PoS staking removes regulatory shackles, US SEC declares these three types of activities do not constitute securities transactions

Author: U.S. SEC

Compiled by: Felix, PANews

The U.S. Securities and Exchange Commission (SEC) today issued a policy statement on PoS network staking activities, clarifying that three types of staking activities do not constitute securities issuance, including self-staking, third-party non-custodial staking, and compliant custodial staking. The statement aims to provide regulatory clarity for staking participants and support compliant participation in the network consensus mechanism.

The following is the full statement:

introduction

To provide greater clarity on the applicability of the federal securities laws to crypto assets, the Department of Corporation Finance has issued its opinion regarding certain activities referred to as “staking” in networks that use proof-of-stake (“PoS”) as a consensus mechanism (“PoS Networks”). Specifically, this statement addresses the staking of crypto assets that are intrinsically tied to the programmatic operation of public, permissionless networks, where such crypto assets are used to participate and/or are earned for participating in the consensus mechanism of such networks, or are used to maintain and/or are earned for maintaining the technical operation and security of such networks. For the purposes of this statement, we refer to these crypto assets as “Covered Crypto Assets” and staking on PoS networks as “Protocol Staking.”

Protocol pledge

Networks rely on cryptography and economic mechanism design to reduce reliance on designated trusted intermediaries to verify network transactions and provide settlement guarantees to users. The operation of each network is governed by an underlying software protocol, which consists of computer code that programmatically enforces certain network rules, technical requirements, and reward distributions. Each protocol includes a "consensus mechanism," which is a method for a distributed network of unrelated computers (called "nodes") that maintain a peer-to-peer network to reach agreement on the "state" of the network (i.e., the authoritative record of network address ownership balances, transactions, smart contract code, and other data). Public, permissionless networks allow users to participate in the operation of the network, including the validation of new transactions according to the network's consensus mechanism.

Proof of Stake (PoS) is a consensus mechanism used to prove that node operators participating in a network (“node operators”) have contributed to the network, and if they behave dishonestly, these contributions may be confiscated in certain circumstances. In a PoS network, node operators must stake the network’s compliant cryptographic assets in order to be programmatically selected by the network’s underlying software protocol to validate new data blocks and update the network’s state. Once selected, node operators take on the role of “validators.” In return for providing validation services, validators receive two types of “rewards”: (1) newly minted (or created) compliant cryptographic assets that are programmatically allocated to validators according to the network’s underlying software protocol; and (2) a percentage of transaction fees paid by parties seeking to add transactions to the network, paid in compliant cryptographic assets.

In a PoS network, node operators must stake or "stake" compliant crypto assets to be eligible for validation and receive rewards, usually through smart contracts. A smart contract is a self-executing program that automatically performs the actions required for network transactions. During the staking period, the compliant crypto assets are "locked" and cannot be transferred within the period specified by the applicable agreement. The validator does not possess or control the staked crypto assets, which means that the ownership and control of the crypto assets will not change during the staking period.

The underlying software protocol of each PoS network contains the rules for running and maintaining the PoS network, including the method of selecting validators among node operators. Some protocols provide for random selection of validators, while others use specific criteria to select validators, such as the amount of crypto assets staked by the node operator. Protocols may also contain rules designed to curb activities that are harmful to the security and integrity of the network, such as validating invalid blocks or double signing (which occurs when a validator attempts to add the same transaction to the network multiple times).

The protocol staking rewards provide economic incentives for participants to use their compliant crypto assets to secure the PoS network and ensure its continued operation. An increase in the number of compliant crypto assets staked can improve the security of the PoS network and reduce the risk of attackers controlling a large portion of compliant crypto assets. If not properly controlled, attackers will be able to manipulate the PoS network by affecting transaction verification or tampering with transaction records.

Users who hold compliant crypto assets can earn rewards by acting as node operators and staking their own crypto assets. In the case of self-staking (or individual staking), users always own and control their crypto assets and cryptographic private keys.

