What crypto “staking” really means

Tezo co-founder Kathleen Breitman speaks at Web Summit 2022 in Lisbon. Piaras Ó Mídheach/Sportsfile for Web Summit via Getty Images

Cryptocurrency exchange Kraken made big news last month when it announced a landmark settlement with the Securities and Exchange Commission, which shut down the firm’s staking-as-a-service business in the US and paid a $30 million settlement.

The news came as a shock, partly because of the defendant’s reputation. Kraken is one of the more responsible players in an industry characterized by reckless business practices. But a bigger shock came in the form of the SEC’s interpretation of “striking”.

For technologists, staking has a simple definition based on its purpose in a cryptocurrency network. In proof-of-stake consensus mechanisms, networks are secured by actors running specialized software that are typically required to put funds “at stake” to deter them from acting maliciously. Under this incentive scheme, funds are slashed by the network if a participant acts dishonestly. Staking refers to using one’s funds to participate in the security of a decentralized cryptocurrency network by running software—rather than burning electricity, as in a proof-of-work consensus chain.

Efforts at exchanges, pioneered by Coinbase, involve a service-based approach. This is where the practice should have begun and ended – exchanges can act as smarter participants to secure a blockchain network on behalf of some token holders, giving them any rewards earned in the process. On the Tezos platform, Coinbase acts as a delegate for token holders to grant rights to validate and vote on the blockchain. Coinbase makes money by taking a portion of the rewards earned by running software on its customer’s behalf. This is a modest but consistent revenue stream, and an easy option for less technical token holders to participate in the Tezos network.

However, at the height of the speculative frenzy of 2020, known as the “Summer of DeFi”, the definition of staking as a technical practice – a security assurance mechanism for a network interconnected with a small incentive structure – was turned into a catch-all phrase to describe it all. from risky lending practices to providing liquidity to decentralized exchanges. Some even started invoking staking to describe the “return” for Ponzi-like projects like the Terra Protocol. The result is that many protocols and tokens no longer use “staking” to describe securing a network, but rather as a marketing term for a dubious reward system for new users. This has led many crypto participants, especially less sophisticated ones, to confuse “return” and “stake” and believe that stake implies double or triple digit returns on newly minted tokens.

As Sam Bankman-Fried described in his now infamous money box analogy, this “weird boxing thing starts out as just this kind of sideshow to the bigger story that we’re going to change the world with the protocol we just built.” It’s no surprise, given Bankman-Fried’s history with the disgraced FTX exchange, that the “weird box staking thing” that supported the crypto markets in 2020 and 2021 proved unsustainable.

That’s why we can’t have nice things.

Conflating securing a network with marketing a token through the common use of “staking” is a microcosm of what has plagued the industry rhetorically for the past decade. By blurring the lines between activities such as lending, token distribution, Ponzi economics and … technical security, now “staking” means nothing at all. Like all security measures, the concept was at its best when it was boring.

At one time, there was a rhetorical distinction between the creation of tokens for network security and the creation of tokens as a distribution strategy to promote a new project. Unfortunately, too many projects have used the language of network security to describe a distribution scheme that would create good feelings through unsustainably high dividends for early adopters. As the market value of the industry expanded, no one felt the need to clarify these two radically different activities. Now that the numbers have gone down, the people who succumbed to peer pressure are starting to see their chickens come home to roost. (My guess is that “stablecoins” will be the next meaningless word to invite scrutiny from regulators.)

A call for precise language in the cryptocurrency space has always felt like a cry into the void. The recent staking-as-a-service settlement feels like a vindication of this lament, and it will be far from the last.

Kathleen Breitman is one of the founders of Tezos. The opinions expressed in Fortune.com comments are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.