Payward Ventures, Inc., d/b/a Kraken, the cryptocurrency exchange, has entered into a $30 million settlement with the US Securities and Exchange Commission (SEC) over allegations that the company failed to register its cryptocurrency betting program, in violation of US securities laws.
Background
Staking programs reward users for unlocking their digital tokens to validate transactions on a blockchain, with the reward consisting of “interest” accrued on the locked tokens, which the user typically receives in the form of additional tokens. Interest payments vary based on the number of tokens staked and the duration of the lock-in period. These programs have become increasingly popular as blockchain operators seek to incentivize users to participate in consensus verification of new transactions, a key feature of distributed ledger technology.
SEC Action
The SEC complaint alleges that the contract in which users stake assets and receive returns from Kraken constitutes an investment contract, subject to the registration requirements of Section 5 of the Securities Act of 1933, as amended (Securities Act). According to the complaint, over $2.7 billion of crypto assets were “invested” in Kraken’s staking program by more than 135,000 US participants. The SEC complaint says Kraken “offered and sold investment contracts without registering the offer or sales with the SEC as required by the federal securities laws, and no exemption from the registration requirement applied.”
SEC Chairman Gary Gensler released a YouTube video saying that “staking-as-a-service providers must register and provide full, fair and truthful disclosure and investor protection.” He added, “[W]whether they call their services “lending,” “earning,” “APY,” or “staking,” that relationship should come with the protection of federal securities laws.” , which calls for greater clarity and an end to the SEC’s practice of regulation by enforcement. Apart from from registration, Kraken could have chosen an exempt offering under Regulation D, where all or most investors would have to be “accredited.”
The SEC noted that the Kraken account agreement itself – where customers agree to stake their assets in exchange for returns – resembled fixed-income investments and should therefore be considered securities.
Under the settlement agreement, Kraken will no longer offer its staking program to US account holders, will remove all staked assets of US customers and pay $30 million in fines, all without admitting or denying guilt.
Why it matters
The action against Kraken signals that the SEC is turning its attention to a new (and increasingly popular) area while continuing to apply the old rules to new technologies. Consumer protection appears to be the SEC’s top priority, based on the complaint’s allegation that because Kraken failed to register the betting program, users “lacked material information” needed to evaluate the program.
By imposing a significant fine for conduct the SEC had not previously made clear was problematic, the agency has adopted an even stricter, less accommodating approach to this industry. As a result, all participants in the crypto space must tread carefully and review how their actions fit with the SEC’s elastic and evolving application of Howey test.
A you, Stablecoin?
In the hours since the SEC announced its settlement with Kraken,
The Wall Street Journal reported that the regulator plans to sue stablecoin issuer Paxos over the issuance of the Binance USD coin. The SEC has yet to comment officially, but if confirmed, this would represent a further expansion of the SEC’s authority over digital assets. Stablecoin has been subject to review by the President’s Task Force on Financial Markets, led by the Treasury Department, the FDIC, and the OCC. This follows similar actions brought by the New York Attorney General, the CFTC and private plaintiffs against stablecoin issuer Tether.
The SEC’s actions against Kraken (and perhaps now Paxos) continue the BlockFi/Kardashian/Coinbase line of enforcement actions that have led to the Truman era Howey test from the real world to the metaverse. Applying the definition of “investment contract” to commercial matters that could not have been foreseen 75 years ago represents an expansion of SEC oversight and its continued aggressive approach to regulating the crypto and blockchain industries by enforcement rather than by affirmative rulemaking.
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