Alternatively, users who hold compliant crypto assets can participate in the validation process of the PoS network by staking directly through a third party in a non-custodial manner, without having to run their own nodes. Users who hold crypto assets grant their validation rights to third-party node operators. When using a third-party node operator, users receive a portion of the rewards, and the service provider also receives a portion of the rewards for their services in validating transactions. When staking directly through a third party in a non-custodial manner, users who hold crypto assets retain ownership and control of their crypto assets and private keys.

In addition to self-staking (or individual staking) and non-custodial staking directly through a third party, a third form of protocol staking is so-called “custodial” staking, in which a third party (“custodian”) holds the owner’s crypto assets and facilitates the staking of such crypto assets on the owner’s behalf. When the owner deposits crypto assets with the custodian, the custodian holds the deposited crypto assets in a digital “wallet” controlled by the custodian. The custodian stakes the crypto assets on the owner’s behalf to receive an agreed share of rewards, either through a node operated by the custodian or through a third-party node operator selected by the custodian. Throughout the staking process, the deposited crypto assets remain under the control of the custodian, and the owner of the crypto assets retains ownership of their crypto assets. In addition, the deposited crypto assets: (1) may not be used for the custodian’s operations or general business purposes; (2) may not be lent, pledged, or re-pledged for any reason; and (3) are held in a manner that does not expose them to third-party claims. To this end, the custodian may not use the deposited crypto assets for leverage, trading, speculation, etc.

Department’s views on protocol pledge activities

The Department believes that the “deal pledge activities” related to the deed pledge do not involve the offer and sale of securities as defined in Section 2(a)(1) of the Securities Act of 1933 (the “Securities Act”) or Section 3(a)(10) of the Securities Exchange Act of 1934 (the “Exchange Act”). Therefore, the Department believes that the parties involved in the deed pledge activities are not required to register transactions with the Commission under the Securities Act with respect to these deed pledge activities, nor are they subject to the registration exemptions under the Securities Act.

Protocol Staking Activities Covered by This Statement

The department’s view applies to the following protocol staking activities and transactions:

• Stake compliant crypto assets on the PoS network;
• Activities performed by third parties related to the protocol staking process, including but not limited to third-party node operators, validators, custodians, delegators, and nominees (“Service Providers”), including their roles in reward earning and distribution;
• and the provision of Ancillary Services (as defined below).

This statement only discusses protocol staking activities related to the following types:

• Self-staking (or solo) means that a node operator uses its own resources to stake crypto assets that it owns and controls. A node operator can be one person or multiple people who jointly operate a node and stake their crypto assets.
• Non-custodial staking through a third party means that the node operator obtains the verification rights of the crypto asset owner according to the terms of the agreement. Reward payments can flow directly to the crypto asset owner from the PoS network or indirectly to the owner through the node operator.
• Custodial staking refers to the custodian staking on behalf of the owner of the crypto asset. For example, a crypto asset trading platform can stake such crypto assets on behalf of its customers on a PoS network that allows customer delegation and with the customer's consent. The custodian can use its own nodes for staking or choose a third-party node operator.

Discussion on protocol staking activities

Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Exchange Act define the term “security” by listing various financial instruments, including “stocks,” “notes,” and “bonds.” Because crypto assets do not fall into any of the financial instruments specifically listed in those definitions, we analyze certain crypto asset transactions involving agreement pledges under the “investment contract” test set forth in the U.S. SEC v. W.J. Howey & Company case. The “Howey test” analyzes arrangements or instruments not listed in the statutory provisions based on their “economic reality.”

In assessing the economic reality of a transaction, the key issue is whether there is a contribution of money to a common enterprise based on a reasonable expectation of profits from the entrepreneurial or managerial efforts of others. Since Howey, federal courts have interpreted that the “efforts of others” requirement in Howey is satisfied when “the efforts of persons other than the investor are undeniably significant efforts, those key managerial efforts that affect the success or failure of the enterprise.” Federal courts have also noted that administrative and clerical activities are not managerial or entrepreneurial efforts that satisfy the “efforts of others” requirement in Howey.

