On Thursday, the U.S. Securities and Exchange Commission announced it had reached a settlement with Kraken, the California-based cryptocurrency exchange, related to a staking feature offered to the company’s customers. Kraken agreed to pay a fine of $30 million and end the product.
After SEC Chair Gary Gensler threatened crypto companies that “the runway is getting shorter” for firms to register with his agency, the latest action increases his influence over the industry by penalizing Kraken, one of the largest global crypto firms. The move will also likely further accusations that Gensler is taking an approach of “regulation by enforcement,” rather than creating new rules to govern the crypto ecosystem.
Staking has emerged as a key element of the crypto ecosystem, with users locking up their crypto tokens as part of the blockchain data validation process and receiving new tokens as a reward. Ethereum, the second-largest blockchain, moved to a “proof of stake” model in September.
Because of its complexity, many companies in the space like Kraken and its competitor Coinbase offer staking as a service, where customers can custody assets with the exchanges, which in turn pool the assets and stake them on the investors’ behalf.
On Wednesday, Bloomberg reported that the SEC was investigating whether Kraken’s staking services broke U.S. securities rules. Under a stipulation called the Howey Test from a 1946 U.S. Supreme Court ruling, a transaction qualifies as a “security” if there is an investment of money in a common enterprise with the expectation of profits derives from the efforts of others.
In September, as Ethereum prepared to move to a “proof of stake” model, Gensler said that the updated blockchain validation system may pass the Howey Test. Thursday’s SEC settlement is the first indication that the agency will begin to enforce staking services as securities.
"Today’s action should make clear to the marketplace that staking-as-a-service providers must register and provide full, fair, and truthful disclosure and investor protection,” Gensler said in a statement.
"As part of the settlement, Kraken has neither admitted nor denied the SEC's allegations," said a Kraken spokesperson, pointing to a company blog post laying out the agreement.
The SEC’s charges, along with Kraken’s willingness to settle and end its staking program, will threaten a key offering of many crypto companies, as well as the Ethereum ecosystem. Prices for the decentralized Lido token, which is used for staking and could fall out of the SEC's remit, surged on the news.
In seeming anticipation of the announcement, Coinbase founder and CEO Brian Armstrong tweeted on Wednesday that the SEC ending crypto staking for retail customers would be a terrible path for the U.S.
“Regulation by enforcement doesn’t work,” he wrote. “It encourages companies to operate offshore, which is what happened with FTX.”
1/ We're hearing rumors that the SEC would like to get rid of crypto staking in the U.S. for retail customers. I hope that's not the case as I believe it would be a terrible path for the U.S. if that was allowed to happen.
— Brian Armstrong (@brian_armstrong) February 8, 2023
After CoinDesk reported the settlement before it was officially announced, Kraken founder Jesse Powell took to Twitter to offer a clarification: Kraken would continue to offer staking outside of the U.S.
While Kraken has largely adhered to regulation in an industry known for rogue companies, this is not the exchange’s first brush with regulators. In November 2022, the company agreed to pay a fine to the U.S. Treasury Department’s Office of Foreign Assets Control related to Iran sanctions violations.
A Wyoming banking subsidiary of Kraken also has an open application with the Federal Reserve to receive a master account, which would provide it access to Fed payment services. After the Federal Reserve denied crypto bank Custodia’s application to become a member in late January, the fate of Kraken’s petition is in flux.
