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Will staking on Ethereum make it a security? Other risks of Ethereum 2.0 fork

Ethereum Fork 2.0

Ethereum fans are excited about staking coming to Ethereum. Will this excitement lead to disappointment?  Will staking open a new can of worms for the Ethereum project with the SEC? 

Ethereum 2.0 is bringing staking to the Ethereum Network so that those who hold Ethereum tokens are paid a dividend.

Last year, the SEC had ruled that Ethereum was more of a commodity than a security. This moved Ethereum into the purview of Commodities Futures Trading Commission (CFTC) rather than the SEC.

In coming to the conclusion, SEC used the Howey Test which addresses four aspects:

Test 1: Involvement of Monetary Investment:  Yes, in order to procure Ethereum – you can invest money (mining was one option as well). 

Test 2: Expectation of profits: Yes,those who invested in Ethereum did so with an expectation of reaping profits down the line.

Test 3: Investment in a common enterprise: Yes, Ethereum issued an ICO to raise its money and has formed an Ethereum Foundation to run the project. 

Test 4: Profits from the efforts of a promoter or third party:  Whether we take Vitalik as a contributor or the Foundation as a whole, now because of their efforts – Ethereum is going to make progress (that is their efforts are contributing to the profits in the form of staking rewards) and could re-trigger the Howey Test.  This time, there is a potential for them to fail to meet the tests to be regarded as ‘commodity’ instead of security.

“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,” William Hinman, director of the SEC’s division of corporation finance said during a conference.

That gave a sigh of relief to the Ethereum community. With staking coming to the network, will we see a second round of ‘scrutiny’ from the SEC?

Too big to fail or ripe to take down?

Because of the open public blockchains like Bitcoin and Ethereum, even with a lot of private enterprise push projects like Hyperledger, Corda, etc., have not found ground yet. IBM is heavily invested in Hyperledger’s success and a blow to Ethereum Network because any potential troubles with the SEC could boost these projects.

In fact, as of this writing, Hyperledger only has about 15 projects on it compared to 2825 DApps on Ethereum.

Because of the industry reliance on the Ethereum Network by startups who are strapped for capital and the big enterprises who are breaking into blockchain space, we expect the SEC to exercise leniency toward the staking move by Ethereum.  

Ethereum Foundation may have already looked into these aspects before working on Ethereum 2.0 and getting ready to roll out the staking model.

Other Risks of Ethereum 2.0 fork 

Besides the regulatory risks from the SEC and other regulatory bodies, the project rollout itself has some inherent risks, including:

  • Moving from Ethereum 1.0 to Ethereum 2.0 requires a lot of coordination and technical expertise;  what if some functionalities from 1.0 do not port to 2.0?
  • What if we find ourselves in the same conundrum as we did before with Ethereum Classic vs. Ethereum 1.0?
  • What if the majority of the community decides to stay with Ethereum 1.0?

These forks that pose a possible split of resources and network support may force the large enterprises to switch to more reliable (even if centralized) blockchain networks.  This in theory could hurt Ethereum and public blockchain space in general.

On the other hand, if the transition goes according to the plan and if the network grows stronger due to the Proof-of-Stake (PoS) model, it could cement Ethereum’s position as the number one public blockchain protocol for smart contracts for projects of all sizes.

Other coins do this, why is it a problem now?

Tezos Latest UpdatesTezos offers staking and so do other tokens, then why is this a problem now with the SEC?  

The problem is, there is no clear cut ruling that these other tokens with staking are not a security.  It may just be a matter of time for the SEC to question these projects about their staking aspect and how they justify not meeting the Howey test.  

In fact, EOS and Tezos have paid penalties for running unauthorized ICOs.  However, a clear ruling on whether or not they are a security is not concluded.

As Ethereum, the second largest crypto in the market, moves to staking mechanism it can draw the attention of the SEC not only to its own project but to other projects as well.

Probably, the founders of these projects anticipate this move from the SEC and so they have met with the SEC to strategize and recommend how these tokens should be treated legally.

The Proof of Stake Alliance (POSA), an association with the likes of Coinbase, Cardano, Polychain in its alliance, has met with the SEC to provide clarity from a regulatory perspective.

Forbes reported that “Coinbase, Polychain And Tezos Meet With SEC On Blockchain,” because they are sensing the direction the staking path is leading toward and they don’t want to mess with the regulations, instead, they want to be the conduits who usher the newer and more sensible regulations that make sense for the blockchain and cryptocurrency reality we live in.

Will they succeed in convincing the SEC that staking itself should not change a token’s ‘utility’ status?

Only time will tell.

Conclusion

Our own opinion is that the SEC will be more compassionate with Ethereum since the network  has already on boarded many projects and any trouble to the project could hamper the progress made in the blockchain space. 

The other projects that are offering staking may run into a bit of a problem if the SEC finds them to be securities and all of a sudden they have to comply with the disclosure and audit requirements of the securities.  This could throw many of those projects out of business (which may be a good thing for Ethereum in consolidating its position as global leader in smart contract blockchain network).

The real trouble may be lurking in the execution of this fork itself, not with the authorities.

For now, let’s wish Ethereum network all the best.

Thank you for reading and sharing this article. Stay safe and healthy!

IMPORTANT DISCLAIMER

Everything in this article is an opinion, not an advice of any kind. This material has been prepared for general informational purposes only and it is not intended to be relied upon as accounting, tax, investment, legal or other professional advice. Please consult with a professional for specific advice.

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