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In a year of crypto upheavals, the United States Securities and Exchange Commission\u2019s settlement<\/a> with crypto exchange Kraken, announced on Feb. 9, set off yet another tremor. Agency chief Gary Gensler took to mainstream media last week to explain the agency\u2019s action, which seemed to be an attack on crypto staking \u2014 part of the validation mechanism used by a number of blockchain platforms, including Ethereum, the world\u2019s second-largest network.\u00a0<\/p>\n The immediate issue, in the agency\u2019s view, was that Kraken had been selling unregistered investment products. Indeed, it was advertising big returns on staking crypto \u2014 up to 21%, Gensler told<\/a> CNBC.com. <\/p>\n \u201cThe problem was they were not disclosing to the investing public the risks that the investing public were entering into,\u201d Gensler said. Moreover, the SEC’s action, which required Kraken to shell out $30 million and shut down its staking operation, could have been easily avoided, he seemed to imply:<\/p>\n \u201cKraken knew how to register, others know how to register. It’s just a form on our website. They can come in, talk to our talented people on disclosure review teams. And if they want to offer staking, we’re neutral. Come in and register, because investors need that disclosure.\u201d<\/p><\/blockquote>\n Not all in the crypto industry were totally satisfied with this response, however. \u201cI find the SEC\u2019s \u2018all crypto projects have to do is come in and register\u2019 line unbelievably insulting,\u201d tweeted<\/a> Morrison Cohen LLP attorney Jason Gottlieb. \u201cThere is simply no path to registration for many crypto products.\u201d<\/p>\n I find the SEC\u2019s \u201call crypto projects have to do is come in and register\u201d line unbelievably insulting. <\/p>\n It assumes there\u2019s this vast quantity of sophisticated securities lawyers advising clients, \u201cnah man, screw the SEC, yolo baby, do whatever you want.\u201d 1\/6<\/p>\n \u2014 Jason Gottlieb (@ohaiom) February 11, 2023<\/a><\/p><\/blockquote>\n \u201cThe registration of staking program securities is not as simple as filing a form on the SEC\u2019s website,\u201d Michael Selig, an attorney with Willkie Farr & Gallagher LLP, told Cointelegraph. \u201cPublic offerings of securities are heavily regulated and expensive to conduct.\u201d<\/p>\n Others view the agency\u2019s decision to charge Kraken as the first salvo in a general assault on crypto by U.S. regulators. \u201cIf approved by a court, the settlement marks a potential turning point for cryptocurrency regulation and the SEC\u2019s broader efforts to bring the industry under its jurisdiction,\u201d reported<\/a> CNN. \u201cThe move could lead to a wider clampdown,\u201d speculated<\/a> The New York Times, including possibly banning staking for retail U.S. investors.<\/p>\n But maybe the industry was over-reacting. That is, staking as practiced by Ethereum and other blockchains as a way to reward network validators may not be on the SEC\u2019s radar screen at all. The agency could be motivated by consumer protection concerns primarily and, in this instance, it wanted to make an example of Kraken, especially in light of FTX\u2019s November collapse and the bankruptcy of assorted crypto lending firms. <\/p>\n \u201cYes, I am sure they [the SEC] wanted to make an example of Kraken, especially because it promoted the opportunity to make returns of up to 21%,\u201d Carol Goforth, university professor and Clayton N. Little professor of law at the University of Arkansas, told Cointelegraph.<\/p>\n Recent:\u00a0Binance banking problems highlight a divide between crypto firms and banks<\/a><\/em><\/strong><\/p>\n \u201cKraken set the returns for amounts staked, not the underlying blockchain protocols. […] Honestly, the way that Kraken operated its program looks like an investment contract under Howey,\u201d she said. The SEC uses the Howey Test to determine whether a transaction qualifies as an investment contract, which then requires SEC registration.<\/p>\n Bill Hughes, senior counsel and director of global regulatory matters at ConsenSys, told Cointelegraph, \u201cIt\u2019s a one-off action that is intended to not just resolve Kraken\u2019s offering but, importantly, to send signals across the space about what features of staking-as-a-service the SEC believes are problematic.\u201d If another staking service fails to pay attention to these signals, they too can expect the SEC to take action, said Hughes, adding:<\/p>\n \u201cI think the SEC hopes the market gets the message and adjusts accordingly \u2014 as they\u2019d probably prefer to move on to other issues.\u201d<\/p><\/blockquote>\n \u201cThe U.S. Kraken case is primarily about sanctioning its [Kraken\u2019s] blatant and non-transparent behavior vis-\u00e0-vis their retail customers, and not for just offering a staking-as-a-service per se<\/em>,\u201d Markus Hammer, an attorney and principal at the Switzerland-based Hammer Execution consulting firm, told Cointelegraph.<\/p>\n The market didn\u2019t necessarily see this as a one-off action on the part of the agency, however. Ether (ETH<\/a>) plummeted<\/a> around 6.5% on the day of the settlement announcement, its largest one-day decline since mid-December. As widely reported, Ethereum moved last year from a proof-of-work to a proof-of-stake (PoS) consensus mechanism. Dubbed \u201cthe Merge,\u201d this technical makeover was hailed by many for radically reducing the network\u2019s prodigious energy usage and carbon footprint. But some, at least, feared Ethereum was now in the sights of U.S. regulators because of its new staking protocols.