A Stake in the Ground? — What the SEC’s Settlement With Kraken Tells Us About the Future of Crypto Regulation and Enforcement

Kraken is comprised of three entities: (1) Payward Ventures, Inc., (2) Payward Trading, Ltd., and (3) Payward, Inc.² Since 2019, Kraken has provided a crypto asset service known as “staking” (the “Kraken Staking Program”), through which Kraken “obtain[ed] investors’ crypto assets, pool[ed] those assets, and then stak[ed] some portion of those assets in order to obtain rewards, a portion of which Kraken distribute[d] to the investors and a portion of which Kraken retain[ed].”³ On its face, it appears that Kraken provided a valid service to crypto asset holders. So what is staking and where did Kraken go wrong?

Generally, staking allows holders of certain crypto assets to invest those assets in exchange for investment returns. Not every crypto asset, however, can be staked. Whether staking is an option for an investor may depend upon the currency the investor holds. For example, Bitcoin cannot be staked because transaction validation for Bitcoin relies upon Proof of Work (which involves Bitcoin mining), rather than Proof of Stake.⁴ Staking also depends upon the platform an investor has chosen, as various platforms accept only certain types of currencies.⁵ The purpose of staking is to allow people to validate transactions that are added to a blockchain. This process of validating is, in a sense, guaranteed by the crypto assets that have been staked. A staked asset is not transferrable while it is being staked, until a validator successfully validates data for the blockchain. Only then does the validator receive its return and profit. The period in which the crypto asset is vested and not transferrable is the primary risk for validators, as they are susceptible to market volatility with no transactional recourse. However, this method of forfeiting assets and validating transactions is meant to promote good faith and honest transactions on blockchains.

The SEC maintains that the Kraken Staking Program constituted investment contracts that were offered and sold by Kraken and, thus, needed to be registered with the SEC under federal securities law.⁶ Kraken failed to do so. As a result, the SEC alleges that investors “lacked material information about the Kraken Staking Program[,]” including, but not limited to, “the business and financial condition of [Kraken], the fees charged by [Kraken], the extent of [Kraken’s] profits, and specific and detailed risks of the investment, including how [Kraken] determine[s] to stake investor tokens or purportedly hold them in reserve and the extent of these purported liquidity reserves, or whether tokens are put to some other use.”⁷ SEC Chair Gary Gensler echoed the position outlined in the Complaint: “Whether it’s through staking-as-a-service, lending, or other means, crypto intermediaries, when offering investment contracts in exchange for investors’ tokens, need to provide the proper disclosures and safeguards required by our securities laws.”⁸ Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, doubled-down on Mr. Gensler’s comments by asserting that “Kraken not only offered investors outsized returns untethered to any economic realities, but also retained the right to pay them no returns at all. All the while, it provided them zero insight into, among other things, its financial condition and whether it even had the means of paying the marketed returns in the first place.”⁹

To settle the SEC’s charges, Kraken agreed to pay $30 million and cease its staking program. Without admitting or denying the allegations in the SEC’s complaint, Payward Ventures, Inc. and Payward Trading, Ltd. also agreed to the “entry of a final judgment, subject to court approval, that would permanently enjoin each of them from violating Section 5 of the Securities Act of 1933 and permanently enjoin them and any entity they control from, directly or indirectly, offering or selling securities through crypto asset staking services or staking programs.”¹⁰

Though cause for celebration in some circles of the SEC who seek to regulate the popular but volatile crypto market, this enforcement action has raised concern in others. Commissioner Hester M. Peirce issued a public statement dissenting from the Kraken settlement.¹¹ In her statement, she issued a harsh rebuke of the Commission’s actions: “Instead of taking the path of thinking through staking programs and issuing guidance, we again chose to speak through an enforcement action . . . [u]sing enforcement actions to tell people what the law is in an emerging industry is not an efficient or fair way of regulating.”¹² Needless to say, Peirce is against regulating through enforcement action. Rather, she would prefer a more collaborative, less punitive system by which the SEC could engage with these operators and work together to determine what the rules are and should be. This is not a novel opinion of Commissioner Peirce. Earlier this year, she delivered remarks to a digital asset conference, recommending that “the SEC should conduct some form of notice and comment process to resolve the thorniest crypto-related policy issues.”¹³ She went on to call upon the SEC to “conduct better, more precise, and more transparent legal analysis.”¹⁴

Commissioner Peirce’s greatest concern regarding the Kraken settlement is the enjoinment against Kraken. “Most concerning . . . is that our solution to a registration violation is to shut down entirely a program that has served people well.”¹⁵ This begs a few questions: Does the punishment fit the crime? After all, the Commission does not allege any fraud, or any actual harm to an investor. Why did the SEC choose to be so heavy-handed against Kraken? Is it possible that something larger is at play?

One theory is that, in the shadow of crypto’s disastrous end to 2022, the Commission feels compelled to be significantly more hawkish in regulating the crypto space. If true, this may lead to overcompensating by the Commission through implementation of punitive measures against actors that may appear to behave, by and large, reasonably. Though not explicit in her remarks, this appears to be at the forefront of Peirce’s mind in connection with the Kraken settlement. It is too early to tell what lies ahead for cryptocurrency regulation, whether by the SEC or Congressional action. In the meantime, however, actors in the crypto space should be cautious about their behaviors and business models, and they would be wise to consult closely with counsel on what the law may or may not require of them.

¹Press Release, Sec. & Exch. Comm’n, Kraken to Discontinue Unregistered Offer and Sale of Crypto Asset Staking-As-A-Service Program and Pay $30 Million to Settle SEC Charges (Feb. 9, 2023), https://www.sec.gov/news/press-release/2023-25.
²Complaint and Demand for Jury Trial at 5-6, Securities and Exchange Commission v. Payward Ventures, Inc. and Payward Trading, Ltd., No. 23-cv-588 (N.D. Cal. Feb. 9, 2023).
³Id. at 10.
⁴See What is staking?, Coinbase, https://www.coinbase.com/learn/crypto-basics/what-is-staking. (last visited Feb. 27, 2023).  
⁵See Benjamin Curry and Farran Powell, Best Crypto Staking Platforms of 2023, Forbes Advisor (Feb. 9, 2023, 7:12 PM), https://www.forbes.com/advisor/investing/cryptocurrency/best-crypto-staking-platforms/.
⁶See 15 U.S.C. §§ 77e(a), (c).
⁷Complaint, supra note 2, at 3.
⁸Press Release, supra note 1.
⁹Id.
¹⁰Id.
¹¹Hester M. Peirce, Commissioner, Sec. & Exch. Comm’n, Public Statement, Kraken Down: Statement on SEC v. Payward Ventures, Inc., et al. (Feb. 9, 2023), https://www.sec.gov/news/statement/peirce-statement-kraken-020923.
¹²Id.
¹³Hester M. Peirce, Commissioner, Sec. & Exch. Comm’n, Speech, Outdated: Remarks before the Digital Assets at Duke Conference (Jan. 20, 2023), https://www.sec.gov/news/speech/peirce-remarks-duke-conference-012023.
¹⁴Id.
¹⁵Peirce, supra note 11.