The SEC’s approach—regulation by enforcement—towards regulating the uncharted crypto sphere is one of the few seemingly predictable aspects of crypto. Continuing its approach of regulation by enforcement, the SEC has charged crypto exchange Kraken for conducting an illegal unregistered securities offering through its staking-as-a-service (SaaS) program. Staking-as-a-service is essentially when a trusted staking provider lets holders of a proof of stake cryptocurrency participate in consensus. In turn, this fosters rewards for customers as the model maximizes customer returns as well as for entities as they receive a fee for providing such a service to customers. 

The SEC’s complaint notes several distinguishable features of Kraken’s staking program: (1) it is a passive investment opportunity where investors only had to open an account and transfer their crypto assets to Kraken; (2) crypto assets are pooled for staking; (3) Kraken determined each individual investor’s returns and received a fee for providing the staking service to customers; (4) Kraken’s staking service promised greater liquidity with respect to rewards while retaining a subset of assets as liquidity reserves; and (5) Kraken marketed itself as a ”one-stop-shop” that was easy to use in terms of technical difficulty and investor interface. 

Kraken’s efforts and marketing approach, as illustrated by the fifth feature of its staking service program described above, led the SEC to classify Kraken’s SaaS program as an “investment contract” and thus an illegal offering under the U.S. securities laws. While this means other SaaS exchanges should be cautious since the SEC can (c)kra(c)k down on others whenever it so chooses, it also adds ambiguity into the already chaotic, confusing, and capricious cryptoverse. Moreover, what will the SEC decide to crack down on next? What about decentralized staking? In fact, SEC Commissioner Hester Pierce has voiced that much of the SEC’s regulation by enforcement approach seems arbitrary and with respect to this Kraken case in particular, the SEC failed to consult others within the industry before charging Kraken with an illegally unregistered securities offering. Consulting with others could have possibly led to a vastly different (c)kra(c)k down… maybe by mandating proof of reserves or increased transparency for staking which both could have had potentially beneficial (and less ambiguous) regulatory impacts.

Ultimately, one of the biggest challenges with the SEC’s approach is trying to decipher between what is permitted and what is not since the slightest change in a fact or circumstance could make or break whether the SEC views the offering as a security or not… and importantly, whether the exchange will be one of the next subjects of the SEC’s crypto regulatory strategy. 

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For the full complaint see https://www.sec.gov/litigation/complaints/2023/comp-pr2023-25.pdf.

For more on “regulation by enforcement” see https://www.protocol.com/policy/what-is-regulation-by-enforcement.

For more on what Commissioner Hester Pierce had to say about this case see https://www.coindesk.com/policy/2023/02/10/sec-did-not-consult-industry-before-kraken-crypto-staking-settlement-commissioner-peirce/.