From the Deep: Kraken Divides SEC
On February 9, 2023, the Securities and Exchange Commission (the “SEC”) chargedPayward Ventures, Inc. and Payward Trading Ltd, (together more commonly known as “Kraken”), for failing to register the offer and sale of their “staking-as-a-service” program. In this program, investors transferred assets to Kraken for staking in exchange for advertised annual investment returns of up to 21 percent.
To settle the SEC's charges, Kraken agreed to immediately cease offering or selling staking services or programs and pay $30 million in disgorgement, prejudgment interest, and civil penalties. In addition to the monetary relief, Kraken also consented to a final judgment that would permanently enjoin them from violating Section 5 of the Securities Act of 1933 and permanently enjoin them and any entity they control from offering or selling securities through crypto asset staking services or programs.
Not all Staking is Created Equal
There are several types of crypto staking that exist, each with its unique features and differences. Some of the most common forms of staking are:
PoS (Proof of Stake) Staking: a consensus mechanism used by some blockchain networks, where validators are chosen to validate blocks and validate transactions based on the amount of cryptocurrency they hold and lock-up as stake. Validators receive rewards for their work in the form of new tokens.
Delegated PoS (DPoS) Staking: token holders delegate their tokens to a set of trusted validators, who then validate transactions and receive rewards. The delegating token holders receive a portion of the rewards as well.
Liquid PoS Staking: a variation of PoS staking that allows token holders to earn rewards while retaining full control over their tokens and the ability to trade them.
Pooled Staking: multiple individuals come together to pool their resources and participate in staking as a group. The rewards from staking are then distributed among the participants based on the number of tokens they have staked.
Each of these staking types has its own unique features and benefits. For example, PoS staking generally requires a high degree of technical knowledge and a significant volume of resources to participate, while Liquid PoS staking provides more accessibility and flexibility. Pooled staking allows individuals to participate in staking without having to meet the minimum requirements of a typical PoS staking setup, but also means that rewards are split among a larger number of people.
Gensler’s Broad Brush
In the present instance, Kraken aimed to address the technical and capital requirement roadblocks to accessing PoS staking by providing a centralized form of Pooled Staking.
The SEC’s complaint alleges that Kraken touted its staking investment program as an easy-to-use platform that allows participants to benefit from Kraken's efforts, including strategies to obtain regular investment returns and payouts.
In an extremely awkward video synopsis of the charge and subsequent settlement, SEC Chairman Gary Gensler (“Gensler”) indicates that crypto intermediaries, whether through staking-as-a-service, lending, or other means, need to provide the proper disclosures and safeguards required by securities laws when offering investment contracts in exchange for investors’ tokens. Proper, of course, in this case refers to treatment of these products as securities for purposes of U.S. law.
Commissioner Pierce Dissents
Breaking from Gensler’s position, Commissioner Hester M. Peirce (“Pierce”) released her own Statement (Kraken Down: Statement on SEC v. Payward Ventures, Inc., et al), pointing out that the current regulatory climate and ambiguity makes it difficult web3 products and ventures to comply with the requirements they are ostensibly responsible for complying with. Pierce notes that the Kraken staking program raises a number of complicated questions about the need for disclosure, including whether such staking programs need to register as a whole or if each digital asset’s staking program would need to be separately registered.
Peirce Further laments that the SEC has failed to issue guidance on staking programs and instead has chosen to regulate through enforcement actions, emphasizing that this approach is not efficient or fair, as staking services are not uniform, and one-off enforcement actions cannot adequately address the complexities of this emerging industry.
Pierce further indicated her concern relating to the fact that the SEC’s solution to a registration violation is to shut down the program entirely, instead of developing a workable registration process that provides valuable information to investors. Peirce questions the need for a uniform regulatory solution, especially given that the SEC is hostile to crypto, and suggests that industry-driven solutions might be a better way to address the issue.
Where do we go from here?
Does this settlement that staking in every form now inherently implicates securities law?
I do not think so. This complaint was rather narrow – specifically dealing with staking-as-a-service (which likely now does universally fall within the scope of this extrapolated framework) – and does not apply to every instance of this essential part of web3 infrastructure.
Hopefully, Peirce’s argument for more transparency around crypto-staking programs is heard, along with a more thoughtful approach to regulation in the emerging crypto industry.
What kind of lawyer would I be without a disclaimer?
Everything I post here constitutes my own thoughts, should only be used for informational purposes, and does not constitute legal advice or establish a client-attorney relationship (though I am happy to discuss if there is something I can help you with). I can be reached via email (dlopezkurtz@crokefairchild.com or david@bsl.group), telegram (@davidlopezkurtz), twitter (@lopezkurtz), and on LinkedIn here.
