How do U.S. regulators consider "ETH 2.0" a security?

特邀专栏作者

2019-12-26 19:44 (UTC+8)

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The more powerful a buyer of a digital asset is, the more likely the buyer is to rely on the efforts of others, and thus the less likely it is to decentralize the network.

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The more powerful a buyer of a digital asset is, the more likely the buyer is to rely on the efforts of others, and thus the less likely it is to decentralize the network.

Editor's Note: This article comes fromEditor's Note: This article comes from(ID: cc-value) Author: Grant Gulovsen, Compiler: Bai Ye, reproduced by Odaily with authorization.

background introduction

How should Ethereum be characterized? This question seems to still have no clear answer.

On November 12, 2019, Heath Talbert, chairman of the US Commodity Futures Trading Commission (CFTC), said that they are working with the US Securities and Exchange Commission (SEC) on Ethereum 2.0, which is based on the proof-of-stake transaction verification consensus protocol. Conduct re-evaluation analysis of potential transactions;
If you push the time forward, on October 10, 2019, Heath Talbot once said: "I, as the chairman of the US Commodity Futures Trading Commission, believe that Ethereum is a commodity."
The same situation also happened in June 2018. William Hinman (William Hinman), head of the corporate finance department of the US Securities and Exchange Commission, also said: "Based on my understanding of the current state of Ethereum, the network, and its decentralized structure, Current Ethereum offerings and sales are not securities transactions.”

Some people in the industry believe that Ethereum completed the token sale in 2014 when the regulation was still unclear, so it escaped being "taken away by the regulator". Today, with the development of work on Ethereum 2.0, regulators seem to have renewed their attention to the native nature of Ethereum. If the SEC determines that its new proof-of-stake verification model is a securities transaction, it could have a significant negative impact on the Ethereum network’s plans to upgrade to version 2.0, and the broader cryptocurrency market.

What is Proof of Stake?

In the field of cryptocurrencies, more people may be familiar with Proof of Work (PoW), because Bitcoin uses this consensus protocol that needs to solve increasingly complex mathematical calculations to create blocks and verify/validate transactions, but Proof of Stake But completely different. Proof-of-stake mining usually requires a validator node ("validator") to store (or "mortgage") a certain amount of cryptocurrency in a wallet and keep the wallet online so that the balance broadcast can be automatically sent to the corresponding network . In addition, for those miners who use mathematical calculations to solve blockchain network verification problems, the proof-of-work consensus protocol will reward a certain amount of cryptocurrency when the block is successfully created, but the proof-of-stake will usually be given in accordance with the mortgage ratio of the verifier. Block rewards.

In the case of Ethereum 2.0, users can use Ether (ETH-USD) as collateral. This model not only allows users to obtain financial returns when verifying or proving the validity of blocks, but also ensures protocol security. , which is conducive to protocol construction. The requirements to become an Ethereum 2.0 validator are as follows:

Configure and run the validator client;
Mortgage 32 Ether in the validator wallet;

To receive staking rewards and transaction fees, a validator must also do the following:

The validator wallet balance needs to keep 32 Ether;
Validators need to ensure that they have updated to the latest software;
Validator clients need to be always online and able to communicate with the network.

How Does the Ethereum 2.0 Proof-of-Stake Model Affect the Securities Act?

If you want to determine whether a financial product meets the definition of "securities" under US law, you first need to look at the legal definition of the so-called "securities". This definition can be found in the Securities Act of 1933 (Securities Act of 1933) Fifth and Section 12(g) of the Securities Exchange Act of 1934. The "Congress" that enacts securities laws is actually very obvious at present, hoping to regulate investment, no matter what the form and name of the financial product is. To this end, regulators have developed a broad definition of "securities" designed to cover almost any financial instrument that might be sold as an investment. It is worth mentioning that the same word appears in the definition of "securities" in the above-mentioned two regulations: "investment contract". As pointed out by the SEC and (at least) one U.S. federal district court, whether a digital currency would be considered a security requires proper analysis, and an important evaluation criterion in the analysis process is whether the digital currency falls under the above regulations "Investment Contract" referred to in . Since the proof-of-stake model of Ethereum 2.0 involves digital assets, the judgment based on the "investment contract" also applies to Ethereum 2.0.

The U.S. Securities and Exchange Commission once had a classic case: "SEC v. WJ Howey Co., 328 US 293 (1946)". Refers to a contract, transaction, or scheme in which a person invests his funds in a general company that results in the person's desired profit solely from the efforts of the originator or a third party.

The concept of joint venture contracts, now collectively referred to as the "Howey test", also embodies a flexible rather than hard-and-fast regulatory principle that can be adjusted to meet various variable scenarios that give some promise of profit , usually designed for those seeking to use other people's funds.

The "Howey Test" will judge whether a product is an "investment contract" (and therefore determine whether the relevant financial product should be classified under the securities category) according to the following four elements that exist in a contract, transaction or plan. These four elements They are:

The investor has contributed cash or equivalents;
Inputs are funneled into a project, organisation, business or pool of funds;
Investors have profit expectations, that is, the investment purpose of most investors is to make money;
Profit is entirely dependent on promoter or third party efforts or operations.

