New York sues KuCoin, claims ether is an unregistered security

New York Attorney General Letitia James has sued digital asset exchange KuCoin for violating New York laws governing the trading of securities and commodities, and named ether, among other tokens, as unregistered securities the exchange has listed in the state. 

KuCoin “offered, sold and purchased and effected transactions in cryptocurrencies that were commodities and securities within New York, without having been registered as a commodity broker-dealer and securities broker or dealer in New York,” James argues in the suit brought against the Seychelles-based firm Thursday. 

James and her office also implicate ether, the second-largest cryptocurrency by market capitalization, as an unregistered security. That argument could have broader implications for digital assets beyond any punitive damages New York may win from KuCoin. 

"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 suit filed with the New York state Supreme Court argues.

It also cited the Ethereum Foundation's initial coin offering as evidence of a securities offering. The suit argues that documents from the time of the initial coin offering describe it "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." This is similar to the capital formation purpose of security offerings in the U.S.

New York's attorney general also claims that ICO materials promoted ether as, "'a digital store of value because the creation of new ETH slows down over time.'" 

Non-binding remarks

A former Securities and Exchange Commission official famously made non-binding remarks in 2018 indicating that the agency saw the Ethereum network as sufficiently decentralized as to no longer consider ether a security, though he refrained from offering an opinion as to whether the ICO had violated any laws. After an ICO bubble formed in 2017 the SEC began cracking down on the practice, successfully pursuing dozens of unregistered securities offering cases. 

The network's transition to a staking protocol, from proof-of-work validation of holdings and transactions, which occurred last year, is also cited in the suit. 

"Buterin and the Ethereum Foundation retain significant influence over Ethereum and are often a driving force behind major initiatives on the Ethereum blockchain that impact the functionality and price of ETH," the suit argues, referring to Vitalik Buterin, the founder of Ethereum.

Common enterprise and value of an asset derived from the effort of others are common aspects of securities in the U.S.

"Most relevant here, Buterin and the Ethereum Foundation played key roles in facilitating the recent fundamental shift of the transaction verification method from proof-of-work to proof-of-stake." 

Feds at odds

There is disagreement at the federal level about whether ether is a security or a commodity, with Securities and Exchange Commission Chair Gary Gensler implying he believes it to be an unregistered security, while Commodity Futures Trading Commission Chair Rostin Behnam sees the cryptocurrency as a commodity. 

The argument about ether in the New York lawsuit lends itself to the need for more clarity at the federal level, legal experts who testified before the new Digital Asset Subcommittee in the U.S. House of Representatives on Thursday told The Block, though they noted that the news was fresh and the suit would need more analysis. 

“I think that lends itself to confusion that is the point of this hearing,” said Tonya Evans, law and computer sciences professor at Pennsylvania State University, referring to the Thursday House hearing on federal digital asset regulation where she appeared. Evans added that it would be interesting to see whether state and federal regulators agree.

Lee Reiners, policy director at the Duke Financial Economics Center and a fellow panelist at Thursday's House hearing, agreed that federal action would have more impact.

“I think it would matter more if the SEC was alleging it,” Reiners said. “I don’t think that even if General James is successful, that means that ether all of a sudden has to register.”

“Ultimately the SEC is the final arbiter of whether something is a security or not,” he added.

Money, user info sought from KuCoin

With regards to KuCoin, James also alleges that the company failed to comply with a subpoena from her office by refusing to appear on Jan. 23, 2023.

New York state wants KuCoin to be barred from doing business in the state, one of the largest markets within the U.S. for cryptocurrency, and pay back money it made from offerings in the state. The attorney general's office also wants KuCoin to “identify all members of the public within the State of New York with or for whom Respondents purchased or sold securities or commodities, at any time from six years prior to the date of this Verified Petition, including their names, email addresses, date of all transactions, associated IP address used at the time of each transaction, and last log-in date and time.” 

Update: with additional information from lawsuit against KuCoin and interviews with legal experts. 

With additional reporting by Stephanie Murray and Sarah Wynn.