World’s Second Most Valuable Cryptocurrency Under Regulatory Scrutiny!!!

Bitcoin has largely escaped government oversight, but regulators are examining whether other widely traded cryptocurrencies should be regulated as securities, according to people familiar with the matter.

The inquiry includes a focus on ether, representing a significant threat to virtual currencies, which so far haven’t been drawn into a regulatory crackdown on potential fraud in the market for the assets. Until now, regulators hadn’t questioned whether rules designed for stocks should apply to virtual currencies such as ether, the world’s second most valuable cryptocurrency after bitcoin with a market value of $67 billion.

The analysis, by federal securities and commodities regulators, turns on whether the creators of virtual currencies other than bitcoin exert significant influence over their value, in the same way a company’s stock price depends on its managers and their strategy, performance and investments, the people said. The Commodity Futures Trading Commission has deemed bitcoin to be a commodity, meaning it isn’t subject to investor-protection laws enforced by the Securities and Exchange Commission.

Some regulators think ether is in a “gray zone,” but believe its creation in 2014 was probably an illegal securities sale, the people said. Silicon Valley backers such as venture-capital firm Andreessen Horowitz disagree, saying no particular person or entity stands behind ether or is responsible for driving its value.

Under U.S. law, companies that issue stocks or bonds must either register the deal with the SEC—and give investors extensive disclosures—or limit the sale to sophisticated institutions and the rich. Ether’s founders didn’t register the 2014 sale and sold the coins to anyone willing to buy.

Any determination from regulators that ether is a security could spark a wave of selling and rattle major trading venues such as Coinbase that allow investors to buy and sell it. Coinbase has discussed applying for an SEC license to operate as a brokerage firm, a process that could bring the fight over ether to the surface because brokers can’t deal in unregistered securities.

Gary Gensler, a former CFTC chairman, said in a speech last week that “there is a strong case that one or both of ETH and [Ripple’s] XRP are noncompliant securities,” using the shorthand for the virtual currencies.

Ether’s backers say it serves a purpose beyond trading. The virtual currency is paid to people who run the Ethereum program on their computer—a necessary function for a decentralized project.

Supporters of ether, including Andreessen Horowitz, also note that ether is mined—or created—by that broad community of users, not any single person or entity.

Ether “has become so decentralized it should not be deemed a security,” a group of venture capitalists including Andreessen and Union Square Ventures wrote in a proposal seeking a broad regulatory exemption, which was submitted to the SEC in late March.

Coinbase declined to comment on regulators’ questions about ether.

Cryptocurrency developers and some of the lawyers representing the industry are frustrated that the SEC continues to apply an arcane legal test to determine whether a new generation of assets, such as ether, fall into the basket of assets that it regulates.

The “Howey Test,” named for a 1946 Supreme Court case involving interests in an orange grove, requires regulators to assert whether the investment was made in a “common enterprise” and whether anticipated profits depend on the efforts of others.

Regulators have studied the role of central actors, such as Ethereum Foundation, which developed ether and oversees improvements to its software network, in driving the asset’s value. The foundation, for instance, pays “bug bounties,” which reward programmers who fix vulnerabilities in ether’s code, showing the nonprofit influences improvements that can boost the virtual currency’s value, one of the people familiar with the matter said.

Regulators are studying what other factors account for fluctuations in ether’s price, some of which temper the case for calling it a security. For instance, the government is looking at how much of its demand stems from people who use ether to run applications on the software platform.