Crypto staking: Is it banned in 2023?

Crypto staking has become a popular investment option in recent years. That's primarily because they offer a convenient passive income-earning opportunity for crypto holders, with some staking protocols offering as high as 20% APY. Consequently, the total value locked in staking protocols has increased over 125x over the past three years.

Source: DeFiLlama

But in the wake of high-profile collapses in the crypto industry, regulators are scrambling to apply greater oversight and investor protection to the cryptocurrency industry. The increased oversight is driven by concerns that the historically unregulated crypto market threatens investors and traditional financial systems.

With lawmakers and financial regulators scrambling to tighten regulation and enforcement, the crypto-staking regulatory environment will constantly evolve. So, in this guide, we'll explain why crypto staking caught the attention of regulators and discuss the current and proposed staking regulations. We'll also examine the crypto industry's response to these regulations and the future outlook of crypto staking.

Current Regulations

Currently, centralized platforms offering crypto staking services must comply with crypto regulations in their jurisdictions. However, no country has any specific laws or regulations targeting crypto staking.

In the US, the SEC is enforcing regulatory actions on crypto staking based on the idea that some crypto tokens are securities and that staking services are deals that involve investing money. The SEC requires that crypto platforms that provide staking services register as securities issuers or broker-dealers and follow the rules for disclosing and reporting information.

The SEC cites the Howey test as its legal basis for fighting against crypto staking. The Howey test is a four-part test determining whether an arrangement involves an investment contract or security under US law. The four parts are:

• There is an investment of money

• There is a common enterprise

• There is an expectation of profit

• The profit is derived from the efforts of others

The SEC argues that crypto staking meets all four parts of the Howey test and should be regulated as securities. It claims that crypto staking involves an investment of money (crypto assets), a common enterprise (the staking platform or network), an expectation of profit (staking rewards), and a reliance on the efforts of others (the platform or network operators).

How Do Different Countries Regulate Crypto Staking?

There is no global consensus or standard on how to regulate crypto staking. Different countries and regions have different approaches and models based on their legal frameworks, policy objectives, and market conditions.

Most countries do not have specific regulations targeting crypto staking. In a general sense, crypto staking regulations fall under their general framework for payment services involving cryptocurrencies. Most require any entity that provides payment services involving cryptocurrencies to obtain a license from the relevant monetary or financial authority. Note that governments treat cryptos as property, and you'll be required to pay taxes on your crypto holdings and earnings.

Is Staking Banned?

No. Apart from countries that have outright banned cryptocurrencies, no other country has specifically banned crypto staking. Note that the countries that have explicitly banned cryptocurrencies include: Algeria, Bangladesh, Bolivia, China, Colombia, Egypt, Indonesia, Iraq, Morocco, Oman, Qatar, and Tunisia.

In the US, the SEC has not banned crypto staking outright, but it has been cracking down on some crypto platforms that offer staking services without registering as securities. The SEC alleges that many digital tokens are unregistered securities and that yield products offered by some platforms are akin to interest-bearing accounts that require regulatory oversight.

A few things to note here: providers of staking-as-a-service who cater to US customers are the only ones affected by the crackdown. Blockchains rely on validators from various countries, so as long as regulators outside the US have a more tolerant stance towards these services, the blockchains will still be operational. This could deepen the divide regarding the regulatory approach between the US and the rest of the world. Crypto staking platforms that offer their services to US investors without registering with the SEC or complying with securities laws may face enforcement actions from the SEC.

Proposed Regulations

Globally, only the US is cracking down on crypto staking. The SEC is pushing to bring crypto operators within the US under the same regulatory framework governing securities sales. It considers crypto lending and staking-as-a-service securities, which are subject to various regulatory requirements. As mentioned earlier, it uses the Howey test to determine whether a product offered by a crypto firm is a security.

Determining whether something is considered a security under US financial laws depends on how closely it resembles shares issued by a company raising money. The Howey test dictates that an asset can be subject to SEC regulation if it involves investors contributing money to a common enterprise, expecting to profit from the organization's efforts. In staking-as-a-service programs, users deposit their coins to earn a yield while the service provider manages the technical aspects.

What Are the Implications of Crypto Staking Regulation?

Evident from the SEC's action against Kraken, the agency's issue is not with staking as a concept but with how staking services are provided to retail investors. But well-intentioned or not, regulating crypto staking (especially through enforcement) could positively and negatively affect innovation and creativity in the crypto space. As most regulatory agencies intend, staking regulation should provide the industry clarity, stability, consumer protection, and legitimacy.

