SEC Crackdown on Staking Services, Will DOT be Affected?
On February 9, cryptocurrency exchange Kraken — the second largest U.S. cryptocurrency exchange after Coinbase, with a daily trading volume of about $700 million — settled with the SEC after being charged with offering unregistered securities. The exchange paid a $30 million fine and agreed to stop offering staking services to U.S. customers immediately.
In a blog post, Kraken said that it will automatically unstake any assets pledged by U.S. customers. Staked ETH will be unpledged after the “Shanghai” upgrade of the Ethereum network, and U.S. customers will not be able to stake new assets. Non-U.S. customers will not be affected.
What does this mean ？
This settlement between Kraken and the SEC acknowledges that the staking services offered by Kraken are classified as securities.
Staking is a feature of PoS blockchain networks, where users pledge their existing tokens to validate transactions and help maintain the security of the network while earning more tokens as a reward in return. PoS networks are generally more energy-efficient and environmentally friendly than PoW networks, which rely on miners running high-calculus machines to solve complex mathematical problems. A number of mainstream blockchains are now PoS networks with staking functions.
In PoS chains, users running their own nodes for staking usually have certain thresholds, such as having enough equipment to run the nodes, having the appropriate technical knowledge, and holding a certain amount of capital. Some centralized exchanges, such as Kraken, offer joint staking services, where the platform brings together multiple people’s coins to stake and share the proceeds, but the user needs to give the funds to the platform to hold them in escrow. This approach has lowered the financial and technical barriers to participation in staking , making it quite popular, with 18% of the ETH staked today being pledged through Coinbase and Kraken.
The SEC said in the charging document that they were particularly concerned about the computerized system for Kraken’s payment of proceeds to users, writing that “the proceeds (received by users) are determined by the defendants, not the underlying blockchain protocol, and that those proceeds are not necessarily based on the proceeds Kraken receives from the actual staking .”
Some in the industry fear that the SEC’s charges against Kraken’s stakings are not a one-time event, but rather a sign that U.S. regulators are cracking down on staking services and may target staking services on other centralized exchanges in the future.
On Feb. 8, Coinbase CEO Brian Armstrong tweeted, “ 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.” However, Coinbase claims to offer a staking service that differs from Kraken’s in that it is a true on-chain staking that directly links user revenue to pledge revenue. Armstrong says that if the SEC pursues Coinbase’s staking service the way it did with Kraken, Coinbase will fight it rather than settle.
Staking Could Become More Decentralized
The SEC’s regulatory actions on staking operations on centralized exchanges may drive more users towards decentralized staking services, thus leading to the decentralization of the blockchain staking landscape.
As mentioned earlier, pledging directly in a PoS network is the most direct, secure, and decentralized way to stake. However, there is usually a certain threshold for users to run their own nodes to do so. Third-party staking services have lower capital requirements and do not require users to run the nodes themselves.
These staking services are divided into centralized and decentralized pledges.
Kraken, Coinbase, and Binance are centralized pledging platforms where users are required to hand over their funds to the platform for escrow. As these platforms are relatively opaque, it is difficult for users to know the actual use of their pledged funds and the source of their earnings, and therefore they have to bear more risk. The bankruptcy of centralized institutions triggered by FTX last year also demonstrates how dangerous centralized services can be if they are not regulated.
Some decentralized staking agreements, such as Lido, Acala, Bifrost, etc., allow users to hold their own funds in custody while using their staking services, which is relatively safer and more decentralized, and provides liquidity staking to improve capital utilization.
Therefore, this Kraken-SEC settlement is not necessarily a bad thing. On the one hand, regulatory involvement may lead to more standardization of staking services on centralized platforms and more disclosure, thereby protecting the average user. On the other hand, if centralized pledge services are indeed restricted, then users may turn more to pledging directly in the network or to decentralized pledge services.
Does it have an impact on DOTs?
The SEC’s crackdown on staking services and DOTs are not directly related.
First, the SEC believes that the core of the problem is that Kraken’s mechanism for paying out returns to users does not make sense, i.e., the returns received by users are not necessarily those generated by on-chain stakes, and such “return products” fall into the category of securities. However, DOT’s staking is mainly direct pledge on the chain (native pledge). DOT provides various native on-chain staking channels, such as the nominator and nomination pool design of Polkadot to make the threshold of pledge lower, thus contributing to the decentralization of DOT staking.
Secondly, the Web3 Foundation, the organization behind Polkadot, has publicly stated that through their communication and cooperation with the SEC for three years, the nature of DOT has been changed from securities to software. For details, see “Less Trust, More Truth: Polkadot’s Native Token (DOT) Has Morphed and Is Not a Security. It Is Software.” https://medium.com/web3foundation/less-trust-more-truth-polkadots-native-token-dot-has-morphed-and-is-not-a-security-b2a8847a70cc
Polkadot Road to Decentralization
In fact, Polkadot pursuit of decentralization is not limited to staking but also to its more decentralized next-generation on-chain governance system OpenGov. In this system, there is no real power agent, and the governance of the network is decided by a referendum of DOT holders. Additionally, all aspects of Polkadot and Substrate are designed to follow decentralization principles to ensure the decentralization of Polkadot and parachains.
Polkadot has been taking steps to make the network more decentralized for a long time, and they seem to be very forward-looking. Back in 2021, Polkadot co-founder Gavin Wood said, “The more central you are, the more likely you are to be targeted by regulators and required to get a license; the more peer-to-peer and decentralized you are, the less likely that is, so moving in a peer-to-peer direction seems like a logical choice……For Polkadot, we are building Polkadot to be the world’s first truly p2p, secure, scalable, free execution platform.” https://mp.weixin.qq.com/s/cShp3VNWUVK6U-LcK5HJdg
Thus, while regulation in the blockchain space has tended to tighten in recent years, Polkadot, which maintains a high degree of decentralization, is relatively safe.
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