SEC Article: What Types of POS and Staking Activities Are Not Considered Securities?

Author: Division of Corporation Finance, U.S. Securities and Exchange Commission

Compiled by: Wu Says Blockchain

Introduction

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 has expressed its views on so-called "staking" activities, particularly those conducted in networks that use Proof-of-Stake (PoS) as a consensus mechanism (hereinafter referred to as "PoS Networks").

This statement focuses on the following situations: the staking involves crypto assets that are intrinsically related to the programmatic operation of public, permissionless blockchain networks. These assets are used to participate in the consensus mechanism of the network and thus earn rewards, or to maintain the technical operation and security of the network, thereby receiving incentives. In this statement, we refer to such crypto assets as "Covered Crypto Assets" and their staking activities in PoS Networks as "Protocol Staking."

Protocol Staking

Blockchain networks rely on cryptography and economic mechanisms to reduce dependence on centralized trusted intermediaries, thereby enabling the verification of network transactions and providing settlement assurances to users. The operation of each network is governed by an underlying software protocol (composed of computer code) that programmatically executes 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") maintaining a peer-to-peer network to reach consensus on the "state" of the network. The network state refers to authoritative ledger records of address balances, transactions, smart contract code, and other data. Public, permissionless networks allow users to participate in the operation of the network, including validating new transactions according to the network's consensus mechanism.

Proof of Stake (PoS) is a consensus mechanism used to prove that participating node operators have contributed value to the network; in some cases, if their behavior is dishonest, that portion of value may be forfeited. In PoS Networks, node operators must stake the Covered Crypto Assets of the network to gain the authority to validate new block data and update the authoritative ledger records of the network through programmatic selection by the underlying software protocol. 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 Covered Crypto Assets by the network according to its underlying protocol;

· Transaction fees paid by users wishing to write their transactions into the network, part of which is paid to Validators in the form of Covered Crypto Assets.

In PoS Networks, node operators must commit and "stake" Covered Crypto Assets to be eligible to participate in validation and earn rewards. This process is typically implemented through smart contracts, which are automated programs used to perform required operations within the network automatically. During the staking period, the Covered Crypto Assets will be "locked" and cannot be transferred for a certain period as stipulated by the applicable protocol. It is important to note that Validators do not actually possess or control the staked Covered Crypto Assets, meaning that ownership and control of the assets remain unchanged during the staking period.

The underlying software protocol of each PoS Network contains rules regarding the operation and maintenance of the network, including methods for selecting Validators from node operators. Some protocols randomly select Validators, while others set specific criteria, such as selecting based on the amount of Covered Crypto Assets staked by node operators. Additionally, various protocols may also establish rules to prevent harm to the network's security and integrity, such as preventing the validation of invalid blocks or "double-signing." "Double-signing" refers to a Validator attempting to write the same transaction into the network multiple times, effectively constituting multiple expenditures of the same crypto asset.

The rewards generated from Protocol Staking provide economic incentives for participants to use Covered Crypto Assets to secure the PoS Network and maintain its ongoing operation. An increase in the number of staked Covered Crypto Assets helps enhance the security level of the PoS Network and reduces the potential risk of malicious parties controlling a majority share of the staked assets. If a malicious entity controls a 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 serving as node operators and staking their own Covered Crypto Assets. When self-staking (also known as "independent staking"), holders retain ownership and control over their Covered Crypto Assets and their cryptographic private keys throughout the process.

Additionally, holders of Covered Crypto Assets can choose not to run their own nodes and participate in the PoS Network's validation process through a "self-custodial staking" method by directly collaborating with third parties. In this case, asset holders delegate their validation rights to third-party node operators. When using third-party node operators, holders of Covered Crypto Assets can receive a portion of the staking rewards, while the third party providing validation services will also receive a corresponding share of the rewards. In self-custodial staking directly with third parties, holders of Covered Crypto Assets still retain ownership and control over their Covered Crypto Assets and private keys.

Besides self-staking (or independent staking) and self-custodial staking directly through third parties, Protocol Staking also includes a third form known as "custodial staking." In this method, a third party (i.e., the "Custodian") holds the Covered Crypto Assets of asset holders in custody and performs staking operations on behalf of the asset holders. When asset holders deposit their Covered Crypto Assets with the Custodian, the Custodian keeps the deposited assets in a digital "wallet" controlled by it. The Custodian performs staking operations on behalf of the asset holders at a pre-agreed reward rate, which can be done using its own nodes or through selected third-party node operators. In the latter case, the Custodian is only responsible for the decision-making regarding node selection during the staking process.

Furthermore, the custodial Covered Crypto Assets must meet the following conditions:

1. They must not be used by the Custodian for operations or other general business purposes;

2. They must not be lent, pledged, or re-staked for any reason;

3. They must be safeguarded in a manner that does not allow third parties to assert rights over them.

To this end, the Custodian must not use the custodial Covered Crypto Assets for leveraged operations, trading, speculation, or other autonomous activities.

