Kraken, a U.S. cryptocurrency exchange, recently settled to pay $30 million to the U.S. Securities and Exchange Commission (SEC) on charges of providing its staking service without registering with the SEC. As a result, the exchange has announced that it is shutting down its US crypto staking operation.
The settlement is the first-ever crackdown on staking, a common crypto service provided by both centralized and decentralized crypto exchanges. Before understanding what this means for the crypto industry, let us understand what exactly staking is.
In this blog, we will cover:
- What is Staking?
- Benefits of Staking
- How does Staking work?
- Why is the SEC concerned about Staking at Kraken?
- What's next?
What is Staking?
Staking is a process where the users lock their crypto assets to a blockchain network for a certain timeframe and earn rewards in return. Different consensus mechanisms (mining processes) are used to add data and validate transactions on the blockchain and one such mechanism is Proof-of-stake. Ethereum uses Proof-of-stake where the network participants stake assets to support the blockchain by validating transactions and adding new blocks to the chain.
Staking is crucial as it helps secure the network from malicious actors. Ethereum recently migrated from Proof-of-work (PoW) to Proof-of-stake (PoS) consensus mechanism as the PoS makes the blockchain more decentralised, secure, and scalable. Moreover, PoS is more energy efficient as compared to PoW which uses vast amounts of electricity. The process ensures that only legitimate data is added to the blockchain. The validators are rewarded for locking up their crypto assets and securing the blockchain.
Benefits of Staking
Staking offers an alternative means for users to earn passive income on their crypto holdings. If you plan to hold your crypto and do not wish to sell your holdings in the immediate future, you can earn additional income through staking calculated in percentage yields.
Staking is how blockchains running on the PoS consensus mechanism cultivate a functioning ecosystem and help secure the blockchain. Through Staking, one can contribute to the security and efficiency of the blockchain projects. Staking makes the blockchain more resistant to attacks and strengthens the network’s ability to process more transactions.
Typically, the bigger the stake, the greater chance validators hold to add new blocks on the chain and earn those rewards. Staking has become a popular means to earn some passive income out of one’s idle holdings which they otherwise wouldn’t have sold. Different chains offer differing returns that vary from time to time.
Mostly all of the major crypto exchanges offer staking services including the likes of Binance, Coinbase, Gemini, Crypto.com, etc. The returns on staking could range from 2% APY to as high as 40% APY with the most popular tokens for staking being Ethereum, Polygon, Solana, and Avalanche. Staking can also be undertaken on decentralised exchanges such as Uniswap.
How does Staking work?
Staking only works via the PoS consensus mechanism. As the validators are forced to lock up a certain amount of tokens in the blockchain, it incentivises them to act honestly and help secure the network. If the blockchain gets corrupted through malicious activity, the price of its native token would plummet and the staked tokens would lose their value. Hence, most of the chains use PoS to keep the blockchain secure.
Every blockchain requires certain conditions to be met for staking. Ethereum for example requires each validator to stake 32 ETH, which is worth around $48,000 as of 11 February 2023.
According to the data by DefiLlama, liquid staking is the third largest category within the DeFi ecosystem, accounting for roughly 25% of the $46 billion worth of assets locked within DeFi. Out of which Ethereum accounts for more than $10 billion in assets locked in liquid staking protocols.
Read more: What is total-value-locked?
Why is the SEC concerned about Staking at Kraken?
Validators receive differing rewards for participating in validating blockchain transactions but also risk losing staked assets due to inactivity or misuse of the investor’s funds. According to SEC chair Gary Gensler, it is crucial that the staking providers should be registered with the SEC and provide proper disclosure to its users on how they are protecting a user’s staked assets.
The main concern raised by the SEC in the matter is that Kraken allegedly wasn’t clear about the way in which it allowed users to stake their cryptos. While the true decentralized way would be to directly stake customer funds to the respective protocols – according to the SEC, Kraken was pooling customer funds themselves and then staking them to different protocols. This in turn defeats the purpose of decentralization within the ecosystem.
Moreover, there should be transparency in how the returns are being generated and calculated on the protocol as opposed to being decided by centralised companies. A part of the SEC’s complaint questioned Kraken on how it calculated the returns for its customers, as opposed to the variable reward rates set by the protocol. This undermines the role of decentration in the staking process while increasing the power that lies with an intermediary, introducing further centralisation.
Additional read: Yield farming vs Staking
What's next?
According to the SEC, the settlement should signal other companies offering similar services in the U.S, whether staking-as-a-service, lending, or other means, to provide full disclosure to their users and comply with the securities laws.
The action is currently specific to the U.S.-based companies, and the companies offering similar staking services outside the US remain unaffected. Kraken mentioned that it would continue offering staking to its users outside the U.S. jurisdiction.
While seen as a crackdown, the settlement could be leaning towards a positive direction to push harder for formulating laws and policies and pass legislation that governs crypto assets. This would not only protect investors’ interests but also promote companies to continue offering innovative crypto products in a way that provides more transparency and decentralisation through full disclosure required from the legal standpoint. The more decentralized the stake, the more secure a protocol becomes!
