SEC Cracks Down On Crypto Staking - Is The Future Of Staking Under Threat?

SEC Cracks Down On Crypto Staking – Is The Future Of Staking Under Threat?

Updated: 08 March 2023

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Kraken, the third biggest crypto exchange by market capitalization, had recently agreed to pay a fine of $30 million to settle allegations imposed by the US Securities and Exchange Commission (SEC). According to the SEC, the exchange failed to register its service before offering investors an option to earn a reward on their staked crypto.

The SEC has been making constant efforts to extend the same regulatory framework that governs all the securities to crypto operators. Essentially treating cryptocurrencies as stocks or bonds.

Staking is a critical aspect of cryptocurrency operation, and a crackdown could very likely result in a failure of the entire market. In this article, we’ll take a look at crypto staking, the benefit of staking to investors, and the implications of the SEC’s crackdown on cryptocurrencies.

SEC Is Cracking Down On Cryptocurrency Staking Providers

Cryptocurrency staking providers have been providing “staking as a service” that lets users stake their cryptocurrency in return for an annual return. The SEC considers this practice to be similar to crypto lending, where investors are paid high returns for their crypto deposits.

Both crypto lending and staking as a service are considered to be a security, a designation that requires a lot of regulatory frameworks. Crypto was considered to be immune from these regulatory requirements before digital assets were recognized as securities by the SEC.

A bunch of lenders, such as Celsius Network and BlockFi, collapsed last year, just when the regulators were cracking down on the practice. Kraken, too, agreed to stop selling these securities through staking services; without the admission or denial of any allegations.

The SEC applies a legal test to determine whether something is a security. Essentially, it comes down to how similar an asset looks to shares issued by a company. Staking as a service resembles this since an investor is putting their money into a common enterprise with the intention of gaining a profit.

The labeling of securities is counterproductive for service providers since declaring asset security demands investor protection and disclosure requirements. At the same time, service providers will face constant scrutiny from regulators, which can lead to fines and penalties.

Not only does this make it difficult for small service providers to continue their operations, but it can also potentially cause the big players to lose funding if they’re involved in any criminal activities. Those who support the regulations believe that it’ll help make the relatively new crypto assets more transparent for investors.

Staking-as-a-service providers focused on US consumers are the only ones affected by the crackdown. As validators from around the world secure blockchains, they will continue to operate, provided that regulators outside the US are less strict about their services. This could widen the gap between the US, which enforces strict regulations, and other regions where regulations are less stringent.

It remains unclear whether the new regulations on staking will affect decentralized staking providers, which claim immunity because they are not run by a specific company or located in a particular place. Such providers are essentially software collections that execute transactions automatically. However, much-decentralized finance (DeFi) services are operated by a core group of individuals whom regulators may still hold accountable for noncompliance.

Here’s How The SEC’s Stance On Staking Could Impact The Future of Cryptocurrencies

There are two ways to look at the matter. Firstly, let’s consider the negative narrative discussed by the media for cryptocurrencies. This narrative assumes that regulatory bodies are completely against staking and exchanges offering the service to retail customers.

If this is true, it could have a drastic effect on investors’ portfolios who purchased tokens in the hope of earning a passive income. As they might consider shifting to other investment options. If Ethereum, the largest staked crypto, is declared as a “security”, it would be disastrous for the token, representing a fundamental risk.

On a closer look, the nuance that SEC is against staking services offered to retail investors and not entirely against staking becomes more apparent. The regulatory body was concerned that Kraken was offering staking services to retail investors without registering it as a security. Plus, the exchange didn’t disclose all the risks associated with staking and the method of how the yields were calculated.

While this makes it difficult for exchanges to offer stake services, it doesn’t mean that staking will vanish altogether. The SEC is only against large exchanges offering these services as a marketing gimmick and doesn’t have any issues with decentralized platforms such as LidoDAO offering staking.

Decentralized platforms offer liquid staking, and there are currently 65 different liquidity stalking providers, accounting for a total of $12 billion staked. Of this, $8 billion is staked in LidoDAO. If investors can’t stake their funds on exchanges, they can still continue to stake on other decentralized platforms.

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