The deal between Kraken (Payward Ventures) and the United States Securities and Exchange Commission set off alarm bells in the crypto community this month. Apparently, Kraken, one of the most compliance-conscious cryptocurrency exchanges, decided to buy its peace rather than fight the SEC for years over whether it was offering unregistered “securities” through its staking program. The nature of the agreement is that Kraken neither admitted nor denied the SEC’s allegations, and the existence of the agreement, technically speaking, cannot be used as legal precedent for any argument that either party may bring.
That being said, the deal is important as it will clearly chill crypto betting in the United States. As SEC Chairman Gary Gensler said, “Whether through staking-as-a-service, lending, or other means, crypto intermediaries, when offering investment contracts in exchange for investor tokens, must provide the appropriate disclosures and safeguards required by our securities laws.” Gensler casts a wide net, in fact, for what the SEC considers “investment contracts,” and perhaps it was precisely what he had in mind to stake out the business.
Related: Expect the SEC to Use Their Kraken Playbook Against Stake Protocols
However, the fact that the SEC was successful in pressing Kraken with $30 million does not make the agency’s position legally or logically correct. As a preliminary matter, “participate” and “lend” are totally different things. Staking is the process by which one pledges their coins or tokens to a proof-of-stake blockchain, either directly or by delegating their coins to a third party, in order to secure the network. Participants are those through whom the blockchain’s consensus mechanism operates, as they “vote” which blocks will be added to the chain. The process is algorithmic and the reward is automatic when one’s position is electronically “selected” as a validator for a given block.
Agreements are not law. They are a decision that the economics of settling down is better than fighting, nothing more.
The SEC believes that staking as a service is a security. Kraken did not admit or deny in any way.
It may be a difficult question, but the SEC has not answered it in any way today.
—Jake Chervinsky (@jchervinsky) February 9, 2023
Participants do not necessarily know who the other participants are, nor do they need to know, as the fate of the participation depends only on following the rules of that blockchain regarding “life” (availability) and other technical considerations. There are risks of “cutting” (losing your coins) due to misbehavior or unavailability, but again, these are algorithmic remedies distributed automatically according to transparent rules built into the code. Simply put, when staking, it is between you and the blockchain, not between you and the intermediary.
Lending, by contrast, invokes the entrepreneurial and managerial skill (or lack thereof) of the people you lend to. This is a distinctly human undertaking. You don’t necessarily know what the borrower is doing with the money; one simply hopes to win it back with a return. This counterparty risk is in part what securities laws are intended to address. In lending, the relationship is between the lender and the borrower, a relationship that can take all kinds of unexpected turns.
Related: Kraken’s Staking Ban Is Another Nail in the Coffin for Crypto, and That’s a Good Thing
The reasons why staking agreements are not “investment contracts” (and therefore “securities”) were eloquently stated by Coinbase’s chief legal officer, Paul Grewal, in a blog post. Simply put, simply serving as an intermediary does not make the underlying economic relationship an “investment contract.” However, here the SEC does not seem to want to consider the differences between service providers and counterparties.
It is true that third parties, such as Kraken, serve a custodial role in the staking relationship, that is, they may have the private keys of the particular coins that the client intended to stake. However, serving as custodian of a fungible asset, especially when such custodian has collateral on a 1:1 basis to back each customer account, is a discreet service.
There is nothing to suggest that Kraken, Coinbase, or any other staking-as-a-service provider uses human judgment, intuition, grit, or any other hallmark of one’s managerial or entrepreneurial ability, to further or inhibit staker purpose. . One’s reward does not improve or decrease based on how the broker performs. There should (and are) rules and regulations about how custodians work, but possession, by itself, does not constitute a guarantee.
Ari Good is a lawyer whose clients include payment companies, cryptocurrency exchanges, and token issuers. His practice areas focus on tax compliance, securities and financial services matters. He received his J.D. from DePaul University School of Law in 1997, his LL.M. in tax from the University of Florida in 2005, and is currently a candidate for the Executive L.M. in securities and financial regulation from the University of Georgetown. Center.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This post The SEC rocked Kraken for $30 million, but that doesn’t mean they had a case
was published first on https://cointelegraph.com/news/the-sec-shook-kraken-down-for-30-million-but-it-doesn-t-mean-they-had-a-case
