Staking Success: SEC's Sensible Stance Finally Stakes Out Clarity

The SEC's Division of Corporation Finance has dropped some surprisingly sensible guidance on liquid staking that has the crypto world cautiously optimistic. After years of regulation by enforcement over liquid staking, and Kraken paying a US$30M fine to settle a prosecution by the SEC under former Chair Gary Gensler, the SEC under new Chair Paul Atkins has acknowledged what many have been arguing all along: not every crypto mechanism is a security under US Law.

The 5 August statement clarifies that certain liquid staking activities should not fall under the SEC’s jurisdiction when they're truly protocol-driven without active third-party management or return guarantees, even when the staking is offered by a third-party.  This is bright line guidance which previously was absent (and in many countries remains absent). Gone are the days when projects were told they just needed to ‘come in and register’ when it was impossible to survive the process, as the current SEC is on track with Project Crypto to give the industry clear guidance.

Liquid what?

Liquid staking lets users lock up their crypto for staking rewards while receiving in return receipt tokens they can use elsewhere, such as in other DeFi smart contracts. The new guidance suggests that when these mechanisms are purely protocol-based—think algorithmic rather than actively managed—they ought to escape securities regulation entirely in the US.

The crypto community's reaction has been mixed but largely positive. Lido Finance, one of the biggest liquid staking protocols, saying:

This guidance provides much-needed clarity for the liquid staking ecosystem. We're encouraged by the SEC's nuanced approach to protocol-driven activities.

Jesse Pollak, co-founder of Kraken, referenced the past settlement of their staking, saying:

Can I get a $30M refund?

The Devil's in the Details

Of course the guidance comes with plenty of caveats. The agency emphasizes this is not a formal rule or binding decision—rather it is more like regulatory tea leaves that industry participants need to interpret carefully.

Key points include, from the guidance:

In a Liquid Staking arrangement, the Liquid Staking Provider (whether a Node Operator or not) does not provide entrepreneurial or managerial efforts to Depositors for whom it provides this service. These arrangements are similar to those discussed in the Protocol Staking Statement with respect to “Custodial Arrangements.” The Liquid Staking Provider does not decide whether, when, or how much of a Depositor’s Covered Crypto Assets to stake and is simply acting as an agent in connection with staking the Covered Crypto Assets on behalf of the Depositor. 

The key factors seem to be:

• A Staking Receipt Token is not a security, because the thing for which it is a receipt, what the SEC calls a Covered Crypto Asset, is itself not a security.
• Protocol-driven operations without human intervention remove managerial efforts which would trigger the Howey test.

TradFi Strikes back

Naturally crypto clarity in regulation doesn't come without the criticism with the former chief-of-staff of the SEC making a wild comparison to Lehman brothers rehypothecation:

The SEC's latest crypto giveaway is to bless the same type of rehypothecation that cratered Lehman Brothers - only in crypto it's worse because you can do it without any SEC or Fed oversight.

Austin Campbell of Zero Knowledge Consulting politely said:

They live in a world that is centralized and intermediated, because that was the only way to do things effectively in the 1970s when these systems were designed...[t]hey don't realize that they think of everything as centralized, so automated systems really throw them.

Joe Doll of Magic Eden was more brutal, calling the statement a deliberate mischaracterization, and saying:

I'm always happy to provide "swift backlash" to those leveraging their pedigree to LARP as experts to impede technological innovation and regulatory progress.

What comes NXT?

For staking providers and DeFi platforms, this guidance offers a roadmap but also requires careful compliance work. Projects will need to review their offerings against the criteria set by the SEC, noting that it does not have the force of law, so plaintiff lawyers are still at liberty to allege that liquid staking is a security.

The broader direction of this statement and ‘project crypto’ are real, practical and largely sensible bright line guidance which the industry can rely on to grow.  With the UK clarifying that staking is not a collective investment scheme earlier this year, more regulators are clearly doing the hard work to draw lines, while others continue a regulation by enforcement position, often with mixed results.

The liquid staking sector, which has grown to billions in total value locked, can finally operate with slightly less regulatory sword hanging over its head. More clarifications from Project Crypto are expected in the US, and as the largest financial market, these will help lead other regulators in the right direction in time.

First published at Bits of Blocks and reproduced with permission. With Steven Pettigrove.