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One of the largest cryptocurrency exchanges, Kraken, has felt the wrath of the Securities and Exchange Commission (SEC) following its failure to register its staking-as-a-service program. We reached out to the industry to find out what sort of knock-on effect this will have on the crypto-staking world.

Payward Ventures, Inc. and Payward Trading Ltd. form the crypto exchange Kraken. Both entities have ceased offering or selling securities through crypto asset staking services or programs and have paid $30million in disgorgement, prejudgment interest and civil penalties following the SEC’s inspection.

What is staking?

Staking is a process in which investors lock up – or “stake” – their crypto tokens with a blockchain validator with the goal of being rewarded with new tokens when their staked crypto tokens become part of the process for validating data for the blockchain. When investors provide tokens to staking-as-a-service providers, they lose control of those tokens and take on risks associated with those platforms, with very little protection.

Kraken’s offence

According to the SEC’s complaint, since 2019, Kraken has offered and sold its crypto asset ‘staking services’ to the general public. The organisation pooled certain crypto assets transferred by investors and staked them on behalf of those investors.

The complaint alleges that Kraken touts that its staking investment program offers an easy-to-use platform and benefits that derive from Kraken’s efforts on behalf of investors. This includes Kraken’s strategies to obtain regular investment returns and payouts.

SEC’s response

SEC chair Gary Gensler said: “Whether it’s through staking-as-a-service, lending, or other means, crypto intermediaries, when offering investment contracts in exchange for investors’ tokens, need to provide the proper disclosures and safeguards required by our securities laws.

“Today’s action should make clear to the marketplace that staking-as-a-service providers must register and provide full, fair, and truthful disclosure and investor protection.”

“In case after case, we’ve seen the consequences when individuals and businesses tout and offer crypto investments outside of the protections provided by the federal securities laws: investors lack the disclosures they deserve and are harmed when they don’t receive them,” said Gurbir S. Grewal, director of the SEC’s division of enforcement.

“Today, we take another step in protecting retail investors by shutting down this unregistered crypto staking program, through which Kraken not only offered investors outsized returns untethered to any economic realities, but also retained the right to pay them no returns at all. All the while, it provided them zero insight into, among other things, its financial condition and whether it even had the means of paying the marketed returns in the first place,” concluded Grewal.

Responding to the complaint

In addition to ceasing the staking program and the monetary relief, Payward Ventures, Inc. and Payward Trading, Ltd, without admitting or denying the allegations in the SEC’s complaint, consented to the entry of a final judgment, subject to court approval, that would permanently enjoin each of them from violating Section 5 of the Securities Act of 1933 and permanently enjoin them and any entity they control from, directly or indirectly, offering or selling securities through crypto asset staking services or staking programs.

The SEC’s investigation was conducted by Laura D’Allaird and Elizabeth Goody, under the supervision of Paul Kim, Jorge G. Tenreiro, and David Hirsch, with assistance from Sachin Verma, Eugene Hansen, and James Connor.

Win for investors?

The announcement was met with a lot of backlash. Many players in the field felt that the SEC got ban-happy and did not analyse other means of action before hitting the crypto exchange with the staking ban. For example, Ryan Sean Adams, the founder of the Ethereum show Bankless, provided three alternatives to the action taken by the SEC.

You could have:

– Mandated proof-of-reserves
– Required staking transparency
– Supported decentralized staking

Instead, we just got another gary g. ban hammer to the head. And we have no confidence you won’t come for decentralized staking next.

You’re driving it all offshore.

— RYAN SΞAN ADAMS – rsa.eth ??? (@RyanSAdams) February 9, 2023

As mentioned at the end of the tweet, a fear of driving crypto services offshore is a real concern. Others in the industry shared this sentiment.. Kristin Smith, CEO of the Blockchain Association, noted in a statement that Congress should be the ones creating blockchain legislation, not the SEC.

“The SEC continues its attack on US crypto companies and retail investors, regulating by enforcement and undercutting the potential of public blockchain networks in the United States. Staking is an important part of the crypto ecosystem, allowing individuals to participate in decentralised networks and giving investors more options to earn passive income.

