The settlement between Kraken (Payward Ventures) and the United States Securities and Exchange Commission set off alarm bells in the crypto community this month. Apparently, Kraken – one of the most aligned-minded crypto exchanges there – decided to buy peace instead of fighting with the SEC for years over whether it offers unregistered “securities” through its staking program. The nature of the settlement is such that Kraken neither admits nor denies the SEC’s allegations, and the existence of the settlement, technically, cannot be used as a legal precedent for any questions that may be raised on either side of the issue.
That said, the settlement is important, as it will make crypto staking clear in the United States. As SEC Chairman Gary Gensler said, “Whether through staking-as-a-service, credit, or other means, crypto intermediaries, when offering investment contracts in exchange for investor tokens, must provide the disclosures and safeguards required by our laws. – securities laws.” Gensler is casting a wide net, indeed, for what the SEC considers “investment contracts,” and walking out of business may be just what he has in mind.
related: Expect the SEC to use the Kraken playbook against staking protocols
That the SEC succeeded in forcing Kraken from $30 million, but does not make the agency’s position legal or logically correct. As a matter of starters, “staking” and “lending” are completely different. Staking is the process of pledging money or tokens to a proof-of-concept block, either directly or by delegating money to a third party, for the purpose of securing the network. Stakers are the blockchain’s consensus mechanism, as they “vote” which blocks to add to the chain. This process is algorithmic, and the reward is automatic when one electronic position is “selected” as a validator for a certain block.
Settlements are not laws. It is his decision that economic stability is better than fighting, nothing more.
The SEC considers staking-as-a-service a security. Kraken neither admits nor denies it.
It may be a tough question, but the SEC has not answered it today.
– Jake Chervinsky (@jchervinsky) February 9, 2023
Stakers don’t have to know who other stakers are, and they don’t need to know either, because the fate of the stake depends only on the rules of the block as “liveness” (availability) and other technical considerations. There is a risk of “slashing” (losing coins) for bad behavior or unavailability, but again, this is an algorithmic drug that is sold automatically according to transparent rules built into the code. Simply put, in staking, it’s between you and the blockchain, not you and the intermediary.
Loans, by contrast, require the entrepreneurial and managerial skills (or lack thereof) of the person you are lending to. This is a distinctly human enterprise. One does not have to know what the borrower has done with the money; one only hopes to get back with a return. This counterparty risk it is in part what the securities law is intended to address. In lending, the relationship between the borrower and the borrower, the relationship can take all kinds of unexpected turns.
related: Kraken’s staking ban is another nail in the crypto coffin – And that’s a good thing
The reasons why staking arrangements are not “investment contracts” (and thus “securities”) were clearly stated by Coinbase legal officer Paul Grewal in a blog post. Simply put, merely being an intermediary does not make the underlying economic relationship an “investment contract”. But the SEC here does not seem to want to entertain the differences between service providers and partners.
It is true that third parties, such as Kraken, have a custodial role in the staking relationship – that is, they may hold the private keys for the specific coins that the client intends to use. However, being an applicable asset custodian, especially where the custodian has a guarantee on a 1:1 basis to create each customer account, is a sensible service.
There is nothing to suggest that Kraken, Coinbase or other staking-as-a-service providers, use human judgment, intuition, grit or other characteristics of entrepreneurial or managerial ability, to advance or inhibit staker goals. One’s reward does not increase or decrease based on how the intermediary performs. There should be (and) rules and regulations on how custodians function, but ownership does not, by itself, create security.
Ari Bagus is a lawyer whose clients include payment companies, cryptocurrency exchanges and token issuers. His practice areas focus on tax, securities and financial services compliance. He received a juris doctor from DePaul University College of Law in 1997, a Master of Laws in taxation from the University of Florida in 2005, and is currently a candidate for an Executive Master of Laws in securities and financial regulation from Georgetown University Law. center.
This article is for general information purposes and is not intended and should not be construed as legal or investment advice. The views, thoughts, and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.