The Breakdown - What We Know About the Ethereum Foundation Investigation

Episode Date: March 22, 2024

Short answer: not much, but that hasn't stopped the crypto community from speculating that it could be a last-ditch effort from the SEC to cripple the crypto space. Today's Show Brought To You By Kraken - Go to https://kraken.com/thebreakdown and see what crypto can be Ledger - 5% to Bitcoin Developers When You Buy https://shop.ledger.com/pages/bitcoin-hardware-wallet Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, March 21st, and today we are talking Ethereum, FUD, and FOMC coverage. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link of the show notes or go to bit.ly slash breakdown pod. Yesterday morning, reporting started to suggest that the Ethereum Foundation has become the subject of a government investigation. The news began with the revelation that the Ethereum Foundation

had removed the Warrant Canary from their website. It was removed in late February but had gone unnoticed until now. A warrant canary is a way of warning users when legal demands are made to a service which they can't otherwise disclose. The presence of the canary means that all is well. When the canary is removed, it means that law enforcement are taking a look. It's a way of getting around confidentiality requirements during investigations by removing a longstanding communication that gives the all-clear. In the Ethereum Foundation's case, their Canary said, The Ethereum Foundation has never been contacted by any agency anywhere in the world in a way which requires that contact not be disclosed. Unusually, the GitHub commit from when the canary was

removed had some additional information, noting, this commit removes a section of the footer as we have received a voluntary inquiry from a state authority that included a requirement for confidentiality. Now, this could mean a lot of different things, and speculation immediately ran wild. As just one example, Ryan Sean Adams of Bankless posted, You know I'm bullish but nightmare scenario. Imagine if instead of delivering an Ethereum ETF, Gensler delivers a lawsuit against the Ethereum Foundation claiming ETH is a security. Within a couple hours, reporting from Fortune presented some additional details. The article cited sources at multiple U.S. companies who had received subpoenas from the SEC

in relation to an investigation into the Ethereum Foundation. One source said that the investigation had begun shortly after the transition to proof of stake in September of last year. Another source said the subpoena was narrow and focused only on the Ethereum Foundation. They said the subpoena had been received over the last few weeks. Each source asked for themselves or their companies not to be identified for fear of retaliation from Gary Gensler. One source described the SEC chairman as vindictive. With firm details being sparse, many industry figures have assumed that the SEC is staging

a last-ditch effort to label Ethereum as a security. This would, of course, have a huge impact on exchanges, aiding the SEC in their multiple pending lawsuits. More immediately, it would form the justification required for the agency to reject spot Ethereum ETF applications. It's not clear how successful these efforts would be or whether there's any grounds for a lawsuit, but the news is still rattled the industry. Patrick McHenry, the chairman of the House Financial Services Committee, tweeted, reports indicate Gary Gensler is moving to unilaterally classify ETH as a security.

This is contrary to the CFTC's assessment and the SEC's prior actions. Congress decides the SEC's jurisdiction and budget. Chair Gensler doesn't get to make it up as he goes along. McHenry is referencing comments from CFTC Chairman Rosten Benham, who has consistently maintained that ETH is a commodity. Most recently, Benham told the Congressional hearing that the SEC needs to understand that there would be consequences if ETH were reclassified as a security. Specifically, that would mean that regulated ETH futures contracts were noncompliant and would need to be delisted, likely causing havoc in the markets. Former CFTC Commissioner and A16 Z Global Head of Policy Brian Quintends broke down the situation in a Twitter thread, writing,

Reminder. When the SEC allowed ETH futures ETFs to trade on its regulated security exchanges, it explicitly acknowledged the status of the underlying ETH as being a non-security and outside of its jurisdiction. Importantly, this ETH approval decision in October 20th, 2003 occurred well after Ethereum changed to proof of stake in September of 2022, meaning that the SEC, ETH in its present state as of October 2023, was not a security. If the SEC had any doubt about the regulatory treatment of ETH in October 2023, if ETH were in fact a security, then the CFTC listed futures contracts on which the ETS were based would be illegal, as any derivative on ETH would be considered securities futures

contracts and subject to different rules, listed on different exchanges and subject to joint CFTC jurisdiction. Moreover, if ETH were a security, then the ETH future its ETF would be an illegal instrument. The SEC cannot approve an illegal instrument to trade over a national securities exchange. It will be interesting to watch what, if any, excuse the SEC uses if it were to delay or deny an ETH-E-TF, given it has already informed the market on ETH being outside its jurisdiction. The SEC's conduct in refusing to acknowledge these facts is causing confusion and actively harming the public. Still, many crypto lawyers suggested that the narrative was getting perhaps a little ahead of itself. They pointed out that there's no way to tell whether this is

