Summary: A crypto crackdown by US regulators appears to have arrived just as digital asset prices were once again gaining their footing. The SEC’s settlement with cryptocurrency exchange Kraken will send major shockwaves through the industry, implying that staking-as-a-service is an investment contract. Third-party staking of assets has become a significant revenue generator for exchanges throughout the past couple of years and all US customers may end up locked out of this service soon.
An additional lawsuit may be set to go ahead against Paxos, a US-based stablecoin issuer who received a Wells Notice early this month from the SEC. New York State Regulators have already forced the company to end new issuance of its Binance USD (BUSD) stablecoin. That case may end up dealing in more of a legal gray area than the Kraken’s staking case, but investors are already beginning to flee stablecoins issued by US-based firms.
Related Assets: Coinbase Global, Inc. (COIN), Binance USD (BUSD-USD), Tether (USDT-USD), USD Coin (USDC-USD)
Over the past week, the US Securities and Exchange Commission (SEC) has rolled out an unprecedented set of enforcement actions against companies operating in the cryptocurrency industry. A lawsuit, concerning “staking-as-a-service”, has already been settled by the commission and Kraken, a popular US-based cryptocurrency exchange. A potential second suit, concerning stablecoin issuer Paxos Trust Co. and it’s issuance of Binance USD (BUSD, a branded stablecoin primarily traded on the Binance cryptocurrency exchange), was likely confirmed by the delivery of a Wells Notice to the company earlier this month. Though the former case appears to be a breach of securities law and will now set precedent for similar cases, the latter may be in more of a legal gray area.
Crypto Exchanges to Face Difficult Staking-as-a-Service Precedent
As MRP highlighted last Friday in our most recent Weekly Crypto Wrap, Kraken settled SEC charges regarding the unregistered offer and sale of securities for a sum of $30 million, further agreeing to discontinue their “staking” services in the US. As MRP has previously highlighted in our Intelligence Briefings, staking is the consensus mechanism of proof-of-stake cryptocurrencies (PoS), used to validate transactions as miners would on a proof-of-work (PoW) blockchain like Bitcoin. Instead of utilizing hardware and intensive amounts of electricity to engage in hashing as one would do to mine Bitcoin, staking requires owners of a certain cryptocurrency to lock up all or a portion of their assets within a specific protocol to become a “validator”. Typically, a larger amount of assets locked up by a user will result in that user receiving a larger share of the network’s transactions to validate. Validation is necessary to prevent network participants from using the same coin in multiple transactions at the same time, known as “double spending”.
The staking validation process results in a reward for whichever user is chosen by the protocol to be the validator for a specific number of transactions, which then become a “block” that will be added to the chain of other blocks which came before it – hence, blockchain. The incentive for users to take part in the validation process is that, for each transaction they validate, they will be compensated with a certain amount of tokens disbursed by the network and/or transaction fees paid by other users who are sending the transactions. Each PoS cryptocurrency’s validation and staking systems will have its own nuances, but this description is meant to provide a general overview of what staking actually is. PoS blockchains accounted for 23% of the total market value of digital assets at the end of 2022, according to a report from Staked and Kraken, cited by Bloomberg. The report estimated the value of staked assets at $42 billion.
We must clearly delineate staking from staking-as-a-service. A cryptocurrency exchange offering staking services typically requires users to provide their assets to the centralized third-party, who will then take custody of those assets and rehypothecate them as they please. This staking-as-a-service approach that exchanges have been engaging in is what the SEC appears to be going after, not the process of staking itself…
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