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Consensys is the center of the Ethereum ecosystem. Its founder, Joe Lubin, is the man who’s made more money from Ethereum than anyone.

Consensys makes the immensely popular MetaMask crypto wallet. They offer a swaps service and a staking service through MetaMask.

Anyway, Consensys got a Wells notice of impending enforcement action from the SEC on April 10. The SEC thinks Consensys is operating as an unregistered broker-dealer by making money on the MetaMask Swaps and MetaMask Staking products.

To head this off, Consensys is preemptively suing the SEC first! [Blog post; complaint, PDF; docket]

Consensys wants a ruling that:

• MetaMask Swaps does not make Consensys a broker-dealer;
• MetaMask Staking is not an offering of securities;
• Ether (ETH), the native token of the Ethereum blockchain, is not a security.

It also wants an injunction against the SEC even investigating MetaMask Swaps or Staking, and against investigating the company’s sales of ETH in terms of ether being a security. And a pony would be nice too.

The complaint

The SEC has been investigating Consensys for two years. The agency first sent Consensys a letter in April 2022 advising them that they were investigating MetaMask. Then in September 2022, Consensys got another letter that the SEC was investigating staking protocols on the Ethereum network.

Consensys complains that it “did not have fair notice” of only two years.

The complaint was filed in the Northern District of Texas — Consensys used to be in Brooklyn, New York, but moved to Fort Worth sometime last year. 

Consensys has hired Wachtell, Lipton, Rosen & Katz, one of the best-known law firms on Wall Street. It’s the same firm Coinbase is using to fight back against the SEC. 

MetaMask

MetaMask is a self-custody crypto wallet that Consensys distributes free as a web browser extension. You can move ETH or tokens running on top of Ethereum, such as altcoins or NFTs, between blockchain addresses.

Two services that Consensys sells via MetaMask are MetaMask Swaps and MetaMask Staking. It even calls these “core features” — though Swaps was introduced in 2020 and Staking in 2023. 

MetaMask Swaps

Swaps lets you “communicate with third-party decentralized exchanges.” Consensys charges a 0.875% fee for use of the service. What does Swaps do?

MetaMask Swaps software itself does not execute transactions and never comes into possession of users’ digital assets. It simply displays pricing information collected from third-party aggregators and sends user commands to DEXs, which execute the transactions. 

Now, you might think this closely resembles a stockbroker buying and selling stocks for you and taking a fee for doing so.

In the world of conventional securities, facilitating trade in beneficial ownership rights in stocks whose owner of record is the Depository Trust and Clearing Corporation (DTCC) is also non-custodial. We still call this job being a “broker.”

But this only matters if any of the tokens are securities. Are they? Well … yes. Almost all of the tokens you can use on MetaMask would be considered securities under the Howey test. They were created as schemes to profit from the efforts of others. The SEC’s 2017 DAO Report and 2019 framework for investment contract analysis bludgeon this point home.

The SEC has settled or won in court in previous cases arguing that many tokens of this sort are securities — such as its actions against Bittrex, Terraform, and ShapeShift — so we expect that a complaint will name various tokens traded in Swaps and detail why they are securities.

Consensys admits that it’s helping customers buy and sell these tokens and it’s taking a fee for doing so. The SEC just has to show that some of the tokens are securities.

MetaMask Staking

MetaMask Staking lets you “stake” ETH to earn more ETH.

Ethereum doesn’t use proof-of-work mining like bitcoin — instead, it uses proof-of-stake. You put up a validator node with 32 ETH locked in it and you have a certain chance to generate a block that goes into the blockchain. If you do, you win the block reward.

Ethereum staking hits all of the elements of the Howey test of whether something is a security:

• “an investment of money” — your 32 ETH stake
• “in a common enterprise” — Ethereum
• “with a reasonable expectation of profits” — the validator specification document literally says “verify and attest to the validity of blocks to seek financial returns” [GitHub]
• “derived from the efforts of others” — promotion and management of the scheme by the Ethereum Foundation and money from the retail suckers who buy your ETH winnings.

The Ethereum Foundation, which determines how Ethereum works, is based in Switzerland. However, staking that involves a US entity would be under SEC jurisdiction.

Various companies have offered staking as an investment to institutional and accredited investors. That’s fine — but it’s not so fine when they offer it to ordinary mom-and-pop retail investors.

In June 2023, the SEC and ten state securities regulators came down on Coinbase for offering its staking product to retail investors. The SEC fined Kraken $30 million in February 2023 over its staking offerings. Kraken had to remove its staking product from the US market. 