even an investigation rather than just a request for information. Mike Selegg, a partner at Wilkie Far, reminded everyone, it's extremely common for Crypto Protocol Foundations to receive voluntary request for information from federal and state regulators, and subpoenas are about as sure as the sunrise for a crypto entity. There were also many comments spelling out just how weak an SEC lawsuit claiming that ETH is a security would be. Coinbase chief legal officer Paul Grewell presented a long list of contradictory statements from the SEC dating back to 2018, commenting, the SEC has no good reason to deny the ETH-ETF applications, and we hope they won't try to invent one by questioning the long-established regulatory status of ETH,

which the SEC has repeatedly endorsed. That's not how the law works, and Americans deserve better. Paradigm policy director Justin Slaughter gave us the view from Washington. He reminded us that at this point, the SEC's actions are not necessarily based on legal principles, but have become overtly political, writing, I think people, especially those within crypto, are overlooking a key fact regarding the Bitcoin-Spot ETF approvals. Chair Gensler took heavy fire from his progressive allies for approving the ETFs, as the consensus view was that the Grayscale case didn't require approval. Slaughter pointed

to Wednesday's issue of American prospect, a widely read political magazine that caters to the progressive left. That issue published an article entitled Crypto's new pal, Gary Gensler, criticizing him heavily for legitimizing Bitcoin via the ETF approval. Slaughter continued, this is only the second time that the publisher criticized him in his tenure as chair. The consensus view among crypto-sceptics in D.C. is the only way forward for the SEC is total war against crypto and, quote, let the chips fall where they may. Anything less than that will be deemed as corruption or cowardice. So, to sum up, we don't know what's going on, but it seems like something is going on. And as finance lawyer Scott Johnson summed up, battle lines are being

drawn. Exciting moment in history. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for others. Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7, 365, and moves at the speed of real life. Not everyone believes it.

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Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, DBA, CRACN. Hello, breakers. Today's episode is sponsored by Ledger. As another cycle ramps up, it's another chance to think about your Bitcoin custody best practices, and of course, to help all the new folks do the same. Ledger is the global platform for securing Bitcoin and other crypto. Ledger combines both hardware wallets and the Ledger Live app to offer the best way to buy,

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Yesterday, the Federal Reserve delivered its policy decision for March, and the theme was holding steady. Fed fund rates remained at the same level between 5.25% and 5.5%. The Q1 summary of economic projections showed no real change. The average committee members still forecast three rate cuts this year, the same as December's SEP. There is only one member forecasting no rate cuts this year and another two penciling in a single cut. It's been almost eight months now since the last rate movement from the Fed. No one seriously expected to change in rates from this meeting, but the surprise came from the FOMC's dovish dance. In the lead-up to the meeting, there had been a string of hot inflation data. This suggested that progress had stalled out, or perhaps that another

pulse of inflation was on the way. Risk assets are also hitting all-time highs alongside longer maturity treasury rates rising above 4.25%. In other words, it's difficult to make the argument that financial conditions are tight enough to cool inflation at the moment. Expectations were that Powell would come out hawkish, taking the opportunity to jawbone markets lower and reaffirmed that the Fed is still tough on inflation. Instead, Powell downplayed recent inflation data to assert that the Fed is still on the right path. Powell said, I think they haven't really changed the overall story, which is that of inflation moving down gradually on a sometimes bumpy road towards 2%. We're not going to overreact to these two months of data, nor are we going to

ignore them. We don't really know if this is a bump on the road or something more. We'll have to find out. FOMC members are forecasting that going the last mile on inflation will take years rather than months. Their median forecast for PCE inflation at the end of this year was 2.4%, falling to 2.2% by the end of next year. When questioned about the Fed's tolerance for higher inflation in the short term, Powell emphasized that the goal is to achieve 2% inflation over time. Powell was also clear that the next anticipated move will be rate cuts, stating, we believe that that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this

year. However, he also noted that the Fed is prepared to maintain current rates for longer, if appropriate. Powell warned that a downside surprise in the labor market could also trigger a policy response, not simply a reduction in inflation. Speaking to when the first cut might arrive, Powell said, we can approach that question carefully and let the data speak on it. Powell expressly rejected the idea that strong labor market growth could be a warning sign for another wave of inflation. This is a long-held tenant of economic theory referred to as the Phillips curve. During his tenure, Powell has been skeptical of the idea that inflation is driven by a strong labor market, noting that recent data just doesn't support that theory. At this meeting, he said,