Self-staking (or individual staking)

The node operator's self-staking (or sole) is not based on the expectation of reasonable profits from the entrepreneurial or managerial efforts of others. Instead, the node operator contributes their own resources and stakes their own crypto assets to secure the PoS network and promote the operation of the network by validating new blocks, which makes them eligible for rewards according to the underlying software protocol of the PoS network. To receive rewards, the node operator's activities must comply with the rules of the protocol. By staking their own crypto assets and participating in protocol staking, the node operator is simply engaging in an administrative or transactional activity to secure the PoS network and promote its operation. The node operator's expectation of receiving rewards does not derive from any third-party management or operational efforts on which the success of the PoS network depends. Instead, the economic incentives expected by the protocol are entirely derived from the administrative or transactional act of staking the protocol. Therefore, rewards are paid to node operators in exchange for their services to the network, not profits from the entrepreneurial or managerial efforts of others.

Non-custodial staking via a third party

Similarly, when an owner of a cryptoasset grants its validation rights to a node operator, the owner of that cryptoasset has no expectation of returns from the entrepreneurial or managerial efforts of others. The services provided by node operators to cryptoasset owners are administrative or transactional in nature, rather than entrepreneurial or managerial, for the same reasons discussed above regarding self- (or sole) staking. Whether a node operator stakes its own cryptoasset or obtains validation rights from other cryptoasset owners does not change the nature of protocol staking under the Howey analysis. In either case, protocol staking is an administrative or transactional activity, and the expected economic incentive derives solely from such activity, not from the success of the PoS network or other third parties. In addition, node operators do not guarantee or otherwise set or fix the amount of rewards payable to cryptoasset owners, but node operators may deduct their fees from that amount (whether a fixed fee or a percentage of that amount).

Compliance custody pledge

In compliant custodial staking, the custodian (whether or not a node operator) does not provide entrepreneurial or managerial effort to the crypto asset owner who receives its services. These arrangements are similar to the above, where the crypto asset owner delegates its validation rights to a third party, but also involve the owner granting custody of its deposited crypto assets to a third party. The custodian does not decide when, if, and how much of the owner's crypto assets are staked. The custodian simply acts as an agent, staking the deposited crypto assets on behalf of the owner.

In addition, the custodian's custody of deposited crypto assets and, in some cases, selection of node operators are insufficient to satisfy the "efforts of others" requirement of the Howey test because these activities are administrative or transactional in nature and do not involve managerial or entrepreneurial efforts. In addition, the custodian does not guarantee or otherwise establish or fix the amount of the reward payable to the crypto asset owner, but the custodian may deduct its fees from that amount (whether a fixed fee or a percentage of that amount).

Auxiliary Services

Service Providers may provide the services described below (“Ancillary Services”) to Cryptoasset Owners in conjunction with Protocol Staking. Each of these Ancillary Services is essentially administrative or clerical in nature and does not involve entrepreneurial or managerial efforts. They are part of the overall activity of Protocol Staking, which is not entrepreneurial or managerial in nature.

• Slashing Coverage: Service providers compensate or reimburse stakers for losses caused by slashing. This protection against node operator errors is similar to the coverage provided by service providers in many traditional commercial transactions.
• Early Unbonding: The service provider allows the return of crypto assets to the owner before the end of the unlocking period specified in the agreement. This service simply shortens the effective unlocking period of the agreement, provides convenience for crypto asset owners, and reduces the burden of the unlocking period.
• Alternative Reward Payment Schedule and Amount: The Service Provider delivers the earned rewards at a different cadence and amount than the schedule set by the Agreement, or the Reward Payment Time is earlier than the Agreement or the payment frequency is less than the Agreement, provided that the Reward Amount is not fixed, guaranteed or higher than the amount granted by the Agreement. Similar to early unlocking, this is only an optional convenience provided to crypto asset owners in terms of reward allocation and delivery management.
• For cryptoasset aggregation, the service provider provides cryptoasset owners with the ability to aggregate their cryptoassets to meet the protocol's minimum staking requirements. This service is part of the validation process, which is administrative or transactional in nature. Aggregating owners' cryptoassets to help achieve staking is also administrative or transactional in nature.

The provision of any or all of such services by Service Provider, whether individually or as a group of services, is not of a managerial or corporate nature.

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