A crypto practice in the crosshairs of regulators – Newspaper

Crypto companies that offer their customers eye-popping returns through so-called “staking” products are getting a dig from the US Securities and Exchange Commission, which says such services should be registered.

Crypto exchange Kraken agreed on February 9 to shut down its betting service for US customers and pay $30 million in fines as part of a settlement with the regulator, and investors are concerned that a wider ban on the practice could follow.

What is staking?

Staking is a process where cryptocurrency owners volunteer to take part in validating transactions on the blockchain, in other words, checking that the ledger matches.

The control is not done by individuals, but by computers in the blockchain network, often via third-party staking services. In return, validators, who cannot use their cryptocurrencies involved in the validation process for a period of time, receive a share of the transaction fees or newly created cryptocurrencies. This reward is then passed on to customers at centralized exchanges who agree to stake their assets.

From a customer’s perspective, it is a way to receive returns on cryptocurrencies, by agreeing to put them to work, or locked up, for a certain period of time. Staking is only possible on proof-of-stake blockchains, such as Ethereum.

Staking is a process where cryptocurrency holders volunteer to participate in the validation of transactions

The question for regulators is whether this reward scheme resembles an investment contract and should follow the accompanying rules.

Which companies are engaged in it?

Almost all the major crypto exchanges offer staking services to their clients for a variety of tokens, including Coinbase, Binance, Crypto.com, Gemini, Huobi and OKX. These firms offer clients anywhere from 2pc annual percentage return to as high as 40pc APY on certain tokens. The most popular tokens that can be staked include ethereum, Solana, Polygon and Avalanche.

While the centralized exchanges offer staking as a service to their clients, cryptocurrency owners can also stake their tokens on decentralized exchanges, such as Uniswap, although this requires more technical knowledge.

It’s not just crypto firms either. British digital banking app Revolut recently started allowing customers in the UK and Europe to bet on cryptocurrencies they hold on the platform.

Why are regulators unhappy about it?

The US Securities and Exchange Commission (SEC) has said that most staking providers fail to provide customers with proper disclosures about how their cryptocurrency will be used, and that they should register their staking services with the agency. In the settlement with the SEC on February 9, Kraken neither admitted nor denied the SEC’s claim that the betting service should have been registered.

SEC Chairman Gary Gensler said the action should put other crypto exchanges offering similar services to US users on notice, and that these platforms should come into compliance with securities laws.

While regulators have expressed concern about crypto products luring customers in with the promise of high returns, the practice of staking has not been singled out for specific regulatory attention in countries other than the United States.

Kraken said it would continue to offer bets to customers based outside the US.

What will be next?

While Gensler said the SEC’s settlement with Kraken should be a warning sign to the rest of the cryptocurrency industry, it’s not immediately clear that other crypto exchanges that offer betting will register those services with the SEC.

In a statement, Coinbase said the betting program was not affected by Kraken’s settlement with the SEC because its own service is “fundamentally different” from Kraken’s.

The Blockchain Association, an industry trade group that represents a number of prominent crypto firms in the United States, noted that the Kraken settlement is not law, but should serve as pressure for Congress to pass legislation governing cryptocurrency.

Published in Dawn, The Business and Finance Weekly, 13 February 2023