuit Consensys filed, Consensys revealed it had been the subject of a yearlong investigation into Ethereum’s security status.

With these specific players involved, it could be argued that the Ethereum Foundation and Ethereum’s key infrastructure providers are being targeted.

Impact of Ether Coming Under Fire

The SEC’s Chairperson, Gary Gensler, asserts that all Proof of Stake networks like Ethereum are securities because they encompass comprehensive frameworks that involve an investment of money with a common enterprise where participants have a reasonable expectation of profits based on the system's setup and operations. In other words, Gensler argues that they violate the Howey test, which was created to test whether an investment contract is in violation of the security law and needs to register as a security with the SEC.

Yale Journal of Law and Technology stated: “For all these reasons, SEC Chair Gary Gensler argues that all networks using Proof of Stake, including Ethereum, are securities.”

Ethereum maintains strong market dominance, representing over 15% of the world’s cryptocurrency market cap. There are ~80 ecosystem projects currently building on Ethereum (Messari).

What could the impact be if Ether and perhaps all PoS come under fire?

The timing of the SEC’s lawsuit against Ethereum, amidst the protocol’s switch from Proof of Work to Proof of Stake, invites speculation about what could happen to other Proof of Stake networks if the lawsuit altered Ethereum’s regulatory status in the United States of America.

As the Yale Journal of Law and Technology put it: “Whether Ethereum is a security has tremendous implications for the entire protocol. Indeed, if the SEC concludes it is a security, Ethereum would likely not exist for much longer due to the high costs of compliance with securities laws.”

Proof of Work vs Proof of Stake Comparison

Build on Proof of Work

To mitigate compliance risk while still attracting the ~40M+ US Web3 token users (Pew), projects using Proof of Stake should consider moving to a Proof of Work network. Proof of Work ecosystems have remained under regulatory scrutiny.

Decrypt has explored this topic in an article titled “The SEC Has Not Labeled Any Proof of Work Asset as a Security—Why Is That?” The article cited reasons such as the absence of a central issuer and a lack of a lock-up requirement to secure the network as potential reasons why PoW networks have been “unfazed” by the regulatory heat that some PoS networks have faced.

CEO of Digital Currency Group added to the conversation in a tweet: “no Proof of Work tokens in any of the lawsuits.”

In Conclusion

As regulatory scrutiny intensifies around Proof of Stake networks, Kadena offers a compelling alternative for developers and projects looking to mitigate compliance risks. With its robust, secure, and scalable blockchain technology, Kadena provides a haven from the regulatory challenges facing other ecosystems and a dynamic platform for growth and innovation.

As the regulatory landscape evolves, choosing Kadena, which combines the security benefits of Proof of Work with advanced features like Kadena’s Pact programming language, positions projects to thrive in an increasingly uncertain environment.

For those navigating the complexities of blockchain compliance, Kadena represents both a shelter and a springboard, promising survival and success.

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