Now, since the proof-of-stake protocol proposed by Ethereum 2.0 also touches the category of "securities", we will analyze each element that may be involved here one by one.

1. Cash into the "Howey Test"

The first question that needs to be answered is whether the relevant project involves "cash investment". According to the latest Ethereum 2.0 GitHub repository, users must have 32 Ether to operate a validator node, so for the first question, the answer is obvious: "Yes, Ethereum 2.0 has cash input". As far as the "Howey test" is concerned, the concept of "cash" may not be so important, because Ether itself can also be regarded as a cash equivalent.

2. Whether the input has been funneled into a project, organization, enterprise or funding pool

The "Howey Test" needs to answer the second question, which is whether the relevant project involves "a public enterprise". Depending on the jurisdiction of the United States Circuit Court of Federal Courts in the matter, the United States federal court system recognizes three different tests:

(1) Horizontal commonality;

(2) Extensive vertical commonality;

(3) Narrow vertical commonality.

For them, the SEC is the regulatory agency that evaluates and analyzes Ethereum 2.0, and there should be no problem with Ethereum 2.0 in this regard. This is because the U.S. Securities and Exchange Commission Innovation and Financial Technology Strategy Center (FinHub) pointed out in the digital asset "investment contract" analysis framework released on April 3, 2019: "The U.S. Securities and Exchange Commission itself does not need vertical or horizontal commonality. Nor does it view a public corporation as a unique component of a long-term investment contract.” Furthermore, the Center for Innovation and Financial Technology Strategy, in its framework for evaluating digital assets, also noted that the SEC found that “a public corporation” was ubiquitous . Whether the US federal courts will side with the SEC on this issue is beyond the scope of this article, but given the above, there are good reasons to believe that the SEC should (at least) find that Ethereum 2.0 meets this requirement. reason.

3. Investors have profit expectations, that is, the purpose of most investors' investment is to make money

The "Howey Test" needs to answer the third question, which is actually the easiest question to answer, namely: Does Ethereum 2.0 involve "reasonable profit expectations". Regarding this problem, Ethereum 2.0 itself wrote in the specification: "The validator is an optional role for users. They can use Ethereum as collateral, and verify and prove the validity of blocks in order to seek financial rewards, and also It can ensure the security of the protocol and is conducive to the construction of the protocol.”

In the "Howey Test", the common sense understanding of "profit" is only - "financial return on investment", so Ethereum 2.0 seems to be "inescapable" on the third question.

4. Profit is entirely dependent on the efforts or operations of the sponsor or a third party

The fourth and final question to be answered by the "Howey Test" is whether the profit is entirely dependent on other efforts or operations, or, as the "Howey Test" states, "derived solely from" the promoter or a third party s hard work.

The "Howey test" has actually been stated very clearly. We can basically draw the conclusion that allowing verifier nodes on the Ethereum 2.0 network cannot actually pass the "Howey test" because users have to spend a lot of energy are eligible to collect Financial Rewards. As mentioned earlier, in order to collect staking rewards/transaction fees, a validator must do all of the following.

(1) Configure and run the verifier client;

(2) Mortgage 32 Ether in the validator wallet;

(3) The wallet balance of the verifier needs to keep 32 Ether;

(4) The verifier needs to ensure that it has been updated to the latest software;

(5) The validator client needs to ensure that it is always online and able to communicate with the network.

If one of the above tasks is not performed, it will result in the user losing the right to collect staking rewards/transaction fees (at least until the problem is resolved). This means that the financial rewards on Ethereum 2.0 come primarily from users, rather than relying solely on the efforts of promoters or third parties.

Unfortunately, given the remedial nature of U.S. securities law, U.S. federal courts have adopted a more realistic test of whether efforts by persons other than investors and those necessary management efforts to affect business failure or success also has undeniable significance. Therefore, we should focus our analysis on which efforts (jobs) affect the failure or success of the entire Ethereum network. In fact, William Hinman, head of the corporate finance department of the US Securities and Exchange Commission, has already begun to pay attention to this issue in his previous speech. He believes that the current iteration of Ethereum does not involve securities laws, and said:

"The Ethereum network can provide more functionality for cryptocurrencies or encrypted tokens. If Ethereum is sufficiently decentralized (cryptocurrency or token purchasers are no longer dependent on the efforts or operations of promoters or third parties), then Ethereum — this digital asset may not represent an investment contract.”

So, the ultimate question has finally surfaced: the SEC previously considered Ethereum to be "sufficiently decentralized" and therefore not considered a security, but with the launch of Ethereum 2.0, what can the SEC do? Continue to think so?

What does "fully decentralized" mean?