However, it will almost certainly impose restrictions, costs, risks, and barriers to entry for users and investors. These are some of the potential implications of crypto staking regulation.

Stifling Innovation and Creativity in the Crypto Space

Stringent crypto staking regulations may limit the ability of developers, entrepreneurs, or innovators to test new ideas, concepts, or models involving cryptocurrencies. This could discourage risk-taking, exploration, and learning by doing.

Some projects may not have the resources or expertise to meet the regulatory requirements or may face delays or rejections in obtaining approvals or exemptions. And to conform to regulations, crypto projects may have to modify their protocols or governance models to fit the regulatory frameworks. This may directly lead to losing their competitive edge or differentiation in the market. Crypto firms may have to limit the types of crypto assets that can be staked, the amount of rewards that can be earned, the duration of staking contracts, and how staked assets can be used or transferred. These are what give the staking protocols their competitive edge.

Consequently, regulations may give rise to large centralized protocols. Ironically, the SEC primarily worries about big, centralized cryptocurrency exchanges providing these services to lure customers. This may undermine the decentralization and autonomy of some crypto networks, as they may have to rely on intermediaries or centralized authorities to meet the regulatory standards or avoid sanctions.

Deterring Potential Investments into Crypto Projects

And considering the potentially stiff compliance requirements, new entrants and investors could be discouraged from joining the crypto space or exploring new possibilities with crypto staking. These regulations can make running a staking-as-a-service program more costly and complicated.

The security label under US laws has strict investor protection and disclosure requirements. The burden can disadvantage smaller providers compared to larger, well-funded competitors. These consequences could hamper innovation and creativity in the crypto space by reducing incentives, opportunities, and resources for those who want to contribute, collaborate, and compete in this industry.

Driving Crypto Projects Offshore

Ironically, regulators may create a hostile or unfriendly environment for crypto staking firms in their jurisdictions. This could force them to relocate or operate elsewhere where regulations are more favorable or flexible.

Without a universal regulatory framework, regulators will most likely create uncertainty, ambiguity, or inconsistency around crypto staking legal status, treatment, or protection. This could undermine confidence, trust, and security among investors who want to back cryptocurrency projects or initiatives.

Killing Existing Crypto Staking Providers

Kraken, BlockFi, and Celsius come to mind. The US SEC took action against Kraken for its crypto asset staking services. According to the SEC, Kraken's staking-as-a-service program is similar to crypto lending, where providers pay high interest rates to depositors for lending out their coins. Last year, regulators cracked down on crypto lending practices, leading to the collapse of lenders such as Celsius Network and BlockFi.

Kraken agreed to stop offering or selling securities through its crypto asset staking services in the US. Although Kraken did not admit or deny the allegations made in the SEC complaint, the exchange has taken immediate action to comply with the SEC's orders. This move is significant because many in the cryptocurrency industry had previously believed they were immune from securities regulations.

Industry Response

The current regulatory landscape in the crypto industry was triggered by the high-profile collapses in 2022. And for the most part, they are viewed as harmful reactionary regulations designed to decapitate the industry rather than foster a transparent operating environment. Most agree that regulation has some upside, such as preventing collapses and bankruptcies like those of FTX and Terra Luna.

However, the consensus from traders to crypto industry leaders is that these regulations shouldn't be punitive. Instead, policymaking should be thoughtful with smart regulations to foster crypto innovation. Understandably, the crypto industry has been concerned about the impact of these regulations on proof-of-stake blockchains such as Ethereum, which rely on staking for network security and rewards.

The SEC Commissioner, Hester Peirce, also offered her dissenting opinion. She noted that regulation by enforcement is neither an efficient nor fair way of regulating an emerging industry. She also pointed out that crypto staking services are not uniform across the industry and that enforcement actions and cookie-cutter analysis do not cut it.

Her sentiments almost unanimously echoed various industry leaders calling for a sober approach. Coinbase CEO, Brian Armstrong, argued that the US regulators have taken the stance of "regulation by enforcement," which he insists doesn't work. Instead, this approach will only encourage crypto companies to operate offshore, exactly what happened with FTX.

Coinbase published its rebuttal of the SEC assertions. Coinbase chief legal officer Paul Grewal insisted that Coinbase's staking services are not securities and gave reasons why. In an interview, Brin Armstrong noted that Coinbase prepared to go to court and defend that its SaaS product isn't security as wildly stipulated by the SEC.

