New York attorney sues KuCoin, names ETH an unregistered security

In a lawsuit filed against Seychelles-based cryptocurrency exchange KuCoin, New York State Attorney General (NYAG) Letitia James listed ether as a security along with other tokens.

New York attorney general Letitia James (center). Image: BBC
New York Attorney General Letitia James (center). Image: BBC

In a suit, James and her office alleged that KuCoin is an unregistered commodities and securities broker or dealer. The enforcement action against the exchange was said to be a part of James’ continuing “efforts to enforce New York laws in the cryptocurrency industry and protect New York investors.”

According to the filing, the Attorney General’s office believes that the crypto exchange broke the law by selling unregistered securities, which include Ether, Luna, and TerraUSD (UST) stablecoin. While both Luna and UST were classified as such by the SEC in its February 16 lawsuit against Terraform Labs CEO and crypto fugitive Do Kwon, James’ move marks the first time a regulator has claimed that ETH is a security.

“ETH’s development and management is largely driven by a small number of developers who hold positions in ETH and stand to profit from the growth of the network and the related appreciation of ETH,” the lawsuit argues, taking a jab at the Ethereum Foundation and Vitalik Buterin, who are said to have played “key roles in facilitating the recent fundamental shift of the transaction verification method from proof-of-work to proof-of-stake.”

Ethereum ICO and the expectation of profits from staking were also cited in James’ rationale for classifying ether as a security. The Attorney General’s stance on initial coin offerings mirrors the opinion of the SEC Chair Gary Gensler, who has earlier doubled down on his predecessor’s statement that “every ICO is a security.”

The lawsuit argues that Ethereum ICO documents “described the sale as a means of promoting the development of the Ethereum blockchain by paying expenses incurred by developers, paying for legal contingencies, research, and further development,” which is similar to fundraising through issuing equity shares of the company.

“By shifting to proof-of-stake, ETH no longer relies upon competition between computers but instead now relies on a pooling method that incentivizes users to own and stake ETH. The shift to proof-of-stake significantly impacted the core functionality and incentives for owning ETH because ETH holders can now profit merely by participating in staking,” the suit further reads.

Those familiar with the Howey test that the regulators apply to determine whether an asset is a security will recognize that common enterprise (funding Ethereum development through token sale), an expectation of profits (staking rewards and ETH deflation), and value of an asset derived from the effort of others (Ethereum Foundation and Vitalik Buterin) constitute an “investment contract” under the US law.

With her lawsuit, Leticia James seeks to stop KuCoin from operating in New York and order it to implement geo-blocking based on IP addresses and GPS location to prevent New Yorkers from accessing its services.

The crypto lawyers and community members have already weighed in on the action brought by the NYAG’s office, saying that even Bitcoin can be classified as security if judged by the devs’ and miners’ ability to engage in a coordinated effort to introduce software upgrades.

Neeraj Agrawal, the director of communications at crypto think-tank Coin Center, voiced his disagreement with James’ arguments and said that his organization will weigh in if there’s an opportunity.

“Separate and apart from any investment contract that may or may not have existed at the birth of Ethereum, ether today is too useful and too decentralized for it to fit the relevant test for treatment as a security. Conflating the pre-sale and the running network is confused analysis that could be misunderstanding the tech or the law or both,” Coin Center stated back in 2018, and its arguments have since remained unchanged.

Classifying ether as a security could have broad implications for the crypto industry — especially for the other proof-of-stake blockchains like Solana, Cardano, and Avalanche. Following the news of the lawsuit, ETH price is down 7%, as the crypto market value falls below $1 trillion due to the perfect storm of Silvergate liquidation, Biden’s proposed 30% tax on crypto mining electricity usage, and Powell’s hawkish comments.