Let staking flourish in the U.S.

Editor’s note: This op-ed is part of a bigger package of crypto policy views. Find the rest here: “Making the U.S. the crypto capital: What it would take.”

Staking is one of the most innovative developments by the crypto community since the launch of bitcoin nearly 15 years ago. The technologies that underpin it — so-called proof-of-stake (PoS) mechanisms — aim to improve the security, throughput, and environmental impact of crypto protocols, all while further democratizing and decentralizing transaction rails. 

Staking should be broadly supported by policymakers and regulators — instead, the SEC in the past few years has inexplicably sought to undermine systems based on the technology by targeting the staking activities that are essential to the operation of the underlying blockchains. Despite the clear benefits and growth of these networks, the SEC has asserted that some staking as a service business models constitute an investment activity or contract under U.S. securities laws. In-line with former Chairman Gary Gensler’s unfortunate and misguided “regulation by enforcement” approach, a number of SEC enforcement actions have in many instances chilled or halted staking models, thereby harming individuals across the country who seek to support decentralized blockchain protocols. The SEC is unfortunately wrong in some of its actions as a matter of law, policy, and common sense.

Stepping back, it’s important to understand that staking is about securing proof-of-stake blockchains, which depend on the technology for their security and accuracy. Proof-of-stake blockchains allow all token holders to participate in maintaining and securing the network. While it varies from blockchain to blockchain, these systems rely on a network of validators who temporarily commit (or “stake”) their tokens for the chance to propose, verify, and add new blocks to the chain, keeping the network accurate and current across the entire network of globally distributed computers. 

To ensure validators act in good faith there is both a carrot and a stick: they are rewarded with newly created tokens, and they have an incentive not to manipulate the blockchain given the sanction of being “slashed” or losing their staked cryptocurrency. In doing so, validators and other base layer actors help to secure blockchains from bad actor attacks. They distribute newly created tokens and related transaction fees to individual stakers rather than centralized firms profiting from monopoly control of existing rails. And, perhaps most importantly, they challenge and encourage the industry to continue competing and innovating.

The early results are already promising. Ethereum’s transition to proof-of-stake in fall 2022 improved the network’s security and scalability, and it drastically decreased its energy usage. Notably, the network’s net carbon emissions dropped by over 99.95%. Today, 19 of the top 20 blockchains employ staking, as do millions of their global users.

Proof-of-stake network users can participate by running their own hardware and software (solo or “squad” staking), or they can choose to place their tokens with a technical “staking-as-a-service” provider, which expands the pool of available stakers. These providers do the technical work of running validators and associated infrastructure, thereby enabling users without the necessary time or infrastructure to participate in proof-of-stake networks (for which, in certain cases, they charge users a portion of the rewards that the users may earn for providing useful work to the network). These service providers can enable the user to engage in delegated self-custodial software-as-a-service staking; delegated custodial staking; or smart contract-facilitated liquid staking — depending on the model.

Here’s where the SEC gets it wrong: With respect to the law, merely providing a service to enable individual participation in validating transactions and adding blocks to proof-of-stake blockchain networks for newly created tokens does not constitute an investment contract. In the vast majority of cases where individual stakers engage a staking-as-a service provider to facilitate transactions, these technical service providers are merely providing a service and receiving compensation for such service — they have very little discretion and any return generated is based on the operation of the underlying network, not the service provider’s entrepreneurial efforts. This type of bona fide protocol staking fails the Howey test — the traditional test for determining whether something constitutes an investment contract — since there is no investment of money and there are no managerial nor ministerial efforts of others.

The SEC has also been wrong in certain circumstances as a matter of sound policy and common sense. As blockchains are global, users in other jurisdictions are currently able to stake using multiple staking models and service providers. Recently approved exchange-traded products (ETPs) in other jurisdictions allow users to participate in staking, while recently approved ETPs in the U.S. do not. 

Digital asset technologies could form the key underlying infrastructure for financial markets and services in the decades ahead. The U.S. should be leading in innovation focused on how to make these rails more efficient, secure, and accessible. It must also ensure that Americans have the same access to participation as other users globally. 

Staking innovation should be viewed by policymakers as a positive development. Fortunately, the incoming SEC administration has an opportunity to right the past wrongs. By pursuing the following actions, the agency can ensure pro-market, pro-consumer, and pro-America innovation continues domestically.

1. The SEC should issue immediate guidance or no-action relief stating that providing staking as a service or engaging in bona fide staking activities does not fall under the U.S. securities laws. The SEC should further clarify that validators and other staking infrastructure providers are not financial intermediaries, but rather providers of ancillary technology services. This would give these technical service providers the clarity they need to operate confidently in the U.S. market, and ensure that Americans — not just those with the time and technical knowledge — have access to full participation in proof-of-stake blockchain networks.
2. The SEC should permit U.S. digital asset ETP issuers to include staking in their S-1 filings. Already, other jurisdictions including Switzerland, Canada, Germany, and Australia have approved staking in digital asset ETPs. Without staking, U.S. ETP products are potentially less attractive and their shareholders may gradually lose their relative network ownership position due to the inflationary nature of staking rewards. Allowing staking would ensure that U.S. investors have the same opportunity to participate fully in proof-of-stake networks and be rewarded for doing so, and also ensure that they are not pushed toward investment vehicles in other jurisdictions. 
3. To the extent that unique, alternative activities involving staking do constitute an investment contract — as with all other areas involving crypto and the securities laws — the SEC should create a clear, workable path to registration. This would enable staking to be used as a fundamental technical building block upon which others can innovate.
4. Policymakers should support further research and development on proof-of-stake protocols, including innovations in security, scalability, and token economics. This can be achieved by way of Congressional study bills, research grants, and public-private sector collaboration.
5. Finally, policymakers and regulators should look for broader opportunities to support public blockchains, including through clear recognition and support for dollar-based stablecoins, many of which are enabled by staking-based networks, as well as other tokenized marketplaces that improve the efficiency, security, and decentralization of economic activities. Ensuring that the staking mechanisms that underlie public blockchains thrive may also help U.S. dollar-backed stablecoins to thrive, further cementing the dollar’s dominance and creating a robust ecosystem for stablecoin issuers. 

Opportunity abounds when it comes to digital asset innovation in America. It is truly a race to the top as various global jurisdictions are all looking to lead, and  now is the time to seize that moment and ensure that the U.S. government serves as a facilitator and leader, not a barrier.

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Ji Kim is the President and Acting CEO of the Crypto Council for Innovation. Previously, he served as the group’s Chief Legal & Policy Officer and General Counsel and Head of Policy & Regulatory Affairs at Gemini, a global digital asset exchange and custodian. 

Alison Mangiero is Executive Director of the Proof Of Stake Alliance, a project within the Crypto Council for Innovation that advocates for clear and forward-thinking public policies that foster innovation in the staking industry. Previously, she founded the Tocqueville Group (“TQ”), an entity that created open-source software and other public goods for the blockchain network Tezos.

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