SEC Ethereum Lawsuit Asserts Control Over Most Crypto Blockchains

Earlier this week, the Securities and Exchange Commission (SEC) buried a very broad and very big jurisdiction claim 69 paragraphs down in a lawsuit about a 2018 initial coin offering (ICO) it claimed was an unregistered securities offering.

The case involves an ICO for SPRK tokens issued by the Sparkster blockchain project. It claimed a promoter, Ian Balina, organized a pool of about 50 investors for illegal securities. It seeks have Balina disgorge all funds earned, and to pay an unspecified fine.

There’s nothing groundbreaking about the claim — the SEC has filed and completed a good number of these suits, settling for fines in the millions of dollars and, not incidentally, effectively killing off ICOs as a way to fund blockchain development.

What is groundbreaking is the SEC’s assertion of United States jurisdiction.

Read more: Lawsuit Suggests US Jurisdiction Over Ethereum

It gives the securities regulator control over transactions on Ethereum — far and away the largest blockchain hosting various cryptocurrency projects — and by implication, many if not most other blockchains.

And, that logic could apply to any other agency.

That’s because of the reasoning. In the 69th paragraph, the SEC argued that, when U.S.-based investors sent Balina’s pool ether tokens, they “irrevocably committed to the transaction.”

So far, so good. But what came next has implications far beyond this case, and possibly beyond securities law.

“At that point, their ETH contributions were validated by a network of nodes on the Ethereum blockchain, which are clustered more densely in the United States than in any other country,” the SEC attorneys said in the suit. “As a result, those transactions took place in the United States.”

Beyond Securities

Not only does the SEC appear to effectively claim jurisdiction over every transaction on Ethereum (and its new incarnation, Ethereum 2.0), which is second only to bitcoin in market capitalization with $158 billion worth of ETH in circulation, it does so over every crypto blockchain in which most nodes — the servers which contain a full copy of the blockchain and validate new transactions — are in the U.S.

Which is a fair number of them.

But the precedent could give any government agency jurisdiction over any transaction on such a blockchain — including law enforcement. And such a claim wouldn’t necessarily be limited to the U.S. government.

That would be an interesting development for a technology whose proponents claim its distributed nature — anyone can set up an Ethereum node anywhere in the world — makes it effectively outside the control of any one government.

See also: Ethereum 2.0 Will Not Be Any Faster, Vitalik Buterin Said. But It Will Still Scale Massively

And while that’s not necessarily enough to actively control a blockchain, the issue is a strong enough one in the crypto community that when a recent Twitter poll of Ethereum token holders asked if node validator’s who comply with censorship requests like U.S. sanctions should have their ether tokens “burned” — destroyed — the primary creator of the Ethereum blockchain, Vitalik Buterin, voted yes.

fwiw I voted X in your above poll

— vitalik.eth (@VitalikButerin) August 15, 2022

Court Support

A big part of this claim would be strengthened by having a court uphold it, which may happen in the Balina case, as all other parties to the ICO, including Sparkster, have already reached settlements with the SEC.

But Balina said on Twitter on Sept. 19, “Excited to take this fight public. This frivolous SEC charge sets a bad precedent for the entire crypto industry …Turned down settlement so they have to prove themselves.”

Excited to take this fight public.

This frivolous SEC charge sets a bad precedent for the entire crypto industry.

If investing in a private sale with a discount is a crime, the entire crypto VC space is in trouble.

Turned down settlement so they have to prove themselves. pic.twitter.com/lVaqnnsLgT

— Ian Balina (@DiaryofaMadeMan) September 19, 2022

However, other ICO token issuers have made similar promises and eventually backed down due to the cost. The exception is Ripple, which is currently fighting an illegal securities sale lawsuit in court. But its case is somewhat different due to the nature of the blockchain — technically a distributed ledger — itself.

Read more: Ripple Lawyer Critical of SEC Push to Regulate Crypto

Behind all of this is the SEC’s campaign to label nearly every cryptocurrency except bitcoin a security under its jurisdiction. Others, notably the Commodity Futures Trading Commission (CFTC), have said ether is not a security.

For all PYMNTS crypto coverage, subscribe to the daily Crypto Newsletter.