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Crypto Staking Targeted by the SEC

Validated Individual Expert

This Friday we dive into the recent charges against Kraken for its staking service. We evaluate the impact it’s had on crypto stocks and how it’s likely to affect the industry in the short-term and long-term.

Network Fees — Sum of total fees spent to use a particular blockchain. This tracks the willingness to spend and demand to use Bitcoin or Ether.

  • Bitcoin fees reached their highest since November with NFTs on the Bitcoin chain driving demand
  • Ethereum weekly fees reached their highest since June 2022, with Uniswap activity climbing

Exchanges Netflows — The net amount of inflows minus outflows of a specific crypto-asset going in/out of centralized exchanges. Crypto going into exchanges may signal selling pressure, while withdrawals potentially point to accumulation under regular circumstances

  • Bitcoin and Ether recorded modest outflows for the second straight week

Crypto Staking Targeted by the SEC

Crypto markets experienced their first sizeable correction of 2023 shortly after news broke of Kraken being charged $30M and being forced to wind down their staking service. While so far this motion by the SEC seems to be targeted just at Kraken, the stock market did not seem optimistic about the implications this would have for Coinbase.

Via IntoTheBlock’s free macro insights

Is Staking a Security? In the eyes of the SEC, staking services may be like institutional lending programs

  • Previously the SEC came after Genesis and BlockFi, fining them after classifying their lending services as a security
  • Based on the Howey Test, an asset is deemed to be a security if it has “a reasonable expectation of profits to be derived from the efforts of others.”
  • While in lending programs one is trusting the counterparty that receives the loan and the issuing platform to do proper due diligence, with staking the expected yield comes from the native asset itself and its underlying technical infrastructure
  • One could argue that staking assets is not that simple since you can get punished, or “slashed” for inactivity or malicious intents; therefore the expectation of profit to certain extent does derive from the platform managing the staking

Presumably this is what the SEC believed with regards to Kraken’s staking initiative, but does this logic apply to all staking?

Via IntoTheBlock, Dune Analytics

Not all staking is executed equally — There are different levels of dependencies depending on how one chooses to stake their crypto

  • In one extreme there is self-custodial staking. This carries extra complexity (and returns), but by definition does not have any expectation of profits from the efforts of others. Based on “unidentified” addresses unstaking on Ethereum, roughly a quarter of ETH staked is done in a self-custodial manner
  • Then there are liquid staking derivatives (LSDs) platforms, which delegate assets staked to a number of entities. Lido is the biggest player with a 30% market share and relying on 30 institutions for validation, whereas RocketPool has 2.4% market share distributed among 1974 independent validators
  • Finally there are centralized exchanges which take custody of assets themselves and build their own infrastructure used to validate proof of stake chains. On Ethereum, these account for approximately 30% of ETH staked altogether

Arguably, the first two categories have much lower risk of being classified as a security given that these networks are more decentralized and do not rely on a sole entity for profits.

Via IntoTheBlock’s stETH network indicators

Will LSDs Benefit from Kraken’s Woes? With Kraken set to discontinue its staking service, it is likely that alternatives will gain traction

  • There are already over 120,000 addresses holding stETH, supported by ~$2B in liquidty across DeFi applications
  • Once people begin exiting from the Shanghai fork’s unstaking queue, it is likely that some capital will be restaked through LSDs such as Lido and RocketPool, especially now that there is regulatory uncertainty for centralized staking services

Overall, the SEC seems to be making moves against crypto companies again. While motions like the one against Kraken may disincentivize innovation and adoption in the US, they are likely to shift the opportunity overseas and to the individual. Though this creates uncertainty for crypto near-term, it should lead to more decentralized networks longer-term.

Get the latest news here: Cointime channel — https://t.me/cointime_en

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