Consensys offers its ordinary retail customers using MetaMask access to the Lido and Rocket staking pools. Consensys doesn’t mention it in the complaint, but they take a 10% fee for staking via MetaMask. [Consensys]

The complaint hammers again on the non-custodial nature of the staking service:

Like the rest of the MetaMask wallet software, the MetaMask Staking feature is entirely non-custodial; at no point does Consensys come into possession, custody, or control of a user’s tokens, nor can it alter in any way the user’s transaction instructions to the protocol. 

But that doesn’t matter — because they’re blatantly offering an investment scheme to retail investors and taking a 10% fee.

In fact, Consensys admits that it put a lot of work into the new staking mechanism, and the SEC subpoenaed information on this work:

They also seek detailed information concerning the role of Consensys, including its software developers, in a host of Ethereum Improvement Proposals related to the Ethereum Merge, the transition from a proof-of-work to a proof-of-stake validation mechanism. 

That is, Consensys themselves helped move the Ethereum network to its current very security-like operating mode, which is entirely different from the 2018 mechanism that wasn’t considered an investment contract.

Is ETH a security?

The complaint rants at length about whether ETH is a security, and even says that “the SEC now claims that ETH is a security subject to SEC regulation.”

This isn’t something the SEC has actually declared yet. What SEC chair Gary Gensler has done is suggest that ETH might possibly be a security now — particularly after Ethereum’s move to proof-of-stake in September 2022.

Consensys is outraged by this. The complaint cites lengthy historical evidence of the SEC and its commissioners telling the world that ETH is not a security. However, most of this dates back to 2018.

In 2018, Ethereum was running on a proof-of-work network, where crypto miners got rewards for spending electricity to guess a number and not for putting in funds.

Consensys notes the switch — but not how the payment model changed.

The crypto world is very good at going “la la la I can’t hear you” when obvious concerns such as this are raised early, then acting surprised when they suddenly become relevant. But crypto people were already talking in 2019 about the then-planned Ethereum staking really obviously being a security in the US, and both the SEC and the CFTC started looking into the question in that year. [Grant Gulovsen, 2019; CoinDesk, 2022]

If ETH is determined to have changed its operating model to now run as an offering of securities, that takes out Consensys’ entire business. It also undermines Lubin’s massive wealth. We’re surprised Consensys was dumb enough to even raise the question.

What happens next?

We’re not lawyers ourselves, but the expensive lawyers who wrote this complaint seem only to have been able to find the crayons that day.

Consensys admits upfront to most of what the SEC would need to nail them on MetaMask Swaps and Staking. The SEC would just need a ruling that tokens on Swaps were securities. On Staking, it looks like Consensys doesn’t have a case.

The extended table-pounding on the history of ETH leaves out how present-day staking works — that is, just like an investment contract. The SEC just needs to note the fact.

After that incredibly stupid Ripple ruling, we won’t say that Consensys can’t prevail here. We do think their chances of winning are incredibly thin, and the complaint leaves itself wide open to the SEC’s obvious responses.

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Update 1: One possible reason for Consensys filing this bizarre complaint in the Northern District of Texas is that it’s likely to go to Judge Reed O’Connor, a George W. Bush appointee known for his history of such bizarre rulings that even the present Supreme Court has consistently knocked them back. O’Connor might plausibly go for the complaint’s good ol’ boy hollering about the evils of fed overreach.

Consensys is weirdly vague about precisely when they moved to Texas. There wasn’t a press release. CoinDesk says Consensys’ office is in a WeWork, though WeWork only has the fourth floor of 5049 Edwards Ranch Road, Fort Worth, TX 76109, and there are other companies in the building. Various sources give their move date to Fort Worth as December 2023, though they were sending out press releases datelined Forth Worth as early as June 2023. [CoinDesk]

Did Consensys move to Forth Worth specifically to try to win a bizarre ruling from O’Connor with this weird filing as their judicial lottery ticket? This is almost too crypto an idea to seriously posit, but it’s less nonsensical than any other interpretation we have. Ideas welcome!

Update 2: Nevermind! Consensys straight up admits they moved to Ft. Worth for the courts.

Laura Brookover, Consensys head of litigation, tells Unchained: “For us, we moved to Texas because it’s a wonderful laboratory for innovation. Texas celebrates individual freedom, celebrates technology, and it’s a great opportunity for us being headquartered here to call on the courts and to say, please help us, because what the SEC is doing is unlawful.” [Unchained]

Feature image: Joe Lubin of Consensys and the Ethereum team in 2014.