What Staking Is All About And Why It's A Thorn In The SEC's Side

Illustrative Image | source Late last week, the Securities and Exchange Commission (SEC) released a report saying it had settled a dispute with cryptocurrency exchange Kraken More detailed information about what this dispute was about is now becoming public.

The Kraken crypto exchange offers its clients a so-called "staking" service (cryptocoin betting) Clients entrusted the exchange with their cryptocoins, which the exchange subsequently used to verify transactions using the proof-of-stake (PoS) method.

Although it did provide a reward to clients in return, this reward was in the form of a proportional share of the coins that Kraken earned for participating in the blockchain verification process of a particular cryptocurrency Thanks to this, it helps to keep the entire blockchain running.

The Securities and Exchange Commission has jurisdiction limited by US borders However, in recent months, the US market has been trying to be proactive and address potential risks early.

This is also the case with the Kraken crypto exchange Indeed, it considers the staking service to be a type of security, and with that title, it also proceeded to regulate the service offered by the Kraken exchange in the US.

To avoid more trouble, Kraken agreed to an out-of-court settlement with the SEC, agreeing to pay a $30 million fine and stop offering the service in the United States In recent months, the SEC has been pushing for crypto exchange operators in the US to follow the same regulatory framework that governs the sale of various securities.

They are trying to set business rules that would force the players in question to treat tokens similarly to stocks or bonds Staking This is a condition where when users lock a portion of their tokens into the blockchain of a certain cryptocurrency.

For this, a so-called smart contract is used, in which the conditions that the user must fulfill are also set One of the conditions can be, for example, what is the minimum number of coins that the user must lock in the system in this way.

This condition is also a guarantee that the user will not cheat when verifying transactions If he cheated and was found out, he would immediately lose his locked deposit.

The PoS system helps keep the blockchain network up and running It verifies transactions and creates a secure public record of them.

The largest and best-known cryptocurrency that uses the PoS method for its operation is Ethereum The Ethereum network switched from proof-of-work (PoW) to PoS last September.

This was undoubtedly one of the biggest events in the world of cryptography last year With this transition, Ethereum reduced the energy consumption of its network by approximately 99% overnight.

This was an important step mainly because the entire cryptographic industry came under fire for the fact that the process of verifying transactions using the PoW method is very energy intensive, while the necessary electricity is produced mainly from fossil sources (oil, gas, coal) What are "proof of" systems for? In order for cryptocurrencies to be created, it was necessary to define the so-called blockchain.

Blockchain is a relatively new technology that performs the function of a ledger in which all transactions that have taken place in this network are recorded in time sequence Transactions are sorted into blocks (English block) and individual blocks are sequentially ordered one after the other as individual links of the chain (English chain).

Hence the word blockchain From older record types, which were written with pencil on paper, the difference is that the ledger is shared on every single user's computer around the world.

In addition, the blockchain has to deal with the double-spending problem, when it has to ensure and guarantee that no one spends a cryptocurrency token more than once, and that they do not tamper with the digital ledger Blockchain systems do not have one central authority to manage the network.

Both PoW and PoS systems rely on group action to organize and protect a sequential record on the blockchain Thanks to these methods, it is difficult and, in the case of Bitcoin, almost impossible to abuse the blockchain for manipulation, theft, or perhaps to modify older records.

How are these two systems different? First of all, it should be noted that that in the case of both systems (PoW and PoS) transactions are organized into blocks and these blocks are subsequently published in a public database (blockchain) as individual parts of the chain In the PoW system, transactions, i.

e blocks, are verified using the so-called "proof of work".

Proof of work is that in order for another block to be added to the chain, a complex computational task needs to be solved This task can only be solved by trial and error.

In order for the miner to complete the task, it is necessary to repeat the calculations easily more than a million times The need to perform so many trials proves that the miner has developed enough work to verify a new block.

The miner who solves the given task first will receive a reward in the form of a new cryptocurrency for his proof of work The PoS method, on the other hand, works in such a way that transaction validators do not compete with each other, but receive an equal incentive, that if they cooperate in verifying transactions, they will receive a pre-arranged reward.

However, in order for the user to become a validator, he must deposit some minimum amount of the given cryptocurrency into the common bank E.

g in the case of Ethereum, this is a minimum deposit of 32 ethers.

Rewards between validators are proportional to the amount of their deposits If you would like to become a validator, but you don't have 32 ether yourself, that's fine.

You can connect with other users and become a validator together What is the motivation to stake? Validators are chosen to verify blocks of transactions in the Ethereum blockchain.

If the validated block is also accepted as valid by other validators, the validators will be rewarded in new ethers If someone tries to cheat and somehow trick the system, he exposes himself to a very high, almost 100% risk of losing his stake.

Users of the staking-as-a-service who pay attention to the rules of the game and follow them will receive a reward of approximately 4% of the value of their stake for their work Why is staking-as-a-service a thorn in the side of the SEC? Staking-as-a-service is offered to its users mainly by large centralized players, including the Kraken crypto exchange.

These companies allow their users to deposit their coins into a common bank, which they manage and decide what the bank will be used for On the other hand, these players bring their technical equipment and know-how to the joint project.

Thanks to this, users do not have to purchase the hardware equipment required for staking The US Securities and Exchange Commission (SEC) considers both cryptocurrency loans and staking-as-a-service to be a type of securities business.

