US crypto crackdown on staking

Hey there! So, there's been some recent news about the SEC, the US Securities and Exchange Commission, cracking down on crypto exchanges. In fact, Kraken, one of the exchanges, just agreed to pay $30 million in settlements. The issue was that they offered a service that allowed investors to earn rewards by staking their coins. But, what is staking, you may ask?

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What is staking?

Staking is a way to use your cryptocurrency to help run a blockchain network, which is essentially a secure public record of transactions. It's a feature of many blockchains, like Ethereum, and it's key to potentially switching other cryptocurrencies away from a system that requires vast amounts of electricity. In September, Ethereum switched to staking to replace the “proof-of-work” system pioneered by Bitcoin, which continues to use it. Ethereum’s switch was said to cut the network’s energy usage by about 99%, which is a big deal since the industry has come under fire for the amount of electricity it uses.

What are the ‘proof of’ systems for?

To understand staking, you first have to understand the underlying technology behind cryptocurrencies, which is the blockchain. It's basically a shared ledger of time-ordered transactions that's maintained on computers all around the world. The blockchain has to make sure that no one is able to spend a cryptocurrency token more than once by manipulating the digital ledger. Both proof-of-work and proof-of-stake systems rely on group action to order and safeguard a blockchain’s sequential record.

How are the two different?

In proof of work, transactions are grouped into “blocks” that are published to a public “chain.” Miners compete to solve a puzzle through trial-and-error computations, and are rewarded with new cryptocurrency if other miners agree it works. Proof of stake works by giving a group of people incentives to collaborate on the task. Validators are chosen to order blocks of transactions on the Ethereum blockchain and are awarded new Ether if a block is accepted by a committee whose members are called attestors. People who stake their coins are rewarded by earning yields of about 4% for staking-as-a-service users on Ethereum.

What’s the SEC’s issue with staking?

Kraken and other centralized providers had been offering “staking as a service,” which lets users stake their coins without buying or maintaining the computers needed for staking. The agency’s action against Kraken makes clear that it considers this to be akin to crypto lending, a practice regulators cracked down on last year. The SEC considers both crypto lending and staking-as-a-service programs to be securities, a designation that imposes a wide range of regulatory requirements.

What does it mean for something to be a security?

If a service is labeled a security, it carries strict investor-protection and disclosure requirements under US rules. This would make running a staking-as-a-service program more expensive and complex, which would put smaller providers at a disadvantage compared to deeper-pocketed competitors. It could also mean losing future funding from investors who may be skittish of those increased compliance burdens and regulatory scr

Why does being labeled a security matter?

So, why does the SEC's designation of staking-as-a-service as a security matter? Well, first of all, it could make running such a program more expensive and complex. According to US regulations, the label carries with it strict investor-protection and disclosure requirements. This burden would put smaller providers at a disadvantage compared to their larger competitors with deeper pockets. Furthermore, exchanges that continue to offer the service would face ongoing scrutiny by regulators, which could result in fines, penalties, and, in the worst case, criminal prosecutions. This could also mean losing future funding from investors who may be hesitant to invest in the face of increased compliance burdens and regulatory scrutiny.

On the other hand, some supporters of more regulation believe that securities designations would ultimately result in more information and transparency for investors, which would help bring more users into the services.

Will other crypto yield services become targets of SEC?

However, there are questions about whether the tightening of regulations surrounding staking will impact so-called decentralized staking providers, which claim to be immune to regulations because they are not operated by a particular company or based in a particular place. In theory, such providers are just collections of software that execute transactions automatically. But many of these decentralized finance (DeFi) services are actually run by a core group of people whom regulators could potentially still hold responsible for noncompliance.

Thank you for reading!

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