“Today’s settlement isn’t law, but is another example of why we need Congress – not regulators – to determine appropriate legislation for this new technology. Otherwise, the US risks driving innovation offshore and taking online freedoms away from individual users,” Smith said.

Inclusivity is key

Speaking exclusively to The Fintech Times, Stefan Rust, CEO of Truflation, the data aggregation platform, said: “This kind of move is typical of regulators, who are ultimately reactive and backward-looking, rather than proactive and forward-looking, when it comes to protecting consumers.

“It is always too late by the time that they step in following a disaster. Customers have already lost millions if not billions of dollars, fraud has been committed despite these entities often being regulated, and the ones to suffer are the good actors left behind.

“The slow and backwards-looking regulation raises the question of whether it is fit for purpose in an industry like cryptocurrency that innovates faster than most others.

“Globally, cryptocurrency and blockchain are going to continue to grow and develop despite, it seems, the wishes of the US government.

“Thus, if the SEC continues to exclude US citizens from participating in this new digital revolution, the US economy is going to be left behind as the next Internet moves elsewhere. Actions like this are pushing innovation out of the US. It is a short-sighted, regressive, and frankly concerning move.

“Only by participating in crypto and blockchain through decentralised applications are participants able to resist the censorship that is so endemic throughout the traditional and centralised finance system.”

Disagreement within the SEC

Perhaps most the most unexpected statement to come from the announcement was one from within the SEC itself. The SEC’s commissioner, Hester Peirce publicly rebuked her own agency over the shutdown of crypto exchange Kraken’s crypto staking program in the US. In her full statement, she explained that “using enforcement actions to tell people what the law is in an emerging industry is not an efficient or fair way of regulating”.

Furthermore, she explained that customers have benefitted from Kraken’s service up until now. Simply ripping the rug out from under the customers and organisation will leave many feeling hard done by and abandoned. Ultimately, she said: “Whether we need a uniform regulatory solution and if that regulatory solution is best provided by a regulator that is hostile to crypto, in the form of an enforcement action, is less clear.”

Industry response

Hugo Volz Oliveira, secretary and founding member at the New Economy Institute, referred to Peirce’s comments when speaking exclusively to The Fintech Times. He discussed investor confidence’s impact following the ban: “The impact on investor confidence is limited to the US and mostly concerns the growing uncertainty that surrounds regulatory action in the crypto industry.

“Investors in crypto organisations exposed to the US market will be less confident in how innovative and competitive their projects can be without risking a hostile fine. And the problem is that only some organisations are affected by this kind of SEC’s regulation by enforcement, as the Commission refuses to clarify the rules the industry should follow.

“SEC Commissioner Hester Peirce put it best in her dissent statement, arguing Kraken couldn’t likely even register their staking program – which is the key violation the exchange is accused off.

“Lastly, retail investors won’t certainly feel safer now. The SEC accused Kraken of benefiting from the pooled resources of their customers, but Commissioner Pierce agrees that Kraken’s offering “served people well”. Because the users who wanted to follow the non-custodial route and stake their assets themselves were likely already doing that.

“Those who prefer the convenience of doing it with a trusted platform – hopefully fully aware of the associated risks, as Celsius showed – won’t likely feel comfortable in managing their staked assets on their own.”

Other staking services must take note

Digital asset trading platform, Fireblocks’ chief legal and compliance officer Jason Allegrante noted how investors won’t be the only ones impacted, but other exchanges will be too: “Following this news, any retail staking service provider must be on notice that they will be subject to intense SEC scrutiny for offering these products.

“The SEC has proclaimed its authority to regulate for a while now. Questions were raised over the last six months about why they have failed to be more aggressive, and I believe that now, we are witnessing them be more aggressive, which should be expected moving forward.

“This is a broader trend – in many parts a reaction to what we’ve seen in the crypto markets throughout the last several months – of not only the SEC, but banking agencies as well, taking steps to limit the exposure of traditional financial and retail consumers to crypto sector, which we need to monitor very carefully.”