The Merge: SEC lawyers Have a Very Rough Understanding of how Crypto Works

The Merge: Ethereum and its long-awaited migration from its current “Proof-of-Work” consensus mechanism to a “Proof-of-Stake” system finally happened. A process that is supposed to look seamless from the user’s side nevertheless carries consequences in the legal aspect. The “toponomy” of the market is going to alter as well. And it’s not certain if everyone will benefit from these changes.

ETH is too significant to be untouchable

This is primarily the fact that with ETH now going Proof of Stake (PoS), most people will be staking with custodians, due to the simplicity and the fact that they don’t have 32ETH. In this way, large companies will have a majority share over the network. Thus it will be possible for the regulator to reach them and prohibit them from validating individual transactions (censorship), which will lead to the fact that such transactions will be confirmed slowly. 

But it should primarily be a problem of confirmation speed, as there will always be some validators who will subsequently confirm the transaction.

ETH, as the most important network for DeFi, would be the main lever for regulatory policy. Tokens such as USDC and many others contain blacklisting and blocking mechanisms at the development level, as opposed to the DeFi market in general. It makes sense that validators and the MEV market will play the role of leverage tools. But in the short term, this is more of a scare since there are too many miners, and no one cannot control this process at a reasonable cost. 

Regarding it all, regulators may intend to oblige those node validators who operate under jurisdiction to implement the AML procedures for the transactions they validate. 

The merge puts it in the SEC crosshairs

US Securities and Exchange Commission chairman Gary Gensler said in a statement on Sept. 15 that staking-based cryptocurrencies are very likely securities that should be regulated by the agency. This sounds like trouble for Ethereum. The SEC also claims that it has jurisdiction over ETH transactions because the network nodes are densely clustered in the United States. 

The organization has been previously criticized for its regulatory approach toward crypto, for example, BlockFi case, when in February SEC announced actions against this company over its failure to register high-yield interest accounts that SEC deems to be securities. One of the SEC’s requirements is to bring BlockFi business activity into compliance with the Investment Company Act of 1940 within 60 days.  

As result – BlockFi ended up on the auction block and two other companies with similar businesses went belly up, these were Stu Alderoty’s (Ripple General counsel) words. 

Thus, a situation has arisen where the SEC used the legislation of 1940 to regulate modern and not yet fully developed technology, which is absurd. 

SEC statement

The statement from the SEC that all Ethereum falls under U.S. jurisdiction is, to put it mildly, untrue. Although if it were, it would be very convenient for the SEC. The SEC’s logic is that the Ethereum blockchain node network is more densely clustered in the U.S. than anywhere else, so the SEC should count all Ethereum transactions worldwide of American origin. 

But according to Etherscan, the U.S. is now home to 46.19% of all Ethereum nodes only. It is not even a simple majority. Similar to this SEC statement, one could argue that only the European Union should regulate Bitcoin. 

I believe these statements are just the result of the SEC lawyers’ very rough understanding of how cryptocurrencies work. But we cannot rule out the fact of previous tendencies of the SEC to regulate through enforcement.

Conclusion

The SEC and other regulators have been worried by the huge sums circulated in the DeFi sector without any control. As ETH blockchain is a basis for the majority of tokens, its new PoS protocol may be used as an argument to control the decentralized market at least partly. 

About the author  

Slava Demchuk is a сertified AML specialist in the cryptocurrency field and an expert in crypto regulation and transaction monitoring. He has ab education in Information Networks Security, and has completed the course in Anti-Money Laundering Fundamentals in the European Institute of Management and Finance. Slava is the founder of AMLBot, a service for checking cryptocurrencies for connections with illegal activities. Also, he is the CEO of AMLSafe, a non-custodial wallet with an in-built crypto AML module. Since 2013, he has been managing the IT team and developing software for the blockchain market. Besides, Slava is a member of the Blockchain Association of Ukraine (BAU).

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