What's Next for Staking on Centralized Exchanges?

In Brief

• Last Thursday, the SEC ordered Kraken to halt all of its staking services. Kraken agreed to pay a $30M fine.
• As part of the settlement, Kraken has neither admitted nor denied the SEC's allegations that it failed to meet securities laws.
• The crackdown could have widespread implications for staking. The Coinbase CEO has said he is willing to take the issue to the courts.

Last week, The SEC forced Kraken to halt its staking services. Could other centralized exchanges be next?

On Thursday, February 9, Kraken agreed to halt all staking services in the U.S. This was in response to accusations by the Securities and Exchange Commission (SEC) that it broke the agency’s rules by failing to register the program. The SEC believes Kraken’s staking services were not in line with its securities laws.

The crackdown could have widespread implications for staking in the U.S.

Kraken told BeInCrypto it had “agreed to end its on-chain staking services for U.S. clients only. Starting today, with the exception of staked ether (ETH), assets enrolled in the on-chain staking program by U.S. clients will automatically be unstaked and will no longer earn staking rewards. Further, U.S. clients will not be able to stake additional assets, including ETH.”

“Staking services for non-U.S. clients will continue uninterrupted. These clients will receive staking services from a separate Kraken subsidiary. As part of the settlement, Kraken has neither admitted nor denied the SEC’s allegations.”

The SEC Speaks
In a statement, the SEC chair, Gary Gensler said: “Whether it’s through staking-as-a-service, lending, or other means, crypto intermediaries, when offering investment contracts in exchange for investors’ tokens, need to provide the proper disclosures and safeguards required by our securities laws.”

“Today’s action should make clear to the marketplace that staking-as-a-service providers must register and provide full, fair, and truthful disclosure and investor protection.”

One of the SEC’s commissioners dissented from the agency’s opinion. Commissioner Hester M. Peirce argued in a separate statement asked whether SEC registration would even have been possible for Kraken.

“An offering like the staking service at issue here raises a host of complicated questions, including whether the staking program as a whole would be registered or whether each token’s staking program would be separately registered, what the important disclosures would be, and what the accounting implications would be for Kraken.

“We have known about crypto staking programs for a long time. Although it may not have made a difference, I should have called for us to put out guidance on staking long before now. Instead of taking the path of thinking through staking programs and issuing guidance, we again chose to speak through an enforcement action.”

What concerned her most was that their solution was “to shut down entirely a program that has served people well.”

Hester M. Peirce is one of five commissioners appointed by the President to the board of the SEC.

Do Staking Services Count as a Security?
Coinbase, one of the world’s biggest centralized exchanges, told BeInCrypto that their staking program is not affected by the news. Paul Grewal, their Chief Legal Officer, said that Kraken was “essentially offering a yield product. Coinbase’s staking services are fundamentally different and are not securities. For example, our customers’ rewards depend on the rewards paid by the protocol and commissions we disclose. Rules making clear these distinctions would provide real clarity to consumers, investors, and the industry.”

Coinbase also provided BeInCrypto with a Shareholder Letter which shows that staking was less than 3% of its revenue in Q3.

After the ruling became public, Kraken CEO Jesse Powell made his opinions clear on Twitter. “Oh man, all I had to do was fill out a form on a website and tell people that staking rewards come from staking? Wish I’d seen this video before paying a $30m fine and agreeing to permanently shut down the service in the U.S. How dumb do I look. Gosh.”

What Is Staking and What Are The Implications in the U.S.?
Staking is a way to earn rewards with your crypto by helping to secure a blockchain network. The longer you commit your digital money to a “stake,” the more rewards you can earn.

However, staking has become more important in recent months. Last September, Ethereum switched its consensus mechanism from Proof-of-Work (PoW) to Proof-of-Stake (PoS). Ethereum is the world’s second most popular blockchain and the leading smart contract platform. PoW uses complex mathematical problems to validate transactions and create new blocks. In PoS, validators are chosen based on the amount of cryptocurrency they are willing to “lock up.”

A centralized exchange’s ability to offer retail staking services will be determined by whether they meet the Howey Test. The SEC and courts use the Howey Test to determine whether a particular investment, such as a cryptocurrency, is a security. On Thursday, an SEC official told reporters that it saw offering a staking service as being similar to a security. There are likely to be further calls for clarity on the definition.

This is unlikely to be the end of the matter. On Sunday, Coinbase CEO, Brian Armstrong said the company would “happily defend this in court if needed.” An escalation of this kind may force the U.S. Supreme Court to rule on the status of staking services.

For the moment, centralized exchanges are likely reevaluating their compliance to avoid the same fate as Kraken. For the time being, staking services elsewhere are largely untouched. DeFi could be a big winner, as the practice is generally harder to regulate on decentralized services.

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