On February 9, 2023, the SEC announced that it had settled charges against the world’s third largest centralized crypto exchange by volume for offering a crypto staking program that the SEC deemed to be the offering and selling of unregistered securities. The firm agreed to pay $30 million, immediately cease its staking program in the US, and consented to the entry of a final judgment permanently enjoining them from ever offering such a crypto staking program in the US again.
Last fall, SEC Chairman Gensler made statements that cryptocurrencies and intermediaries, like crypto exchanges and trading platforms, that allow holders to stake their crypto are “securities.” The statements followed Ethereum’s transition to proof-of-stake consensus, and news that the SEC was investigating the listing process and staking programs of US crypto exchanges. Chair Gensler described intermediaries’ crypto staking programs as effectively offering crypto lending by a different name, a product that has resulted in several notable SEC and state enforcement actions.
Fast forward to February 8, 2023, news reports began circulating that a settlement with a centralized crypto exchange for the sale of unregistered securities was imminent, and that the SEC was considering a ban on crypto staking for U.S. retail customers. On February 9, 2023, the SEC proved the rumors and news reports to be true, charging the crypto exchange with unlawfully offering and selling unregistered securities through its crypto staking program. As of this writing, the settlement itself has yet to be published.
What does this mean for PoS cryptocurrencies?
The action is plainly another shot across the bow for other centralized crypto exchanges and intermediaries offering crypto staking programs. It may also represent a larger issue for cryptocurrencies utilizing proof-of-stake (PoS) consensus. In its complaint, the SEC cites 15 specific cryptocurrencies as PoS crypto assets. As noted above, Chair Gensler publicly expressed concerns about whether crypto assets utilizing PoS as a validation protocol should be viewed as securities.
The SEC’s complaint does not go so far as to say that a PoS cryptocurrency itself is a security, but we will see where the SEC turns its attention after the likely forthcoming actions against other crypto exchanges and intermediaries offering crypto staking programs.
The SEC’s expectations for crypto and investor protection are disconnected.
The SEC’s actions and statements leave both consumers and crypto firms in a cloud of uncertainty. Although the settlement noted over 135,000 unique users’ staked crypto through the crypto exchange’s crypto staking platform, notably the SEC cited no user complaints; nor did it identify any fraud or misleading statements. Users earn (or earned) returns on their staked crypto in multiples significantly higher than any traditional financial platform.
Chair Gensler touted the action as addressing investor protection and vindicating full, fair and truthful disclosure, but this case was brought solely as an unregistered securities action, not under the antifraud provisions of the federal securities laws.
Additionally, Chair Gensler stated that “the action should make clear to the marketplace that staking-as-a-service providers must register,” but the complaint alleges no violation for acting as an unregistered broker-dealer or unregistered national securities exchange. Thus, the disconnect between Chair Gensler’s statements and the settlement beg the question, “register as what?”
Finally, as Commissioner Hester Peirce noted in her statement about the action, perhaps the biggest concern here is that the SEC’s solution to an unregistered securities offering with no cited fraud is to not offer guidance or a path to regulatory compliance, but instead to permanently shut down the crypto staking program to the very investors that the SEC claims it is protecting. Quite the odd result.
In the immediate future, crypto exchanges and other intermediaries offering “staking-as-a-service” programs should review the complaint and their own programs. Despite the SEC’s broad categorization in the complaint, not all staking programs or PoS cryptocurrencies are the same. In this action, the SEC appears especially concerned with the pooling of multiple customer’s assets and the comingling of these customer assets with the centralized exchange’s. In the aftermath of the SEC enforcement proceedings and state actions on crypto lending programs, many turned to offering the programs via private placement exemptions to accredited investors. Whether that’s a viable and practical route for crypto staking programs remains to be seen.
On broader issues, given Chair Gensler’s focus on PoS cryptocurrency, centralized crypto exchanges and trading platforms should review their crypto listing processes for any enhancements (or establish one now). While the SEC appears currently focused on crypto-related programs, Chair Gensler’s statements suggest a look at other functions of centralized crypto exchanges and trading platforms (such as the trading of crypto itself) could be on the horizon.
As other countries like the UK announce robust plans to foster growth and clarity for the crypto industry while providing for customer protection, the US seems to be continuing the regulation by enforcement approach for now.