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US SEC: What types of POS and stake activities are not considered securities?
Author: SEC Office of Corporate Finance
Compiled by: Wu Says Blockchain
Introduction:
In order to further clarify the applicability of federal securities laws in the field of crypto assets, the Division of Corporation Finance of the U.S. Securities and Exchange Commission (SEC) has expressed its views on so-called "staking" activities, particularly those conducted in networks that use Proof-of-Stake (PoS) as their consensus mechanism (hereinafter referred to as "PoS networks").
This statement focuses on the following situation: the staked assets are those crypto assets that are related to the programmatic operational nature of public, permissionless blockchain networks. These assets are used to participate in the consensus mechanism of the network and thereby earn returns, or are used to maintain the technical operation and security of the network and thus receive rewards. In this statement, we refer to such crypto assets as "Covered Crypto Assets" and their staking behavior in PoS networks as "Protocol Staking."
Protocol Staking
The blockchain network relies on cryptography and economic mechanism design to reduce reliance on centralized trusted intermediaries, thereby achieving transaction verification and providing settlement guarantees to users. The operation of each network is dominated by underlying software protocols (composed of computer code), which programmatically execute specific network rules, technical requirements, and reward distribution mechanisms. Each protocol embeds a "consensus mechanism," which is a method that allows distributed computer systems (referred to as "nodes") to reach a consensus on the "state" of the network. The so-called network state refers to the authoritative ledger records of address balances, transactions, smart contract code, and other data. Public, permissionless networks allow users to participate in the network operation, including verifying new transactions based on the network's consensus mechanism.
Proof of Stake (PoS) is a consensus mechanism used to prove that the node operators participating in the network have contributed value to it; in certain cases, if their behavior is dishonest, that portion of the value may be forfeited. In a PoS network, node operators must stake the covered cryptocurrency assets of the network in order to gain the permission to validate new block data and update the network's authoritative ledger records through the automatic selection by the software protocol of the network. Once selected, the node operator will serve as a "Validator." In return for providing validation services, validators can earn two types of "rewards":
Newly generated and distributed encrypted assets based on the underlying protocol programmed by the network;
Transaction fees paid by users who wish to write their transactions to the network, of which a portion is paid to validators in the form of crypto assets.
In a PoS network, node operators must commit and "stake" covered cryptocurrency assets to be eligible for validation and rewards. This process is typically implemented through smart contracts, which are automated programs used to execute the required operations automatically within the network. During the staking period, the covered cryptocurrency assets will be "locked" and cannot be transferred for a certain period as per the applicable protocol's provisions. It is worth noting that validators do not actually possess or control the staked covered cryptocurrency assets, meaning that ownership and control of the assets remain unchanged during the staking period.
The underlying software protocols of each PoS network include rules regarding the operation and maintenance of the network, including the method for selecting validators from node operators. Some protocols randomly select validators, while others set specific criteria, such as choosing based on the amount of crypto assets staked by the node operators. Additionally, various protocols may also establish rules to prevent threats to the security and integrity of the network, such as preventing the validation of invalid blocks or "double signing" behaviors. "Double signing" refers to validators attempting to write the same transaction multiple times to the network, which effectively amounts to spending the same crypto asset multiple times.
The rewards brought by staking agreements provide economic incentives for participants to use covered crypto assets to ensure the security and continuous operation of the PoS network. The increase in the number of covered crypto assets staked helps enhance the security level of the PoS network and reduces potential risks, such as a malicious party controlling the majority share of the total staked assets. If a malicious entity holds the majority of the staked covered crypto assets, it will have the ability to manipulate the PoS network, including influencing the transaction validation process and even altering the network's transaction ledger records. Holders of covered crypto assets can earn rewards by acting as node operators and staking their own covered crypto assets. During self-staking (also known as "independent staking"), holders retain full ownership and control over their covered crypto assets and their crypto private keys throughout the entire process.