Thanks to the change in approach to cryptoassets, the SEC can apply a much wider range of regulatory measures to individual players than it did before the rate change The SEC has thus found a loophole to step on dishonest players who until now thought that cryptocurrencies were immune to all restrictions and regulations.

The lawsuit filed by the SEC against cryptocurrency exchange Kraken shows that it considers staking-as-a-service to be similar to crypto-lending, from which the provider of such a service should pay some interest to cryptocurrency depositors The SEC has become increasingly concerned about this practice after a series of bankruptcies last year, when crypto companies such as BlockFi, Celsius Network, FTX and others went bankrupt.

Crypto exchange Kraken has agreed, as part of an out-of-court settlement with the SEC, to immediately end its staking-as-a-service offering in the US and to pay a fine of $30 million However, she did not admit the accusations made by the Securities and Exchange Commission in the filed lawsuit, but at the same time she did not deny them either.

How does the SEC determine that something is a security? Already in 1946, the American Supreme Court established a legal test in its jurisprudence, on the basis of which even a layman can determine whether it is a security or not This test is very simple and anyone can do it.

The SEC now uses this test to justify why a matter falls within its purview and, therefore, why it is subject to regulation The SEC's jurisdiction under this legal test includes: an investor who invests money in a joint venture with the intention of profiting from the efforts of the organization's management.

In the case of the staking-as-a-service offered: users contribute their crypto-coins to a common project with the expectation of receiving a return from them, while the service provider provides the necessary technical equipment From the logical framework described above, on which the new SEC relies in its actions, it follows that what will or will not be considered a security by the SEC will depend on a simple premise, namely that a project that is supposed to provide some appreciation provided deposits can be considered similar to securities.

The fact that it will be a project in the world of cryptographic finance does not change anything That the SEC's position in this new assessment is strong is also evidenced by the fact that Kraken agreed to settle the dispute out of court and pay the fine.

Why may or may not more regulation be beneficial? Currently, the regulation of staking-as-a-service is limited to the US market only However, it is not written anywhere that similar regulations will not be introduced by other countries.

If anyone wants to continue offering staking-as-a-service in the US today, they must prepare to meet strict investor protection and disclosure requirements If these requirements are met, such a project deserves the label that it is safe.

On the other hand, there will be a significant increase in administration for such a project, which can make such a service more expensive, thus reducing returns on invested funds Another downside is that this bureaucratic burden would put smaller players at a disadvantage.

At the same time, staking-as-a-service providers will have to be prepared for more frequent inspections by regulatory authorities Any misconduct can lead to a fine, in the worst case, partial inspections can have legal consequences.

Providers of such a service should also be prepared for the possibility that investors would withdraw their capital from the project precisely with reference to the increased administrative burden, or they might be concerned about possible control by regulatory authorities Proponents of greater regulation, however, argue that a clearly defined legal framework and the designation of certain products as securities could, on the contrary, contribute to greater transparency and information for investors.

At the same time, it could lead to a purification of the market and ultimately such products and services could attract many more users Can regulations limit staking or DeFi? Basically, users can rest easy for now.

The Securities and Exchange Commission has only local jurisdiction over the American market Staking-as-a-service providers in other countries should not be subject to similar regulations.

Additionally, validators can reside anywhere in the world, so the SEC can't reach them Therefore, if overseas regulators do not come up with other options to limit and regulate the offered staking service, even blockchains using proof-of-stake methods will be able to function without difficulty.

On the other hand, the tightened regulatory framework of the American regulator has further deepened the split between the strict regulation there and other states in other parts of the world More than one user has certainly wondered whether the tightening of regulation around staking will affect the so-called decentralized staking providers.

When it comes to decentralized finance (DeFi), there are two views on it The first claims that, thanks to their decentralized nature, regulations do not apply to them.

DeFi has no specific headquarters and is basically just a collection of software that performs transactions or tasks automatically On the other hand, there is the fact that many DeFi services are run by a specific group of people, who live somewhere.

These operators could thus potentially be subject to regulations and could be affected for non-compliance and non-respect of the set regulations Conclusion The regulatory framework only applies to the American market so far.

Countries that have not banned or otherwise restricted cryptocurrencies (eg China, UAE, etc ) view the staking service more leniently.

For that reason too, small users do not have to worry about not being able to become full-fledged validators and valorize their investment funds However, they should look for providers that will offer them something more than just the usual fee (around 4%) for verifying transactions.

The proof-of-stake method will probably become the norm for any cryptocurrency, for any cryptographic system, but with one exception The Bitcoin blockchain will probably remain the same in the future, which will retain the proof-of-work mining method.

Staking will thus continue to be an important part of the crypto market, as well as efforts to regulate the entire industry by central regulators Ing.

Zbyněk Kalousek Studied economics and management at Masaryk University in Brno In the past, he was engaged in the analysis of financial markets.

He returns to this activity after a short pause Co-founder of a company that deals with consulting and accredited education.

He cooperates with several other companies He perceives the world of cryptocurrencies as a progressive part of the market, which offers a lot of opportunities, but at the same time presents a lot of pitfalls, from decentralization, an apolitical approach, to high volatility of exchange rates, to the increasingly difficult mining of cryptocurrencies.

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