Kraken vs SEC: End of Cryptocurrency Bets

In its long war with cryptocurrencies, the SEC has dealt another blow. This time it’s Kraken’s turn to take the hit, with the US regulator accusing the exchange’s parent company (Payward) last week of failing to register the offering and sale of securities.

“But what titles?” a casual observer might ask. Well, in this case it was Kraken’s staking-as-a-service program – its service of picketing users’ cryptocurrencies on their behalf – that collided with the regulator’s hyper-watchful eye.

And instead of being dragged into a lengthy legal battle with the regulator (just like Ripple did), Kraken chose to quickly settle with the SEC in the amount of $30 million, while also agreeing to end all staking services for its US-based clients with immediate effect.

This is undoubtedly a big loss for Kraken and its American customers, but this article will also explain how this brief case affects the broader cryptocurrency industry in the United States and beyond. And while it may seem that the SEC’s action here could mean the end of the crypto bet in the US, it’s already clear that the industry won’t let that happen without a major struggle.

SEC accuses Kraken of offering unregistered securities, Kraken ends cryptocurrency picketing

There was nothing special about Kraken’s crypto staking service, which allows users to earn a return (i.e. interest payments) by pointing/blocking their proof-of-stake cryptocurrencies. Several other exchanges and platforms in the U.S. and elsewhere offer a similar service, but for whatever reason — which the SEC did not share — the regulator chose Kraken for its first enforcement action on that service.

The important thing here is that for the SEC, offering a crypto staking service constitutes an “investment contract,” largely because that service also offers users a return.

As SEC Chairman Gary Gensler explained in the press release, “Whether staking-as-a-service, lending, or other means, crypto brokers, when offering investment contracts in exchange for investor tokens, must provide the appropriate information and collateral required by our securities laws.”

Gensler reiterated those remarks in an interview with CNBC’s Squawk Box, adding that the element of risk involved in cryptocurrency staking also reinforces the SEC’s view that Kraken had sold unregistered securities.

And as noted above, Kraken responded to the SEC’s assertiveness by shutting down its crypto staking service to U.S. clients. He noted in an official blog that this closure means several things for customers on a practical level:

  • US-based customers will no longer be able to bet cryptocurrencies on Kraken.

  • Previously wagered cryptocurrencies will be automatically ticked on behalf of clients. Such cryptocurrencies will be automatically returned to customers’ regular spot wallet and will no longer earn any wagering return.

  • All Ethereum bets will become unstaked after the Shanghai update, which is expected around the second half of the year. Staked ETH will continue to earn rewards until then.

  • Finally, Kraken will pro-rata the final rewards until February 9. This means that customers will receive a percentage of what they would have earned if they were able to keep their cryptocurrency wagered for the entire (monthly) staking period.

It’s also worth adding that staking for non-U.S. customers remains completely unaffected by this change. So, whether you are located in Canada, Australia, the UK, Europe or elsewhere, your cryptocurrency staked will remain staked and you can continue to bet new proof-of-stake tokens.

Staking tokens respond by falling, industry remains rebellious

Almost needless to say, the cryptocurrency market responded to this news on Thursday, February 9, by taking a little plunge. And while the market as a whole fell by about 6%, proof-of-stake cryptocurrencies declined harder than others.

For example, Ethereum (ETH) is currently down 6.5% over the past week, compared to a 4.5% drop for bitcoin (BTC). Similarly, cardano (ADA) is down 7.5% and solana (SOL) down nearly 10%, underscoring the fact that the reaction of (some) investors to this news is to get their money from proof-of-stake cryptocurrencies.

In fact, some observers are predicting the worst for Ethereum following the SEC’s latest adventures. This is also because Shanghai’s upcoming update will mean that millions of ethereum stakers will be able to bet their tokens and sell them, with a potential resulting stream of ETH coming to market.

And based on SEC observations surrounding Kraken’s indictment, it’s possible that other U.S.-based staking-as-a-service providers will feel the regulator’s heat in the coming months.

As Gary Gensler stated in the accompanying press release, “Today’s action should make clear to the market that staking-as-a-service providers must register and provide full, fair and truthful disclosure and investor protection.”

Gensler also warned in the aforementioned CNBC interview that other U.S.-based exchanges are likely to face similar scrutiny, since they, too, likely violate U.S. “federal securities laws.”

“When a company or platform offers you these kinds of returns, whether they call their services ‘lending,’ ‘earning,’ ‘rewards,’ ‘APY,’ or ‘staking,’ that relationship should come with the protections of federal securities laws,” he said.

However, while this may imply the worst regarding participation in cryptocurrencies in the US, other exchanges have already come out to declare that they will not yield so easily to any SEC action. That includes (the largest U.S. exchange) Coinbase, whose CEO Brian Armstrong tweeted on Feb. 12 that its “staking services are not securities” and that the exchange will “happily defend [such services] in court if necessary.”

The blog advertised in Armstrong’s tweet makes several strong arguments about why betting encryption is not a security. Here is perhaps the most convincing:

“Staking services are not an investment of money […] When a customer asks us to bet some of his cryptocurrency, he is not giving up one thing to get something else: he owns exactly the same thing he did before. Staking’s clients retain full ownership of their assets at all times.”

The blog also touches on an important distinction that has relevance to the Kraken case and the question of whether other US-based staking services may now be affected. That is, note that the rewards that Coinbase distributes to users come from the underlying blockchain protocol itself, rather than Coinbase. In other words, Coinbase doesn’t determine the return customers receive for crypto staking, nor does it add any extra interest to attract customers.

On the contrary, it seems that the premiums that Kraken paid to customers were not determined solely and exclusively by the corresponding blockchain protocol. Instead, as attorney Gabe Shapiro commented in his tweets about the case, it appears that Kraken determined the rewards themselves and may have marked returns higher than those offered by the underlying protocols themselves.

Therefore, it would be rash to conclude that Kraken’s deal with the SEC means that crypto participation in the United States is now dead. So, with other platforms offering staking services inside and outside America, investors still have plenty of options when it comes to earning passive rewards from their tokens.

Also there are decentralized liquid-staking tokens like Lido and Rocket Pool that probably won’t get the same attention from the SEC as they aren’t centralized entities like exchanges. Particularly tech-savvy crypto users can also skip intermediaries altogether and point directly with protocols.

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