All Your Ether (Are) Belong To US: SEC Claims Jurisdiction Over Entire Ethereum (ETH) Network

The US Securities and Exchange Commission (SEC) has filed an enforcement action against crypto influencer Ian Balina in the Western District of Texas alleging that he promoted unregistered securities in connection with the Initial Coin Offering (ICO) of Sparkster, Ltd.’s Sparkster tokens (SPRK) and failed to disclose the compensation he received from Sparkster to do so. Most saliently, the SEC claims that because the majority of the Ethereum network’s validating nodes are located in the United States, the entire network is subject to US securities laws.

In its push toward greater regulatory oversight of crypto assets, the SEC’s latest claims and the outcome of this case may have significant implications across the crypto/digital asset space, the metaverse, and beyond, particularly for Ethereum-based applications and projects.

Context

An ICO is a means of fundraising, somewhat akin to an initial public offering (IPO), in which an organization generally offers new crypto assets in exchange for Bitcoin, Ethereum, or other currency to raise funds for a project. Often, organizations partner with celebrities and/or influencers, who help promote the IPO via social media.

Sparkster develops blockchain-based software and raised approximately $30 million between April and July 2018 during the ICO of its SPRK tokens. In connection with its ICO, Sparkster partnered with and paid Balina, a crypto asset influencer who promoted the ICO on social media and his personal website.

The SEC Complaint

According to the SEC, the sale of SPRK tokens in Sparkster’s ICO was an unregistered sale of a security in violation of federal securities laws. In its complaint against Balina, the SEC alleged that because SPRK tokens are securities, Balina’s unregistered sale of SPRK tokens and his failure to disclose compensation received in connection Sparkster’s ICO violated federal securities laws.

Sparkster swiftly settled the SEC’s charges without admitting or denying the allegations, and further agreed to repay investors and to pay an additional civil penalty, destroy its remaining SPRK tokens, remove SPRK tokens from any trading platforms, and publish the SEC’s order on its website. However, Balina vehemently rejected settlement of the “frivolous SEC charge” and expressed his intentions to “take this fight public.”

SEC’s Claim to Ethereum

In contending that the transactions relating to Sparkster’s ICO took place in the United States, the SEC did not simply rest its allegations on the fact that Balina was a US resident, located in the United States at all relevant times, and that at least some of the investors were US based. Rather, the SEC asserted jurisdiction over the entire Ethereum network, stating that:

“[the investors’] 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. As a result, those transactions took place in the United States.”

This allegation seems to suggest that the SEC is claiming that all transactions on the Ethereum blockchain network take place in the United States and are thus subject to U.S. laws based on the location density of the validating notes.

Implications

If the SEC’s theory of jurisdiction over the Ethereum network is affirmed, such a precedent could present significant challenges for other applications, services, and projects, including NFTs, by subjecting them to regulations under the federal securities laws. Moreover, the SEC may seek to use similar arguments to assert jurisdiction over transactions on other blockchain networks e.g., Cardano (ADA), Cosmos (ATOM), Polkatdot (DOT), and Solana (SOL).

As the first major law firm to purchase land in the metaverse, ArentFox Schiff is closely monitoring the emerging regulatory landscape and any related developments at the SEC and other governmental agencies aiming to regulate the crypto/digital asset space.