Post Ethereum 2.0 Merge ETH Could Qualify as a Security Or Not?

It’s been nearly seven years since Vitalik Buterin’s Ethereum (ETH) network began creating blocks now, as the Ethereum 2.0 merge draws ever closer in mid-September, the argument of whether or not the digital asset should qualify as a security rages on.

According to a new report, ETH has always been a work-in-progress. Before its launch in July of 2015, the native token ETH was sold via an initial coin offering (ICO) in exchange for the most popular digital asset, Bitcoin (BTC). During that ICO, around 50 million ETH were sold, which netted the ETH Foundation, which was a non-profit entity at the time, close to $19 million.

Even in ETH’s early days, those heavily involved in the still emerging crypto space felt as though the digital asset would pass the SEC’s Howey test, which would automatically constitute it as a security. According to the Howey test, an investment must pass the following criteria to be considered security: if it’s an investment of real money; if it’s a “common enterprise;” if it comes with the expectation of profit directly and explicitly from the interest and cash investment of others.

Financial experts say, from its inception, ETH was sold directly to the masses. In this regard, it clearly met the requirement of a cash investment. Also, when it comes to the ETH network, for which ETH is its currency, it required more than 100 developers for its launch, and this qualified it as a common enterprise.

Lastly, the ETH ICO, which occurred in August of 2014, almost a full year before its network launch, fully depended on its developer’s efforts. All this boils down to that under legal parameters, ETH should have been determined to be a security according to the Howey Test.

But despite these facts, ambiguity over the digital asset’s status as a security plagued its formative years, and since then, the bureaucracy-bound SEC has made its opinion on the matter public.

Back in 2018, William Hinman, the SEC’s former Director of Corporate Finance said that if you discount the fundraising aspect that accompanied ETH’s initial launch, based on his general understanding of the ETH network, taken along with its decentralized structure (which is what Ethereum is all about), then current investment in the digital asset does not constitute a securities transaction.

Therefore, based on Hinman’s opinion, which carried great weight in Washington, the SEC was very unlikely to classify ETH as an investment security. He also argued that in 2018, the ETH network was so decentralized that it could never be considered a traditional security under the laws stipulated by the U.S. government which regulates centralized securities.

But now, with the ETH 2.0 merge to “Proof-of-Stake” just weeks away, the security argument is once more in play. The merge is expected to “significantly change the underlying structure of the Ethereum network.” Proof-of-Stake will replace Proof-of-Work whereby miners compete to solve complex mathematical equations to mine blocks of ETH.

While other blockchain assets still use Proof-of-Stake for their operations, post-merge, ETH’s new validation system will profoundly affect Hinman’s 2018 evaluation and prove a challenge for the SEC’s current chair, Gary Gensler. Thus far, Gensler has shown a distinct distrust of decentralized digital assets.

So, the major billion-dollar question remains. Will the post-Ethereum 2.0 merge finally qualify ETH as a security? To answer this question, experts say that it’s necessary to understand how the merge will affect the overall network.

Currently, ETH uses Proof-of-Work validation mechanisms, allowing independent miners to come up with new blocks of the digital asset, much like they do for Bitcoin. The ETH mainnet will be docked with the beacon chain post merge, making it a Proof-of-Stake. In other words, no more miners.

Under the parameters of Proof-of-Stake, any investor who owns 32 Ethereum will be able to establish one full validator node on the ETH network. They can also team up with other validators to validate more blocks.

Once each block becomes validated, the validators will be given a reward along with “priority fees” for each approved transaction.But the Proof-of Stake argument is getting pushback from some financial experts, who argue that those running validators on ETH’s Proof-of Stake chain will not always be “pooling their funds.”

This contradicts the notion that the post Ethereum 2.0 merge can be considered a “common enterprise.” This alone will weaken the argument that ETH will be considered a security under the current SEC guidelines.