<\/p>\n Equating Kraken and Ethereum could be a mistake, though. As Matthew Hougan, chief investment officer at Bitwise Asset Management, told Cointelegraph:<\/p>\n \u201cThe SEC’s enforcement action against Kraken is not an enforcement action against Ethereum for using a proof-of-stake consensus mechanism. It was an enforcement action against Kraken for offering a staking service. Those are different things.\u201d<\/p><\/blockquote>\n Moreover, Ethereum could continue to function securely as a PoS network even if the SEC were to ban all staking services in the U.S., said Hougan, though he doesn\u2019t expect that to happen. \u201cActivity would simply migrate offshore or be done directly by individuals,\u201d he said. More than enough ETH could still be staked to ensure network integrity. \u201cThe main result would be that U.S. investors would lose out on both the opportunity and the risk of staking. The world, however, would go on.\u201d<\/p>\n \u201cThe action is not against staking platforms but against staking service providers that organize and operate pools,\u201d Goforth said. \u201cIf the organizer controls the pools and the rates of return\u201d \u2014 as with Kraken \u2014 \u201cthen this action does suggest that the SEC will treat the program as involving the distribution of investment contracts.\u201d <\/p>\n By comparison, she said, \u201cif the blockchain protocol allows others to set up pools,\u201d as with Ethereum, \u201cthat is not necessarily within the rationale of this order.\u201d<\/p>\n Hughes agreed. There is nothing in the SEC\u2019s complaint that implies that staking itself is problematic. \u201cSEC\u2019s action focuses squarely on the Kraken custodial staking program, which promised a specific yield, pool funds and did not disclose risks or fees. It says nothing about ETH staking or any other chain\u2019s consensus mechanism,\u201d he said.<\/p>\n Ethereum also hosts many use cases that have nothing to do with investing (e.g., elections). Just because the network has moved to a proof-of-stake consensus mechanism doesn\u2019t by itself mean that its native coin, Ether, should now automatically be classified as a security. One has to look at \u201cthe nature of the underlying multi-purpose blockchain and respective ecosystem,\u201d said Hammer. Moreover, these will need to be assessed blockchain by blockchain, he added.<\/p>\n All this may be well and true, but could this really be an opening fusillade as part of a broader post-FTX attack on cryptocurrencies and blockchain technology \u2014 and not just \u201cinvestment solutions\u201d offered by a few centralized service providers?<\/p>\n \u201cThe SEC tends to act in an incremental way, bringing new enforcement actions that build upon prior enforcement actions,\u201d Selig told Cointelegraph. \u201cThe crypto industry is sensibly concerned that the SEC is focused on custodial staking programs today but will set its sights on staking more broadly in the future.\u201d<\/p>\n Hughes tends toward the more limited view, mainly \u201cbecause that is what this complaint is on its face. Whether the SEC gets more aggressive and goes after core blockchain functionality is to be seen.\u201d <\/p>\n Blockdaemon CEO and founder Konstantin Richter appeared to agree. \u201cWith the complaint, staking itself does not appear to be the issue,\u201d Richter told Cointelegraph. \u201cThis indicates that institutional investors that have the ability to stake can continue without using a centralized custodial exchange.\u201d <\/p>\n Hougan, for his part, isn\u2019t quite so confident that a clampdown isn\u2019t coming, telling Cointelegraph:<\/p>\n \u201cCrypto is facing a coordinated regulatory crackdown in the U.S. You are seeing that crackdown in the SEC’s recent statements and actions, and in recent efforts by the FDIC, OCC and Federal Reserve to restrict the crypto industry’s access to the traditional banking system.\u201d<\/p><\/blockquote>\n These actions are worrisome but not surprising, continued Hougan. The numerous failures over the past year like FTX, Celsius, Genesis, BlockFi, Voyager and Terra have \u201cpointed to some significant risks in the crypto ecosystem and the need \u2014 in certain cases \u2014 for better regulation.\u201d <\/p>\n \u201cThis is far from the first salvo in a U.S. assault on crypto,\u201d said Goforth. \u201cThe SEC has been relatively hostile to crypto assets for years; this seems to be a continuation of that approach […] as it continues to devote resources to case-by-case enforcement rather than offering a genuinely helpful roadmap for compliance, such as by drafting exemptions based on tailored disclosures.\u201d<\/p>\n Gensler may have been disingenuous when he invited exchanges like Kraken to just fill out a form on the SEC\u2019s website. SEC registration is an involved undertaking. \u201cIt is an incredibly difficult process, often costing a million dollars or more \u2014 in legal, accounting, and investment advisor fees \u2014 the first time an issuer seeks to register a conventional security,\u201d noted Goforth. It also can take a long time to get approved.<\/p>\n It doesn\u2019t necessarily follow, however, that Gensler will go after Ethereum and other PoS platforms. The agency chief, it might be remembered, once taught a course on blockchain technology at the Massachusetts Institute of Technology, and he knows a good bit about decentralized networks and their purposes. He probably understands that the technology offers all sorts of non-investment use cases, even PoS platforms with validators that have \u201cskin in the game\u201d as they work to ensure network integrity. <\/p>\n\n
Is Ethereum at risk?<\/h2>\n
An opening volley?<\/h2>\n
\u2018First inning of a nine inning game\u2019<\/h2>\n