Additionally, crypto asset holders can choose not to run their own nodes and instead participate in the PoS network validation process through a "self-custody staking" method by collaborating directly with third parties. In this case, asset holders delegate their validation rights to third-party node operators. When using third-party node operators, crypto asset holders can earn a portion of the staking rewards, while the third parties providing validation services will receive a corresponding proportion of the rewards for their transaction validation services. When directly engaging in self-custody staking with third parties, crypto asset holders still retain ownership and control over their crypto assets and private keys.
In addition to self-staking (also known as independent staking) and self-custody staking directly through third parties, protocol staking also includes a third form, known as "custodial staking." In this approach, a third party (the "custodian") holds the covered cryptocurrency assets for the asset holder and performs staking operations on behalf of the asset holder. When the asset holder deposits their covered cryptocurrency assets with the custodian, the custodian keeps the deposited assets in a digital "wallet" under their control. The custodian performs staking operations on behalf of the asset holder at a pre-agreed reward rate, which can be done using their own nodes or through selected third-party node operators. Throughout the staking process, the covered cryptocurrency assets are always controlled by the custodian, while the ownership of the covered cryptocurrency assets remains with the asset holder.
In addition, the custodial coverage of crypto assets must meet the following conditions:
Shall not be used by the custodian for operations or other general commercial purposes;
Shall not be lent, mortgaged, or rehypothecated for any reason;
It must be kept in a manner that does not give rise to claims by third parties.
To this end, the custodian shall not use the entrusted assets covering cryptocurrencies for leverage operations, trading, speculation, or other autonomous activities.
The opinion of the company's finance department on the agreement pledge activities.
The company's finance department believes that the "Agreement Pledge Activities" related to agreement pledges (as defined below) do not constitute the issuance and sale of securities as referred to in Section 2(a)(1) of the Securities Act of 1933 and Section 3(a)(10) of the Securities Exchange Act of 1934. Therefore, the finance department believes that parties involved in agreement pledge activities are not required to register such agreement pledge activities with the U.S. Securities and Exchange Commission (SEC) under the Securities Act, nor do they need to rely on the registration exemption provisions established by the Securities Act.
The agreement staking activities covered by this statement
The opinions of the company's finance department apply to the following activities and transactions related to agreement pledges (broadly referred to as "agreement pledge activities" and individually as "agreement pledge activity"):
· Stake cryptocurrency assets on a PoS network;
· The roles and actions of third parties involved in the protocol staking process, including but not limited to third-party node operators, validators, custodians, delegates, and nominators (collectively referred to as "service providers") in obtaining and allocating rewards;
· Provide ancillary services (definition see below).
This statement only applies to the pledge activities related to the following types of agreements:
Self or Solo Staking: Refers to node operators using their own resources to stake the crypto assets they own and control. These node operators can be an individual or multiple people jointly operating the node and staking their covered crypto assets.
Self-Custodial Staking Directly with a Third Party: Refers to the verification rights obtained by node operators on behalf of cryptocurrency asset owners according to the terms of the agreement. Under this structure, rewards may be distributed directly by the PoS network to the cryptocurrency asset holders or distributed indirectly through the node operators.
Custodial Arrangements: Refers to the custodian executing staking operations on behalf of the owners of the crypto assets. For example, a crypto asset trading platform holds the crypto assets deposited by customers on their behalf. If the PoS network allows staking in the customer's name and obtains the customer's consent, the platform can stake on behalf of the customer. The custodian can stake through proprietary nodes or choose third-party node operators. In the latter case, the custodian is only responsible for the decision-making related to node selection during the staking process.
Discussion on Staking Activities
The Securities Law Article 2(a)(1) and the Securities Trading Law Article 3(a)(10) both define the term "securities" by enumerating various financial instruments (such as "stocks", "notes", "bonds", etc.). Since covering crypto assets does not fall under the categories of financial instruments explicitly listed in these articles, when analyzing certain protocol staking transactions involving crypto assets, we apply the "investment contract" standard established in the case of SEC v. W.J. Howey Co. The "Howey test" is applicable for examining arrangements or financial instruments that are not explicitly listed in the relevant legal provisions, with the core basis being the "economic substance" of the transaction or arrangement.
