- The fine imposed on cryptocurrency exchange Kraken is rethinking cryptocurrency gambling as a service.
The U.S. Securities and Exchange Commission (SEC) has just fined U.S. cryptocurrency exchange Kraken $50 million for allegedly violating securities laws.
However, Kraken agreed this week to pay USD 30 million and will have to cancel its cryptocurrency betting service that offered rewards to investors, it emerged this week.
The regulator alleged that the company had failed to legally register the offer and sale of its cryptoasset staking program as a service. The SEC plans to bring tokens under the same regulatory framework that governs the sale of other securities such as stocks and bonds.
The point is that staking is part of the fundamental features of Ethereum and other blockchain. It is also a key element in improving network efficiency and avoiding the consumption of large amounts of electricity in the process.
In addition, staking lowers mining costs by eliminating the need to purchase or invest in expensive computer equipment. But the SEC has its own opinion on the staking service and threatens to further escalate its fight.
What is staking?
It is a process by which investors block or “stake” their crypto tokens with a blockchain validator. In return they receive a reward by getting new cryptocurrency tokens when the staked tokens are integrated into the data validation process for the blockchain.
By handing over their tokens to the staking-as-a-service provider companies, investors lose control of those tokens. Therefore, they must bear the risks associated with those cryptocurrency platforms and do not have sufficient legal protection.
Cryptocurrency tokens such as Ether and others are used in the process known as “proof of stake,” which serves to run a blockchain network by ordering transactions to create a secure public record.
To improve its processes and become greener, Ethereum changed in September the “proof of work” (Proof of Work – PoW) system to Proof of Stake (PoS). The “old” system is still used by Bitcoin to mine new tokens.
According to expert comments, by switching systems, the Ethereum network reduced the network’s power consumption by about 99%. This, of course, is a very important breakthrough for cryptocurrency mining, which was being heavily challenged by the large amounts of energy it uses.
Why is ‘proof of stake’ important?
To “produce” and exchange cryptocurrencies, the blockchain is vital. It is based on a new technology that is responsible for creating – as its name suggests – a blockchain of transactions or ledger ordered by time.
This electronic and public ledger is shared among a network of computers distributed across the planet. The blockchain must guarantee the security of the network and prevent the system from being violated or manipulated.
However, this function is not performed by a central body but by a group surveillance system made up of tens of thousands of machines. Regardless of whether this sequential logging function is executed through proof-of-work or proof-of-participation.
What is the difference between the two systems?
In both systems (PoW and PoS), the transaction log is grouped into “blocks” that will be available to the public on a “blockchain”. In proof-of-work (PoW), the mission of validating peer-to-peer transactions is performed by miners.
This does not require the use of external intermediaries. The miners themselves are in charge of verifying the validity of each transaction in a block and for this they receive a reward. The miners compete with each other to solve the system’s mathematical puzzles.
While the proof of participation consists of giving an incentive to people who own tokens to participate in the process. For example, an investor who bets or places 32 ETH, whose current value is 1509.27 according to eToro data, can become a validator.
Those who own a smaller amount of the cryptocurrency can also be joint validators on the Ethereum network. Validators are in charge of ordering transaction blocks on the network’s blockchain.
What incentive do investors receive for “betting”?
There is a committee made up of attestors who are responsible for accepting blocks and rewarding validators with new Ether. If any person attempts to game the system they risk losing the tokens wagered. The reward that coin-as-a-service gamblers receive is usually around 4% in the case of the Ethereum network.
Why does the SEC reject staking as a service?
Both Kraken and other centralized platforms offer staking as a service. In this way, users can bet their cryptocurrencies without having to buy tokens or invest in the expensive computers required for staking.
The SEC considers Kraken’s product to be similar to cryptocurrency loans. The fund providers would pay token depositors high interest rates for the loan of their digital currencies.
U.S. regulators do not agree with this practice and have been fighting it since last year. Especially, after the bankruptcy of companies like Celsius Network and BlockFi among others.
For the SEC, cryptocurrency lending and participation-as-a-service programs are equally securities. This consideration implies that companies engaged in this business must comply with a number of regulatory requirements.
Previously, it was thought that cryptoassets were not subject to these types of regulatory rules. Following the settlement with the SEC, Kraken will cease offering and selling stalking as a service in the US.
What is the significance of something being considered a security?
In principle, the SEC is comparing cryptocurrencies to the stock a company issues when it goes public. So it is applying the rules of the U.S. stock market.
The agency is applying legal reasoning based on a 1946 Supreme Court decision. According to case law, an asset can fall into this category and become supervised by the SEC if it meets these four requirements.
(1) The asset involves investors; (2) it involves an investment of money, (3) in a common enterprise for the purpose of obtaining a return (4) from the efforts of the organization’s management.
In this sense in staking as a service, investors deliver their cryptographic funds on the premise of achieving a monetary return for them, while the service provider, i.e. the company operating with the funds, takes care of the technical process.
Why does being labeled represent a security issue?
For starters, being designated as a security, the execution of a staking program as a service makes the operation more costly and complex. U.S. law provides that labeling as a security requires more stringent disclosure and investor protection requirements.
So smaller providers of these services would be at a disadvantage relative to those larger firms. On the other hand, cryptocurrency exchanges that attempt to continue offering these types of services face a higher level of regulatory oversight.
Stricter scrutiny translates into higher risks of fines and penalties for cryptocurrency platforms that are in business. They could even be subject to lengthy and costly legal proceedings.
As for investors, they run the future risk of losing their money due to the levels of compliance scrutiny and regulatory rules. However, for some increased regulation these securities designations are beneficial to the market and investors.
With greater scrutiny, cryptocurrency platforms are forced to hand over more information and be more transparent. Stricter regulation is seen as a necessity as it cleans up the market and will attract more users.
What will be the consequences of a crackdown on crypto staking?
For the time being, the stricter regulations will only affect staking-as-a-service providers in the U.S. Blockchain networks will not be inconvenienced as they are protected by legions of validators around the world.
So they will continue to do their job to keep the network operating. That is if regulators in other countries are more lenient on these financial services. Which will open a regulatory gap for digital assets between the US, and the rest of the world.
Still many analysts wonder whether tightening regulations on staking will affect decentralized staking providers. So far these players have been untouched as their operation does not depend on a particular legally constituted company.
Currently, these providers are a series of software dedicated to the automatic execution of transactions on the network.
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