Over the last week there have been pronounced moves to target the staking industry in the United States. But moves to ban retail staking for retail users could have several profound consequences – from friction and centralisation risks, that threaten financial inclusion, to functional risks as well as capital and business flight. We urge European regulators to consider the overall impact that such enforcement action could have and want to encourage dialogue, knowledge exchange, and empirical evidence as ways to arrive at a regulatory environment in Europe which is palatable for everyone. Read our full statement below.
Regulation-by-enforcement will harm European industry
Over the last week there have been pronounced moves to target the staking industry in the United states. Recent comments by Coinbase’s Brian Armstrong surrounding ‘rumours’ that the Securities and Exchange Commission was turning its views toward staking were followed by the settlement of a lawsuit levied by the SEC against crypto exchange Kraken to shutter its staking business. The grounds? Kraken was accused of selling unregistered securities. The US $30 million settlement also sees Kraken agreeing to never re-open its staking business for US retail customers. Not surprisingly, this has been met with criticism, no less than by the SEC’s own Commissioner Hester Peirce who called it the latest attempt of regulation-by-enforcement over the digital asset space. The articulation of regulatory posturing and general anathema towards the industry is not undocumented, with the pace of crack-downs accelerating globally in the wake of the FTX collapse.
However, by seeking to do more and quickly, there is a real risk that such actions will have long-run prohibitive consequences on the development of innovation and access to financial inclusion for consumers. Moreover, in an era of digital transformation, putting undue guardrails on what is shaping up to be a strategically important part of the digital asset space from the perspective of operational security, runs the risk of increasing systemic events in the future. Thereby essentially manifesting the consequences regulators were seeking to avoid in the first place.
We urge European regulators to consider the overall impact that such enforcement action could have and that it runs antithetical to both the tenets of consumer protection and the European Union’s goal of achieving a strategic digital advantage in the lead up to industry 4.0.
Risk1: friction and centralisation risks
In brief, staking is a means of ensuring network security in a proof-of-stake (PoS) network. It is the essence of decentralisation where all token holders can pitch in for the security of the network. In many cases, staking also underlines the qualification of the underlying token, meaning its utility is being played out in the staking process. Throughout this process, staking infrastructure providers play a vital role in the staking ecosystem as they enable token holders to stake their tokens to secure the network without needing to set up the required infrastructure (and bear the associated costs) of doing so themselves.
Moves to ban retail staking for retail users could have several profound consequences. First, the concentration of staking to institutional players creates friction and centralisation risks. If decentralization is reduced fragility is increased. Instead of protecting consumers, it could unduly create operational security risks that threaten the viability of the network and a de-facto negative feedback loop putting consumers at risk. Such a move is also antithetical to the EU’s envisaged goals of promoting financial inclusion.
Cordoning off staking to favour traditional financial incumbents is done at the expense of everyday people who are seeking a means to take ownership over their own financial futures. Retail staking is the democratisation of finance in practice.
Risk 2: undermining the development of entire industries
There are also pronounced governance risks which can undermine the development of entire industries. For example, many Decentralised Autonomous Organisations (DAOs) and other Decentralised Finance (DeFi) services rely on staking as the decision-making process of their participants. The elimination of retail staking would choke out many protocols or otherwise lead to functional risks that could see the decentralised finance ecosystem vanish from Europe eventually. On this point, there are many small and medium sized enterprises in Europe developing staking infrastructure solutions to service both retail and institutional clients. Aside from the major players already operating cross-border (with more developed economies of scale), such a move would hurt the entrepreneurial class the most.
SMEs looking to grow profitable and productive businesses in Europe would face serious disruptions or be forced to shut down entirely leading to employment loss, and a deterioration of technological output. It would also prevent many new business models such as slashing insurance providers from setting up their operations in the Single Market.
Risk 3: capital and business flight
The economic cost of ring-fencing the Single Market from the proliferation of staking services could see other jurisdictions reap the benefits of more inclusive policy. This leads to the final consideration which is the inherently global nature of staking. A blanket ban on retail staking would be essentially unenforceable. The outcome for Europe would only result in capital and business flight with regulatory arbitrage in other jurisdictions.
At present there is no definitive regulation on staking in the European Union. However, the direction of travel would suggest that staking along with the broader scope of DeFi regulation is slowly materialising. There is a compelling argument to be made for a more detailed appraisal of staking in the context of financial services regulation in Europe. The specific token custody arrangements in staking design, governance processes and network security risks should all be taken into account as they determine the scope of liability and whether a given transaction is or is not a bona fide investment contract.
Moreover, the uniqueness of earning returns while simultaneously performing validation functions points to the fact that staking should be considered within the greater abstraction between the protocol and application layers – with consequences for governance processes.
Understanding the role and liability of adjacent ecosystem providers such as the role of slashing and slashing insurance would help Europe achieve its goals of consumer protection while enabling innovation. The global nature of staking also does not make this a simple task. Admittedly, it layers complexity over an already complicated landscape.
Our proposition: overcoming complexity through dialogue and exchange
Our goal at the European Blockchain Association is to work with policy makers on identifying knowledge gaps through advocacy and research.
We maintain an open-door policy and encourage dialogue on important issues such as staking. Dialogue, knowledge exchange, and empirical evidence are the ways in which we can overcome complexity and arrive at a regulatory environment in Europe which is palatable for everyone.
The consequences of regulation-by-enforcement both in the US and in Europe are too costly to be ignored.
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