Crypto Exchange Settles SEC Charges, Ends Unregistered Staking Service Program
Commentary by Steven Lofchie
A U.S.-based cryptocurrency exchange settled SEC charges for failing to register the offer and sale of its crypto asset "staking-as-a-service" program. According to the SEC, the program allowed for investors to transfer crypto assets to the exchange to be used for staking, advertising annual investment returns that could reach 21 percent.
Staking is a process in which an investor locks up their crypto tokens with a blockchain validator; the aim is for the investor to receive new tokens as a reward for offering their staked crypto tokens to be used in validating data for the blockchain. In the Complaint, the SEC explained that the exchange pooled crypto assets transferred by investors and staked them on behalf of those investors. The program purported to provide material benefits to investors including regular investment returns and payouts, no minimums, reliance on the technical expertise of the defendants, and ability to use the defendants' simplified and "easy-to-use one-stop-shop" trading platform.
The SEC asserted that when holders of tokens entrusted those tokens to the exchange to be used for staking purposes, the token holders were effectively purchasing a security, which was not registered, and thus those securities were issued by the exchange in violation of Securities Act Sections 5(a) and (c).
To settle the charges, the two entities comprising the cryptocurrency exchange agreed to (i) cease offering and selling securities through their crypto asset staking services or programs and (ii) pay $30 million in disgorgement, prejudgment interest and civil penalties.
SEC Director of Enforcement Gurbir S. Grewal said the exchange "not only offered investors outsized returns untethered to any economic realities, but also retained the right to pay them no returns at all." Mr. Grewal added that the exchange provided investors "zero insight into, among other things, its financial condition and whether it even had the means of paying the marketed returns in the first place."
SEC Commissioner Hester M. Peirce criticized the agency's action, stating the use of "enforcement actions to tell people what the law is in an emerging industry is not an efficient or fair way of regulating." She said that the "most concerning" aspect was that the SEC's response to a registration violation was to "shut down entirely a program that has served people well."
Commentary
In regard to the regulation of digital assets, the SEC is often accused of "regulation by enforcement." This seems a model example.
While staking is a common practice, it would not be obvious to the ordinary person that the practice, even as performed in the instant situation, constitutes a security. Therefore, the SEC's determination that in this case the practice constitutes a security may prevail if challenged in court. That said, making that determination in this enforcement action just serves to create anxiety in the market, since there has been no guidance from the SEC as to which staking practices are acceptable and which are not. This is not the right way to regulate in areas where the law is unclear; regulatory guidance should precede enforcement.
Further, Paragraph 3 of the SEC's Summary of the Complaint recognizes the substantial benefits the token holders received from the staking program; those benefits would not have been possible if the staking program were forced to register under the Securities Act. By neither adjusting the Securities Act requirements to permit programs that benefit token holders, nor providing guidance as to what types of staking programs are permissible without Securities Act registration, the SEC does token holders a disservice.