The bottom line is that the industry response to regulatory agencies regarding the potential staking ban has been unanimous: regulate staking-as-a-service by rules and guidance, not enforcement.

Proposed Solutions

In the US, Coinbase has been at the forefront of the advocacy to protect crypto staking rights. It launched Crypto 435, a pro-crypto advocacy campaign, on February 28, 2023. The campaign aims to advance pro-crypto policy in all 435 Congressional Districts across the US by growing the crypto advocacy community and sharing tools and resources to make their voices heard. The campaign invites anyone who believes in crypto and web3 to join and influence the decisions of legislators and regulators that will impact the future of crypto.

And in a March 20 Petition for Rulemaking, Coinbase urged the SEC to exclude staking from securities laws. The company argued that staking does not meet the criteria of security because users have full control over their assets, do not expect profits from service providers, and do not rely on managerial efforts. The company also cited historical cases and economic impacts to support its position. The petition aimed to clarify the regulatory landscape and provide certainty for the crypto industry.

Future Outlook

It goes without saying that crypto exchanges offering staking services should be transparent and compliant. They should comply with their jurisdictions' relevant laws and regulations and communicate clearly with their customers about the potential benefits and risks of staking. The major pain point is regulation by enforcement.

As of this publication, there are no specific laws or regulations on crypto staking. In the US, the SEC is cracking down on crypto staking, insisting that crypto lending and staking-as-a-service be securities, and should be subject to regulatory requirements.

As mentioned earlier, crypto staking is not banned, except for countries that have banned cryptocurrencies. More so, there is no global consensus on crypto staking regulations, meaning countries have their approaches and models based on their legal frameworks, policy objectives, and market conditions.

In the US, the SEC's apprehensions are with platforms offering staking services as an investment product to retail investors without properly registering it as an offering and sale of securities. Its main concern is that they do not fully disclose all the risks involved in staking or accurately reveal how the yields are calculated.

And as we've discussed, if the regulation-by-enforcement model currently being implemented by the SEC continues, the repercussions could be dire for the future of the crypto industry.

What to Expect

The SEC's main point of contention with the crypto industry so far has squarely been that crypto products should be treated as securities. So, in the future, the Howey Test could play a significant role in the regulation (or lack thereof) in the crypto industry in the US. Kraken paid a $30 million civil penalty and agreed to discontinue offering crypto staking services to US investors. However, it didn't admit or deny any of the SEC allegations regarding staking services being securities, and it will continue its staking programs outside the US.

The SEC could use this settlement as a blueprint to go after other SaaS providers. The SEC doesn't seem that keen on allowing crypto firms to register their staking services. A couple of days after Coinbase sent its Petition for Rulemaking, the SEC served it with a Wells Notice. A Wells Notice means that the SEC staff within the Enforcement Division has informed Coinbase that they intend to recommend to the SEC Commissioners that they authorize a lawsuit against Coinbase. According to the notice, the SEC staff believes that the Coinbase staking program and certain of its listed tokens may qualify as securities.

Crypto Contingent Staking?

In a webcast, Cardano founder Charles Hoskinson suggested that regulators adopt a "contingent staking" certification model. This would allow crypto staking pool operators to comply with US regulations. Remember, the SEC's bone of contention is that staking platforms take customer tokens and transfer them to other platforms.

In the "contingent staking" model, the transaction would need the signatures of the staking pool operator and the delegate before it can be processed. This is different from the current staking model, where a person who wants to delegate their stake to a pool only sends a transaction to the pool. With contingent staking, the transaction would wait until both parties have signed it. This way, pool operators can agree to the delegation before it happens. Contingent staking would also let pool operators choose their delegates, which could help them follow regulatory requirements better.

Conclusion

As of this publication, crypto staking is legal in all countries that haven't explicitly banned cryptocurrencies. And most financial regulators globally have expressed their willingness to regulate the crypto industry rather than ban it. To that end, they are working on different regulatory frameworks to eliminate legal ambiguity, with specific laws targeting various assets in the crypto market.

Note that the regulation in the crypto industry is, at best, afflux. We've focussed on the legality of crypto staking throughout this article; however, most financial regulators globally have proposed various rules and regulations across the entire crypto industry. So, while you conduct your due diligence when staking, also look into the legal status of staking in your jurisdiction before investing.