SEC Says "Protocol Staking" Activities Do Not Create a "Security"
Commentary by Gage Raju-Salicki
The SEC Division of Corporation Finance ("Division") analyzed the "economic realities" of protocol staking activities under the Supreme Court's Howey test to determine whether money was invested with "a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others."
In a public statement, the Division concluded that "activities in connection with Protocol Staking do not involve the offer and sale of securities within the meaning of [the Securities Act or the Exchange Act]."
In a separate statement, SEC Commissioner Hester Peirce explained that "proof-of-stake network protocols are designed to encourage users to voluntarily coordinate and cooperate to secure the network. But uncertainty about regulatory views on staking discouraged Americans from doing so for fear of violating the securities laws." She welcomed the Division's statement clarifying that certain proof-of-stake protocol staking activities are not securities transactions.
In its analysis, the Division evaluated three types of Protocol Staking arrangements: (i) Self (or Solo) Staking; (ii) Self-Custodial Staking Directly with a Third Party; and (iii) Custodial Staking.
The Division concluded that Self Staking lacks "a reasonable expectation of profits" from others' efforts, as Node Operators use their own assets and resources to perform "administrative or ministerial" tasks. The Division emphasized that rewards are earned for validating the network, not from the success or management of third parties.
On Self-Custodial Staking Directly with a Third Party, the Division found that delegating validation rights to a Node Operator does not create an "expectation of profit" from others' efforts, as the Operator's role remains "administrative or ministerial." The Division stated that, whether staking their own assets or acting on behalf of others, the nature of Protocol Staking is unchanged and does not depend on the success of a third party.
On custodial staking, the Division concluded that custodial arrangements do not involve the "entrepreneurial or managerial efforts" of others, as the Custodian acts merely as an "agent" and performs "administrative or ministerial" tasks. The Division stated that taking custody or selecting a Node Operator does not satisfy the Howey test, and that rewards remain subject to protocol terms, not the Custodian's discretion.
The Division also considered Ancillary Services—such as Slashing Coverage, Early Unbonding and Alternate Rewards Payment Schedules—and found that they are "merely administrative or ministerial in nature" and "do not involve entrepreneurial or managerial efforts."
SEC Commissioner Caroline A. Crenshaw criticized the Division's statement, arguing it reflects "what some wish the law to be" rather than what the law is. She said the Division's conclusions disregard court rulings and "conflicts with applicable law."
Commentary
The SEC Division of Corporate Finance public statement agrees with arguments proposed by crypto advocates. The Division concluded that "protocol staking" activities are not investment contracts under Howey. Their argument relies on the notion that these activities are "administrative or ministerial," as opposed to being "derived from the entrepreneurial or managerial efforts of others"—the test under Howey.
Some have contended that cryptocurrency staking is, as the Division noted, a system of rewards "earned for participating in such network's consensus mechanism or otherwise used to maintain and/or earned for maintaining the technological operation and security of such network." This statement is technically correct. Staking is a form of protocol security and operation.
There is a direct line of reasoning from the Division's March statement on crypto mining activities to the current statement, as the Division similarly explained that mining activities are merely "administrative or ministerial activit[ies] to secure the network, validate transactions and add new blocks, and receive Rewards."
Accordingly, proof-of-stake protocols like Ethereum appear to be cleared by part of the SEC as non-securities—something identified in the crypto market structure bill, the CLARITY Act, just introduced in Congress. In that bill, the "end user distributions" are not considered to be offers or sales of securities, with "end user distributions," including "activities directly related to the operation of the blockchain system, such as mining, validating, [or] staking[.]"