When evaluating the economic substance of a transaction, the criterion is: whether there is an investment of funds in a joint venture, and whether that investment is based on a reasonable expectation of profits derived from the entrepreneurial or managerial efforts made by others. Since the Howey case, federal courts have further elaborated on this standard, stating that when the efforts expended by third parties, other than the investors, are undeniably key efforts—specifically those core managerial efforts that have a decisive impact on the success or failure of the enterprise—the requirement for "efforts of others" in the Howey test is satisfied. Furthermore, federal courts have clarified that administrative or ministerial activities do not constitute the managerial or entrepreneurial efforts required to meet the "efforts of others" standard in the Howey test.
Node operators engaging in self-staking (also known as independent staking) do not base their reasonable expectations of profit on the entrepreneurial or managerial efforts of others. Instead, node operators invest their own resources and stake their own covered crypto assets to secure the PoS network by validating new blocks and facilitating its operation. According to the provisions of the underlying network protocol, they are eligible to receive rewards distributed by the PoS network. To earn rewards, the actions of node operators must comply with the protocol rules. By staking their own covered crypto assets and participating in protocol staking, the activities of node operators are merely administrative or transactional actions aimed at ensuring network operation and facilitating block validation. The expectation of rewards for node operators does not rely on any third-party managerial or entrepreneurial efforts contributing to the success of the PoS network; rather, this economic incentive entirely stems from the transactional nature of protocol staking. Therefore, such rewards are essentially compensatory payments from the PoS network for the services provided by node operators, rather than profit distributions from the efforts of others.
In an escrow arrangement, the custodian, whether or not it is a node operator, does not provide entrepreneurial or managerial efforts to the holders of covered cryptoassets it serves. This arrangement is similar to the situation in which the holder delegates its verification rights to a third party, but it also involves the asset holder entrusting the Covered Crypto Assets deposited by the asset holder to a third party for safekeeping. In this arrangement, the custodian does not decide if, when, or how much of the Covered Crypto Assets will be staked. The custodian only acts as an agent on behalf of the asset holder to perform staking operations on the covered crypto assets deposited by it. In addition, the custodian's custody of crypto-assets, and in some cases, the selection of node operators, are administrative or transactional in nature and do not constitute managerial or entrepreneurial efforts as required by the "efforts of others" element in the Howey test. Further, while the custodian may deduct a fixed or prorated fee from the rewards payable to holders of Covered Cryptoassets, it does not guarantee, set or fix the specific amount of rewards due to holders.
Service providers may offer the following services (collectively referred to as "Affiliate Services") to assist cryptocurrency asset holders in participating in protocol staking. The aforementioned types of Affiliate Services are essentially administrative or transactional operations and do not involve entrepreneurial or managerial efforts. These services constitute a component of a general action — protocol staking — which itself does not possess entrepreneurial or managerial nature.
Slashing Coverage: Refers to the compensation or reimbursement provided by the service provider to staking clients for losses caused by the operational errors of node operators when slashing penalties occur. This protective mechanism, designed to prevent node errors, is similar to the guarantees provided by service providers in traditional commercial transactions.
Early Unbonding: Refers to the service provider allowing the early return of covered crypto assets to asset holders before the end of the unbonding period set by the agreement. This service is essentially just for convenience, shortening the actual unbonding period of the agreement for covered crypto asset holders, in order to reduce the time cost of their assets being frozen.
Alternate Rewards Payment Schedules and Amounts: This refers to situations where the service provider differs from the agreement in the frequency or amount of reward distribution. For example, rewards may be paid out earlier or the payment frequency may be lower than stipulated in the agreement, with the condition that the reward amount is not fixed, is not guaranteed, and does not exceed the total reward amount set in the agreement. This type of service is similar to "early unbinding," and is intended to provide administrative convenience for cryptocurrency holders during the reward allocation and distribution process.
Aggregation of Covered Crypto Assets: Refers to the function provided by service providers to aggregate the assets of crypto asset holders to meet the staking threshold of the protocol. Such services are part of the verification process, which inherently has administrative or transactional characteristics. In the absence of other factors, the act of achieving staking purposes solely through asset aggregation is essentially an administrative or transactional operation.