While acknowledging that its statement “does not alter or amend applicable law,” staff ignores how its conclusions conflict with that applicable law. The applicable law to determine whether something is an investment contract is the Howey test. In multiple enforcement actions, the Commission alleged that staking-as-a-service programs were investment contracts under Howey.[1] Two separate courts upheld the legal basis of these allegations.[2] The Commission recently dismissed one of these actions[3] and today, paving the way for this statement on staking, it dismissed the other.[4] But abandonment of these enforcement actions does not erase the underlying court decisions.

The staff’s analysis may reflect what some wish the law to be, but it does not square with the court decisions on staking and the longstanding Howey precedent on which they are based. This is yet another example of the SEC’s ongoing “fake it ‘till we make it” approach to crypto – taking action based on anticipation of future changes while ignoring existing law. It has been over four months since the launch of the SEC Crypto Task Force, which will supposedly deliver a “clear regulatory framework.”[5] But we still have no hint of whether, when, and how that new framework will come into being. Rather than initiate rulemaking or take other formal regulatory action, the Commission and the Task Force have instead rolled out a flurry of staff statements, enforcement action dismissals, and roundtables. These actions, while celebrated by industry, have not changed the law or set out a path to do so. Rather than promote clarity, this approach continues to sow uncertainty around what the law is and what parts of it the Commission is willing to enforce, which is bad for investors and the markets.

Today’s staff’s statement, the most recent in a series of Howey interpretations declaring that particular crypto products or services are not securities, is premised on the idea that protocol staking is an “administrative or ministerial activity” devoid of entrepreneurial effort. From there, staff concludes that third-party services that stake on behalf of customers are likewise not engaged in entrepreneurial efforts, and so not offering investment contracts under Howey. But investment contracts have been found to exist in a variety of circumstances where a promoter takes an established product or technology— which itself may not be a security or involve entrepreneurial effort— and “buil[ds] an enterprise on top of it.”[6] Besides the staking cases, another good example is Gary Plastic, where a bank program offering certificates of deposit was deemed an investment contract because of its profit-enhancing features not available from typical CDs (which are not themselves securities).[7]

Consistent with this longstanding Howey precedent, courts in the recent SEC enforcement actions ruled that staking services were properly alleged to be investment contracts because, as alleged, they involved entrepreneurial efforts. Through these alleged efforts, the services enhanced profit potential beyond what customers could get from staking on their own, including:

• Pooling of investor assets: pooling “mak[es] it more likely that [a service’s] staking customers will receive returns because [the service] can … amass a considerably larger pool of assets to be staked,” thereby increasing the likelihood that the service will be selected to participate in validation.[8] Pooling is in fact essential to retail participation in staking, because many protocols require users to stake high minimums of assets to be eligible to validate transactions and earn rewards. For example, the Ethereum blockchain has a minimum of 32 ether, currently equal to about $84,612.[9]
• Technical infrastructure and expertise: the staking programs, as alleged, offered “an opportunity to profit from [ ] complex staking infrastructure,” as “deployment of sophisticated and expensive software and hardware” allows the service to more readily earn and distribute returns to investors.[10] The services were thus “designed to attract investors who lacked the technical acumen and hardware requirements to operate on their own.”[11]

Contrary to these decisions, staff concludes that pooling is a mere “Ancillary Service” that is not relevant to the Howey test. Besides pooling, the staff categorizes other common staking service features as “ancillary” and non-managerial, such as “slashing coverage” (indemnifying against losses) and “early unbonding” (increasing liquidity by allowing return of staked assets faster than what the protocol would allow). Yet, courts have found that product features that protect against losses[12] and increase liquidity[13] are indicative of managerial efforts under Howey.

Of course, Howey is a facts-and-circumstances analysis, and it may well be that certain bare-bones staking programs do not rise to the level of investment contracts. It could be useful for the staff to analyze common staking program features (consistent with existing law) and explain why they do or do not constitute managerial efforts. But unfortunately, as with the Division’s other recent Howey statements, the conclusions here are vague generalizations that cannot readily be mapped onto real-world services.

The caveats are as usual found in the footnotes, where staff excludes staking services that decide “whether, when, and how much of” a customer’s crypto assets to stake as outside the scope of the statement and, therefore, possible investment contracts. But staff does not explain what it means in practice for a staking service to make such decisions. Does this implicate technical infrastructure and staking strategies, such as those addressed in the prior court staking decisions? What about staking services that automatically re-stake earned rewards on behalf of customers?

In sum, this statement fails to deliver a reliable roadmap for determining whether a staking service may be an investment contract. And for all its effort to bring protocol staking outside the scope of the securities laws, it still describes these services with terminology that (wrongly) invokes the imprimatur of regulatory protection. For example, the statement defines any third-party to whom crypto is entrusted for staking as a “custodian.” “Custodian” and “custody,” as used in the securities laws, refer to a host of requirements designed to protect customers against loss by requiring registered entities to hold customer assets fairly and safely. No such protections currently exist for customers of staking services. Nor will they if, as the staff asserts, these services are not subject to the securities laws. It is not clear such protections are even available for staked crypto assets, which are subject to the risk of loss through protocol operation (i.e. “slashing”), protocol failure or errors, and hacking or other theft.[14]

Relatedly, the staff insists that even after a person’s crypto is transferred to a service provider’s wallet and locked up in a staking protocol, he or she retains “ownership” of the staked assets “[a]t all times during the staking process.” While this concept certainly applies to securities owners whose securities are custodied by a registered entity like a broker, there is no equivalent legal framework to protect investors who turn over their crypto to a staking service. Ownership rights to some extent may be defined through a customer user agreement, and so will vary from one staking service to another. User agreements may or may not spell out important information affecting risk, such as whether customer assets will be comingled in an omnibus account.[15] User agreements also often contain “lulling” language designed to suggest that customer assets will be protected if the service provider becomes insolvent or declares bankruptcy, when in fact, such language often lacks legal force and the matter will be determined instead by bankruptcy law.[16]

I continue to believe that these staff statements do more harm than good by purporting to carve out broad categories of crypto products without analyzing the realities of how they really work. These statements paint an incomplete picture that obfuscates, rather than clarifies, what the law is. Along the way, they minimize and often misstate the significant risks these products pose to investors and markets. The SEC is the financial regulator charged with overseeing the preeminent U.S. securities markets, a responsibility whose import cannot be overstated. When we choose to speak, at any level of our organization, it should go without saying that we must do so accurately, in a way that serves our vital mission and the public interest.

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