Since William Hinman, head of the SEC's Division of Corporate Finance, stated that current Ethereum offerings and sales are not securities transactions, discussions have sparked online about the criteria for "sufficient decentralization." Some commentators have suggested that innovators should be reassured that decentralization standards are not cumbersome or impractical to properly understand, and that regulation seems to allow certain projects to have the necessary centralized leadership. However, others believe that for various reasons (such as our insufficient understanding of the concept, the inevitable nature of transfer), using "decentralization" as a legal standard is very problematic. Actually, it’s not a good idea to devote all your energy to analyzing the term “sufficient decentralization”, especially considering the fact that:

“Even in the context of blockchain protocols, there is often confusion about what the word decentralization actually means.”

Judging whether a blockchain protocol or system is "sufficiently decentralized" for the purposes of securities law alone does not seem to be the original intention of building a legal basis. As William Hinman said, securities law is based on eliminating information asymmetry between promoters and investors. especially--

1. Important information asymmetries are reduced when third-party efforts are no longer a key determinant of business success. As the web becomes truly decentralized, the ability to identify an issuer or originator to make the necessary disclosures will instead become increasingly difficult and less meaningful.

2. Of course, for those systems based on relying on centralized participants, the efforts of these participants will be the key to the success of the enterprise. In such cases, securities laws can protect investors who have purchased cryptocurrencies or cryptographic tokens.

So, given the way Ethereum 2.0 is being released, and the new norms around proof-of-stake, what the SEC may have to grapple with is: Without someone like Vitalik Buterin or an organization like the Ethereum Foundation involved , can Ethereum continue to succeed?

For this question, if Ethereum can succeed, then for the purpose of "Howey Test", the US Securities and Exchange Commission may still regard Ethereum as "sufficiently decentralized"; if Ethereum cannot succeed, then the result will be different. Forget it.

For the above reasons, if the "Howey Test" believes that Ethereum is not "sufficiently decentralized", the US Securities and Exchange Commission may conclude that the implementation of the Proof-of-Stake consensus on Ethereum 2.0 will involve the US Securities Act, then it must be in accordance with 1933 Section V of the Securities Act of 1934 and Section 12(g) of the Stock Exchange Act of 1934 — something that the Ethereum Foundation may be reluctant to do.

Is Ethereum 2.0 "fully decentralized"?

Exactly how the SEC will tackle this is anyone’s guess these days, but we may have an answer within the framework of the Center for Innovation and FinTech Strategy. The framework provides several examples for judging whether a network is "sufficiently decentralized," including the following:

1. Network Active Participants (AP) are responsible for developing, optimizing (or enhancing), allowing or upgrading, especially if digital asset purchasers expect Network Active when a task is required to achieve (or retain) its intended purpose and function.

2. Active network participants play a leading or central role in the sustainable development of the network or digital assets.

3. Active network participants play an ongoing stewardship role in making decisions about the characteristics or rights represented by the network or digital assets, and in exercising judgment. As an example, network active participants can determine whether to provide compensation to those who provide services to the network, or to one or more entities that oversee the network, and how to provide compensation.

4. Buyers would reasonably expect that network active participants will work to promote their own interests and increase the value of the network or digital assets, such as network active participants being able to realize capital appreciation from the value of digital assets (as long as network active participants continue to retain digital share or interest in the asset, as evidenced by this). In such circumstances, the purchaser would reasonably expect that the Network Active Participant will work to further its own interests and increase the value of the Network or the Digital Asset; or, the Network Active Participant directly or indirectly owns or controls the Network (or/and) the Digital Asset Ownership of Intellectual Property.

So what would the above four examples look like if they were applied to Ethereum 2.0?

1. As we all know, the specification of Ethereum 2.0 is formulated by a small team of the Ethereum Foundation including Vitalik Buterin. The Ethereum Foundation is mainly responsible for developing, or improving the network through Ethereum 2.0, or enhancing the network through 2.0 upgrades.

2. Therefore, the Ethereum Foundation plays a leading role in the continuous development of the network or digital assets. The purchaser of Ether (or decides to invest at least 32 Ether in the validator node on the deployment of Ethereum 2.0 to decide to become a validator) Human purchasers) clearly expect the Ethereum Foundation to implement or oversee the Ethereum network or Ether tokens to achieve (or retain) their intended purpose and functionality.

3. The Ethereum Foundation provides grants to various independent teams to establish specifications to determine whether those who provide services to the network, or provide supplements to one or more entities that oversee the network, and how to provide compensation - although currently It is not yet known how much the Ethereum Foundation spends on its organization and grants each year.

4. The Ethereum Foundation owns or controls the intellectual property rights of the network or digital assets, including the following trademarks: ETHEREUM, ETHHER, ENTERPRISE ETHEREUM and ENTERPRISE ETHEREUM ALLIANCE.

5. The Ethereum Foundation retains the rights and interests of Ethereum digital assets, which can be proved by the fact that the multi-signature wallet of the Ethereum Foundation is known. As of April 10, 2019, its wallet holds 645,137 Ether , equivalent to about $118 million.

in conclusion

It is important to remind everyone that the purpose of this article is not to bring "fear, uncertainty and doubt" (FUD) to the market, but to let those who develop digital asset-based technologies accept the fact that the law applies to What they are doing, they can only ensure that their work is not affected by the legal and regulatory framework by actively cooperating with regulators.

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