Crypto Would Survive an SEC Crackdown on Staking

Coinbase CEO Brian Armstrong has heard rumors the securities watchdog may go after proof-of-stake services. That may hurt his bottom line but open protocols should survive.

AccessTimeIconFeb 9, 2023 at 6:56 p.m. UTC
Updated Feb 9, 2023 at 10:05 p.m. UTC

On Wednesday Coinbase CEO Brian Armstrong went public with "rumors" about the U.S. Securities and Exchange Commission (SEC) working to “get rid of” retail-focused crypto staking offerings. If concerning, the scuttlebutt isn’t new: SEC Chair Gary Gensler took the moment of Ethereum’s historic “Merge” to a proof-of-stake system to call the yield-generating practice into question, much as he’s drawn a line around the entire token economy. Also, in August news broke the securities regulator was probing Coinbase specifically over its staking services.

Staking, the process of locking native blockchain tokens to secure the network and receive rewards, has become a major business line for centralized exchanges looking to diversify their revenue streams away from transaction fees. Coinbase is the second-largest staker on Ethereum, even as competitors such as Kraken and Binance have moved into the business. In many ways, if the SEC is successful in banning staking programs, decentralized alternatives like Lido and RocketPool, the largest and third-largest Ethereum-based platforms by value, will benefit.

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The SEC cannot block users from posting 32 ether (ETH) to become an Ethereum validator, or from pledging coins to other hosts, even if the regulator can put serious restrictions around the activity for crypto economy on-ramps like Coinbase. That message seems to have moved the market: Lido’s governance token has surged following tweets from Armstong and Coinbase itself. As my colleague Sam Reynolds put it: “As a decentralized protocol, it's unlikely [Lido] will have the same compliance with securities rules as a U.S.-domiciled centralized entity like Coinbase.”

If the SEC does move to restrict staking, I’d expect for the crypto industry to put up a major legal challenge – much in the way diverse participants collaborated to prevent U.S. President Donald Trump’s administration’s eleventh-hour ban on “unhosted wallets.” In just a few years, staking has gone from a theoretical security mechanism to the backbone of many high-valued blockchains – comprising about a quarter of the crypto industry’s market cap. And while Armstrong may be a bit bold in calling staking a “national security” interest, it is a growing economic activity regularly tracked by firms like JPMorgan.

For all I know, the SEC could be right in saying that staking – which incentivizes people to secure a crypto network through payments – does satisfy the “Howey Test” to determine if an asset is a security. But that shouldn’t be up to the SEC to decide alone. It’s also worth noting that staking is not really like “crypto lending,” which requires exchanges to seek yield to pay to depositors, such as the shuttered Gemini “Earn” platform or Coinbase’s DOA offering the SEC shut down. Staking has its risks – protocols could be compromised, companies can cheat – but it’s part of an open-source process baked into a blockchain’s security, making it far less risky than rehypothecation-driven yield programs.

All that said, the recent staking rumors seem to be part of a widespread crackdown against the crypto industry. As venture capitalist Nic Carter wrote, nearly every financial watchdog seems to be working towards detaching crypto from the real economy – in particular by using the private banking sector as a cudgel. If this speculation is true, what Carter deemed “Operation Choke Point 2.0” after the Obama-era campaign to de-bank legal but morally dubious businesses, crypto has bigger problems at hand. Staking should stay open, even if Coinbase goes down.

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Daniel Kuhn

Daniel Kuhn is a deputy managing editor for Consensus Magazine. He owns minor amounts of BTC and ETH.