in and of itself, strong job growth is not a reason for us to be concerned about inflation. Regarding the balance sheet, the FOMC began discussions about reducing the pace of quantitative tightening at this meeting. Powell reported the decision that reducing the pace of balance sheet runoff would likely become appropriate, quote, fairly soon. The current plan is to slow down QT while continuing to reduce the size of the balance sheet over the longer term. The goal is to ensure that the reduction is sustainable and does not cause distress in markets by impacting liquidity. Powell said, The idea is that we may be able to get a lower level because we would avoid the kind of frictions that can happen. Liquidity is not evenly distributed in the system. There can be times when,

in the aggregate, reserves are ample, but not in every part. He added that the Fed doesn't want to stop the process of reducing the balance sheet due to stress in the system. Powell spoke to indicators of stress was showed up in 2019 the last time the Fed attempted to reduce its balance sheet. He believes there is now a greater understanding of what to look out for. This slowdown in the balance sheet runoff was a big focus of the press conference. Overall, the main takeaway was that the Fed doesn't want to be forced to go back to buying assets due to going too fast and blowing something up. Toward the end of the press conference, the topic of CBDCs was brought up. Powell recently appeared in Congress and said that a surveillance CBDC is, quote, not something we would stand

for or do or propose in the United States. Assertions that the Fed is still working on a CBC were put to Powell, who responded, we haven't come to a conclusion that we should propose or anything like that, that Congress should consider legislation to authorize a digital dollar. We're just a long way away from that. Powell did acknowledge that the Fed is keeping up with financial technology, with a view to making sure the payment system is up to date, but that, quote, it's wrong to say that we're working on a CBDC, and we've secretly got a lab here where we've got one, and we're just going to spring it on Congress at the right moment. We don't. He closed that section by saying, I haven't at all in my own mind made a decision that I think this is something the U.S. should be

doing. I just think it's something we need to understand. as part of the broader payments landscape. During the press conference, Powell spoke to the importance of transparency. He noted that by better understanding the Fed's reaction function, markets will, quote, do your work for you. And with zero hawkish comments on the record, markets certainly did some kind of work. As Powell spoke, the stock market went risk on, with the S&P 500 ending the day up 0.9% and the NASDAQ seeing a 1.2% gain. Bitcoin was also a big beneficiary of Fed dovishness, breaking its slump with an 8% to get back to 68,000. Ethereum managed to recover from a double dose of Fed and SEC FUD to end the day up 10%, passing 3,500. The sentiment from commentators was that Powell had given the markets

the green light. Principal asset management chief global strategist Seema Shah said, Powell has perhaps shown his cards. He needs a good reason not to cut rates rather than a reason to cut rates. Markets perhaps couldn't have asked for more from the Fed and equities will celebrate. David Russell, Global Head of Market Strategy at Trade Station said, We had some inflation bumps this year, but Jerome Powell's not blinking. Investors are relieved to see three cuts stay in the dot plot, supporting markets and risk appetite. The Fed might wake up with a hangover, but the punchbowl isn't going away yet. There was some hand-wringing that putting rate cuts so clearly on the table could be counterproductive for the inflation

fight. Joseph Davis, the chief global economist at Vanguard, said that given sticky inflation, there is a growing prospect that, quote, they should not be cut at all. Others were skewed in the other direction, simply waiting on the final data point that indicated rate cuts were on the way. Omar Sharif, the president of Inflation Insight said, we're kind of right back where we've started. We need something to get us over the finish line on rate cuts, and that has to be at least one report that shows that inflation is going back to cooling. Former New York Fed President Bill Dudley was satisfied with the explanation that inflation is still more or less on the right path, stating, Powell's basic message is that the

underlying story hasn't changed. We didn't completely buy into how good the inflation numbers were in the second half of last year, weren't completely put off by the bad inflation readings in January and February. Until friends, there you have it. It is a hold pattern. And right now, given that we are in a bull market big time, a hold pattern on the macro side, well, it ain't bad. One more big thank you to my sponsors for today's show. Go to crackin.com slash the breakdown to see what crypto can be. And of course, check out Ledger, buy the Ledger Bitcoin Nano, and 5% of sales will go to support Bitcoin development. Until next time, be safe and take care of each other. Peace.