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Coinbase CEO Brian Armstrong.
Patrick T. Fallon/AFP via Getty Images
When the CEO of
Coinbase Global
warned this week that the Securities and Exchange Commission might be considering cracking down on a process called staking, he was onto something.
On Thursday, Kraken, a crypto trading company, agreed to end staking and pay a $30 million fine to the agency, which said offering the product amounted to selling unregistered securities.
Coinbase stock (ticker: COIN) has taken a beating because any crackdown on staking would would be bad for the cryptocurrency broker’s business and likely hurt
Ether,
the largest crypto after
Bitcoin
.
Staking refers to a process that both underpins blockchain networks and offers investors a way to earn yield on their crypto holdings.
While staking doesn’t exist for Bitcoin, it does for Ethereum, one of the biggest blockchains. Holders of Ether—Ethereum’s token—can lock up or stake their tokens as collateral in a process that validates transactions and secures the network, earning money in the process. Current yields for staking Ether are upward of 5%. “Validators” must lock up at least 32 Ether, or about $52,000, to participate in staking on Ethereum.
Coinbase (ticker: COIN), which is itself a validator, has a service that lets investors stake smaller amounts of Ether. There is no minimum amount needed, thus opening up the yield opportunity to a wider pool of people.
Investors earn crypto yield that would otherwise be out of reach, and Coinbase receives a fee: 25% of the Ether yields. Analysts say that is the type of diversification that Coinbase needs, given that revenue from crypto trading has tumbled in tandem with Bitcoin prices over the past year.
“We’re hearing rumors that the SEC would like to get rid of crypto staking in the U.S. for retail customers,” Armstrong said Wednesday on Twitter. “I hope that’s not the case as I believe it would be a terrible path for the U.S. if that was allowed to happen.”
The SEC declined to comment, but Gensler said Thursday in a statement accompanying the Kraken news that the action “should make clear to the marketplace that staking-as-a-service providers must register and provide full, fair, and truthful disclosure and investor protection.”
While Coinbase’s chief legal officer has outlined how the company’s offering is different from Kraken’s, it still looks as if the group’s staking services could be at risk. Coinbase stock tumbled 14% on Thursday and was down again in early Friday trading.
In its second-quarter financial filings last summer, Coinbase disclosed that its staking program was under scrutiny from the SEC, which it said had sent investigative subpoenas and other document requests.
A potential ban on staking would be negative for both Coinbase and Ether. Coinbase would lose a source of high-margin revenue that looks poised to be a pillar of growth. Ether would lose out on the participation of U.S. retail investors—a group that played a big role in cryptos’ latest bull run—in staking. It wouldn’t be crushing to Ethereum’s ability to operate, but rather a hit to the wider adoption of the network, which would support prices.
“The SEC charges against Kraken and comments from SEC Chair Gensler are squarely focused on centralized crypto service providers … staking is not exclusively enabled by centralized crypto service providers, though these centralized crypto service providers do substantially lower barriers to staking participation,” KeyBanc Capital Markets analyst Alex Markgraff wrote in a Thursday note. “We look to better understand the nuance around various staking implementations and staking terms of service across industry participants as it pertains to further SEC action.”
Not surprisingly, Armstrong wants staking to continue.
“Staking is a really important innovation in crypto,” the Coinbase CEO said on Twitter. “It allows users to participate directly in running open crypto networks. Staking brings many positive improvements to the space, including scalability, increased security, and reduced carbon footprints.”
Armstrong, and others, say that staking doesn’t make Ether a security, which would put the coins under the purview of the SEC. But the agency and the broker have had this argument before: The SEC has said that some tokens Coinbase says aren’t securities are just that.
The market is taking the issue seriously. Coinbase stock tumbled 14% Thursday as the worries add to uncertainty for cryptocurrencies and crypto companies that are already facing threats from a bear market in prices, other regulatory pressures, and waning investor interest.
Coinbase stock was off 1.5% Friday morning.
Write to Jack Denton at jack.denton@barrons.com
