Yesterday the famous US exchange Coinbase sent the SEC a petition asking that cryptocurrencies based on Proof-of-Stake (PoS) not be considered security tokens.
The petition is addressed to Vanessa A. Countryman, secretary of the US Securities and Exchange Commission (SEC) in Washington, and is titled “RE: Petition for Rulemaking – “Proof-of-Stake” Blockchain Staking Services.”
This is a comment given by the exchange in response to an earlier petition from July last year regarding crypto regulation.
The petition: Coinbase asks the SEC to retract the definition of security token
The petition sent yesterday is an impressive 18 pages long, and is a commentary by Coinbase in response to a recent SEC action, described as “surprising,” suggesting that the agency may consider some staking services as constituting an investment contract, and therefore a security.
The action referred to in the petition is the one against Kraken, which forced the major US crypto exchange to stop providing its staking service to all US users.
In the petition, Coinbase focuses on how US securities law treats services related to block validation in PoS-based crypto protocols, arguing that staking is not a monolithic operation concept.
According to the exchange, some of the models in existence to date actually could fall under the definition of “investment contract offerings,” but others clearly do not. In particular, major staking services would not meet the criteria of the Howey test.
What are they and how do securities work?
The Howey test was used in a case before the US Supreme Court to determine whether a transaction qualified as an “investment contract” or not.
According to the Howey Test, they are true investment contracts when there is an investment of money in a joint venture with a reasonable expectation of profits from the efforts of others.
In this particular case, those who are staking on their own node make profit by validating blocks, meaning not through the efforts of others. However, those who instead entrust their tokens to third-party validators with the promise that they will validate the blocks obtaining a profit with which to pay a financial return on the tokens staked may actually be entering into an investment contract.
The key point is that securities in the U.S., as indeed in almost all other countries with developed financial markets, can only be offered on the open market with the approval of the authorities. Such authority in the US is precisely the SEC.
Therefore if some PoS-based cryptocurrencies, or some crypto staking services, do not pass the Howey test, to date they would be found to be sold illicitly.
In order to be sold lawfully, they would have to apply for and receive approval from the SEC, and this is a scenario few considered likely.
Ethereum and other PoS cryptocurrencies
From this reasoning, it would seem to emerge that those staking ETH on their own node should take no risk. The problem would be for those who entrust their ETH to a third-party node for it to be used for Proof-of-Stake, receiving a financial return in return.
Such staking-as-a-service is provided by many intermediaries, including many exchanges such as Coinbase and Kraken.
Right now, excluding staking on its own nodes, the main pool offering this service is the decentralized Lido, followed precisely by Coinbase, Kraken and Binance.
As far as Lido is concerned, it is very difficult for the SEC to really intervene, since it is a decentralized platform, but as far as Coinbase, Kraken and Binance are concerned, it could. That is why Coinbase is concerned.
In addition, it is worth mentioning that there are other cryptocurrencies that natively allow delegated-Proof-of-Stake (dPoS), which is the protocol-level management of the staking of one’s own tokens on third-party validator nodes.
However, even in these cases it might be difficult for the SEC to intervene, since if these are decentralized protocols it would be difficult for the agency to find a so-called “legal entity” (i.e., an enterprise) to rely on.
Coinbase’s objections: PoS crypto assets are not security tokens
According to Coinbase, basic staking services would not be investments, because the opportunity cost of staking would not be an investment, seeing as users are simply temporarily giving up the alternative use of their tokens, since they retain full and exclusive ownership of them.
Moreover, in these cases there is not even a joint venture between staker and service provider, causing the very concept of a contract to be dispelled.
However, it is worth mentioning that handing over one’s tokens to an intermediary, such as a centralized exchange, takes away the full and exclusive ownership of the tokens from the user.
Whereas on core staking services, where the users do not hand over their tokens to any intermediary, there would not even be an expectation of financial gain, because in reality the gains from staking would simply be payments for block validation services rendered.
The issue therefore is complex and still absolutely open, with the SEC seeming to want to force the issue a little bit perhaps in order to be able to start some kind of negotiation from a stronger position than it would have without this overreach.