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Why the SEC’s ‘Staking Ban’ Is Not What You Think

Published Feb 10, 2023 11:15AM ET Updated Feb 10, 2023 12:30PM ET
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Why the SEC’s ‘Staking Ban’ Is Not What You Think
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  • Coinbase (NASDAQ:COIN) CEO suggested that the SEC could ban staking for retail customers. He said this would be a “terrible path” for the US. Staking services made up 11% of Coinbase’s revenue in Q3 2022.
  • These comments come after Kraken settled a lawsuit with the SEC. The exchange agreed to pay $30 million and cease offering staking services.
  • However, SEC’s rules could bring more transparency to staking and make it more decentralized.

Since the catastrophic FTX collapse, the US Securities and Exchange Commission (SEC) has been ramping up efforts to regulate crypto exchanges. The latest casualty is a myriad of unregulated staking services these exchanges provide. However, rather than a “ban on crypto staking,” the SEC’s regulatory push is something else entirely.

On Thursday, Coinbase CEO Brian Armstrong sounded the alarms over “rumors” about an upcoming ban on crypto staking. The SEC was supposedly moving to ban crypto staking for retail customers in the US. According to Armstrong, this would be a “terrible path” for the US.

Armstrong’s comments came after rival exchange Kraken settled a case against the SEC over its own staking products. Kraken agreed to pay a $30 million fine and to stop providing staking services.

Why Exchanges Fear SECs ‘Staking Ban’

For proof-of-stake networks like Ethereum, crypto staking is a way to secure the network. On the other hand, it allows users to earn rewards for locking up tokens. However, staking typically requires a large amount of capital to bring reliable returns. To mitigate this, retail users can pool their tokens into decentralized staking pools – or stake them with exchanges.

For crypto exchanges, staking services have become an essential source of revenue. As trading volumes dropped, the share of staking rewards in their revenues grew. For Coinbase, blockchain rewards accounted for 11% of the revenue in Q3 of 2022, up from 8.5% in Q2.

Exchanges argue that these staking services are essential to securing blockchain networks. However, the SEC has a different view on these services.

Genser: Investors Deserve to Know what Exchanges Are Doing with Their Tokens

On Friday, the SEC Chair Garry Gensler explained the agency’s move to rein in staking services.

Gensler said that crypto exchanges advertise returns on these products, “whether they call their services lending, earn rewards, API or staking.” As such, these staking contracts should come with the protection of federal Securities laws.

“That means you, the investor, should receive important disclosures. For example, what do they do with your tokens; Are they really staking them? Are they lending, borrowing, or trading with them? Are they co-mingling them with their other businesses?” Gensler added.

Other questions include where the rewards come from and whether investors are getting their fair share. Moreover, investors have the right to know whether staking “protocols genuinely create value” or whether they just dilute the tokens they already hold.

“Remember, if you have a stake meant for two and cut it into three pieces, it's still the same amount of steak,” Gensler said. Another big issue is in custody over the tokens. Staking services may require users to transfer the ownership of these tokens to exchanges. “There’s an expression in crypto, not your keys, not your crypto,” he added.

These staking agreements make a user “basically an investor in their platform,” Gensler claims. This is critical if an exchange goes bankrupt, like in the case of FTX. In that event, stakers may end up in line at a bankruptcy court.

SEC Staking Ban – What It Really Means

If the SEC Chairs’ recent comments indicate the agency’s intentions going forward, the so-called staking appears to be something else entirely. The SEC is not closing in on proof of stake networks like Ethereum.

Instead, the SEC’s enforcement seems to align with its push to bring more transparency to centralized exchanges. The agency is looking to make these centralized entities adhere to the same rules traditional institutions must follow.

This could be good news for crypto. Multiple analysts, including those at JP Morgan, believe that more rigorous regulation could help push crypto forward. After the FTX collapse, regulators are under increasing pressure to rein in centralized exchanges.

At the same time, users are moving towards more decentralized solutions. These are coincidentally also likely less vulnerable to regulation for legal and technical reasons.

The SEC may be less likely to move against decentralized tokens and protocols, as suggested by its references to the Howey test. Moreover, decentralized protocols are much harder to ban, as the case of Tornado Cash shows.

On the Flipside

  • The FTX collapse put immense pressure on regulators to take a more proactive approach to crypto.
  • Not all SEC Commissioners have the same views on crypto regulations. Commissioner Hester Peirce, for instance, believes that regulators should leave space for crypto innovation.

Why You Should Care

A ban on staking services could be a serious blow to crypto exchanges in the short term. At the same time, it could help educate users on decentralized alternatives.

You may also like:

SEC Commissioner Calls for Clarity on Howey Test After the FTX Debacle

US SEC Announces Plans to Monitor Crypto Brokers and Advisors

See original on DailyCoin

Why the SEC’s ‘Staking Ban’ Is Not What You Think

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