Kraken Crypto Staking Program For U.S. Investors Have Been Shut Down as the Howey Test Continues to be Aggressively Expanded

Kraken, a cryptocurrency exchange owned by Payward Ventures, Inc., which is also known as Payward Ventures, Inc., has entered into a $30 million settlement agreement with the U.S. The Securities and Exchange Commission (SEC) has filed a complaint against the company alleging that the company failed to register its cryptocurrency staking program in violation of securities laws in the United States.

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Background

During staking programs, users receive incentives for locking up their digital tokens, which allows them to validate transactions on the blockchain. In exchange for locking up their tokens, users receive "interest" accruing on the locked-up tokens, which are usually received in the form of additional tokens. Incentives vary depending on the number of tokens staked and the duration of the lock-up period. As blockchain operators seek to encourage users to take part in consensus verification of new transactions, which is a key feature of distributed ledger technology, these programs have become increasingly popular.

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SEC Action

There is a complaint filed by the SEC alleging that the contract under which users stake assets and receive a return from Kraken constitutes an investment contract and therefore must be registered pursuant to Section 5 of the Securities Act of 1933, as amended (Securities Act). It is alleged that more than 135,000 U.S. participants have "invested" over $2.7 billion worth of crypto assets into Kraken's staking program as a part of its staking program. As stated in the complaint filed by the SEC, Kraken "offered and sold investment contracts without registering the offer or sale with the SEC as required by the federal securities laws, and no exemption from the registration requirement was applied.".

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Gary Gensler, the chairman of the Securities and Exchange Commission, released a video on YouTube in which he stated that "staking-as-a-service providers must register and be required to provide full, fair, and accurate disclosures along with investor protection." In addition, Gensler also stated that "whether the provider calls their services 'lending,' 'earning,' or 'APY,' the relationship should be protected by federal securities laws." Of note, SEC Commissioner Hester Peirce made a public dissent from the action against Kraken, calling for greater clarity and an end to the SEC's practice of regulation by enforcement. Kraken could have opted for an exempt offering under Regulation D, where all or most investors would need to be "accredited."

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Specifically, the SEC noted that the Kraken account agreement itself - in which customers agree to stake their assets as part of a profit-making scheme - resembles a fixed-income investment and therefore should be categorized as a security.

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It has been agreed that Kraken will no longer offer its staking program to U.S. account holders, that all staked assets of U.S. customers will be removed, and that Kraken will pay $30 million in fines, without admitting or denying any wrongdoing.

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Why It Matters

With the action taken against Kraken, the SEC is demonstrating its dedication to a new area (and one that is becoming increasingly popular) while continuing to apply the old rules to these new technologies at the same time. Based on the complaint's allegation that Kraken failed to register the staking program, it would seem as though consumer protection is the SEC's number one priority, considering that due to Kraken's failure to register the staking program, users would be left with no material information to evaluate it.

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Due to the substantial fine imposed by the SEC for conduct that had not previously been clarified as problematic, the agency has adopted an even stricter, less accommodating posture towards this industry than it had previously. Consequently, all stakeholders in the crypto space must tread carefully in order to make sure that their actions are in line with the SEC's flexible and evolving application of the Howey test.

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Et tu, Stablecoin?

According to Trade Algo, within a few hours of the SEC announcing its settlement with Kraken, the regulatory body is planning to sue the stablecoin issuer Paxos over the issuance of the Binance USD coin by the cryptocurrency exchange. There has yet to be any official comment from the SEC on this matter, but if it is confirmed, it will represent a further extension of the SEC's authority over digital assets if confirmed. It has been noted that stablecoins have been the subject of a review by the President's Working Group on Financial Markets, which is led by the Department of the Treasury, the FDIC, and the OCC. A similar action has been taken against stablecoin issuer Tether by the New York Attorney General, the Commodity Futures Trading Commission, as well as private plaintiffs.

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Objections by the SEC against Kraken (and perhaps now Paxos as well) continues the lineage of enforcement actions that the BlockFi/Kardashian/Coinbase group has been taking that have brought the Howey test from the real world to the metaverse during the Truman era. There is no question that applying the definition of an investment contract to commercial relationships that cannot have been foreseen 75 years ago represents an expansion of the SEC's oversight of crypto and blockchain industries by enforcement action rather than affirmative rulemaking, which continues its aggressive approach to regulating the crypto and blockchain industries.