Views of the Division of Corporation Finance on Protocol Staking Activities

The Division of Corporation Finance believes that "Protocol Staking Activities" (as defined below) related to Protocol Staking do not constitute the issuance and sale of securities as defined in Section 2(a)(1) of the Securities Act of 1933 or Section 3(a)(10) of the Exchange Act of 1934. Therefore, the Division believes that parties involved in Protocol Staking Activities are not required to register such Protocol Staking 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 set forth in the Securities Act.

Protocol Staking Activities Covered by this Statement

The views of the Division of Corporation Finance apply to the following activities and transactions related to Protocol Staking (collectively referred to as "Protocol Staking Activities" and individually as "Protocol Staking Activity"):

· Staking Covered Crypto Assets on PoS Networks;

· Activities conducted by third parties participating in the Protocol Staking process, including but not limited to the roles and actions of third-party node operators, Validators, Custodians, Delegates, and Nominators (collectively referred to as "Service Providers") in obtaining and distributing rewards;

· Providing ancillary services (as defined below).

This statement only applies to Protocol Staking Activities related to the following types of Protocol Staking forms:

· Self-Staking: Refers to node operators staking their own Covered Crypto Assets using their own resources. The node operator can be an individual or a group of individuals jointly operating a node and staking their Covered Crypto Assets.

· Self-Custodial Staking Directly with a Third Party: Refers to a situation where the node operator obtains validation rights from the owners of Covered Crypto Assets according to the terms of the protocol. In this structure, rewards may be directly distributed by the PoS Network to the holders of Covered Crypto Assets or indirectly distributed through the node operator.

· Custodial Arrangements: Refers to situations where the Custodian performs staking operations on behalf of the owners of Covered Crypto Assets. For example, a crypto asset trading platform holds the Covered Crypto Assets deposited by clients on their behalf, and if the PoS Network allows staking in the client's name with the client's consent, the platform can stake on behalf of the client. The Custodian can stake using its own nodes or choose third-party node operators. In the latter case, the Custodian is only responsible for the decision-making regarding node selection during the staking process.

Discussion Related to Protocol Staking Activities

Sections 2(a)(1) of the Securities Act and 3(a)(10) of the Exchange Act define the term "security" by enumerating various financial instruments (such as "stocks," "notes," "bonds," etc.). Since Covered Crypto Assets do not fall within the categories of financial instruments explicitly listed in these provisions, we apply the "investment contract" standard established in the SEC v. W.J. Howey Co. case when analyzing certain Protocol Staking transactions involving Covered Crypto Assets. The "Howey Test" is used to examine arrangements or financial instruments not explicitly listed in the relevant legal provisions, with the core basis being the "economic substance" of the transaction or arrangement.

When assessing the economic substance of a transaction, the determining factor is whether there is an investment of money in a common enterprise, and whether that investment is based on a reasonable expectation of profits derived from the entrepreneurial or managerial efforts of others. Since the Howey case, federal courts have further elaborated on this standard, indicating that when the efforts of parties other than the investor are undeniably key efforts—those core managerial efforts that decisively impact the success or failure of the enterprise—the "efforts of others" requirement 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.

1. Self-Staking:

Node operators engaging in self-staking (or independent staking) do not do so based on a reasonable expectation of profits derived from 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 and facilitate its operation by validating new blocks, thereby qualifying for rewards issued by the PoS Network according to the underlying protocol. 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 actions of node operators are merely administrative or ministerial in nature, aimed at ensuring the operation of the network and facilitating block validation. The expectation of rewards for node operators does not rely on any third party's managerial or entrepreneurial efforts for the success of the PoS Network; rather, this economic incentive entirely stems from the ministerial nature of Protocol Staking. Therefore, such rewards are essentially compensation for the services provided by the PoS Network to the node operators, rather than a distribution of profits derived from the efforts of others.

2. Custodial Arrangements:

In custodial arrangements, the Custodian (whether or not it is a node operator) does not provide entrepreneurial or managerial efforts to the Covered Crypto Asset holders it serves. This arrangement is similar to the aforementioned situation where holders delegate their validation rights to third parties, but it also involves the asset holders entrusting their deposited Covered Crypto Assets to a third party for custody. In this arrangement, the Custodian does not decide whether to stake, when to stake, or how much Covered Crypto Assets to stake. The Custodian merely acts as an agent for the asset holders, executing staking operations on their behalf for the Covered Crypto Assets they have deposited. Furthermore, the Custodian's custody of the Covered Crypto Assets, as well as its decision-making regarding node selection in certain cases, is fundamentally administrative or ministerial in nature and does not constitute the managerial or entrepreneurial efforts required by the "efforts of others" standard in the Howey Test. Additionally, while the Custodian may deduct fixed or proportionate fees from the rewards payable to the Covered Crypto Asset holders, it does not guarantee, set, or fix the specific amount of rewards that the holders are entitled to receive.

3. Ancillary Services:

Service Providers may offer the following services (collectively referred to as "Ancillary Services") to assist Covered Crypto Asset holders in participating in Protocol Staking. The aforementioned Ancillary Services are fundamentally administrative or ministerial in nature and do not involve entrepreneurial or managerial efforts. These services constitute a general activity—namely, Protocol Staking—which itself does not possess entrepreneurial or managerial characteristics.

· Slashing Coverage: Refers to the compensation or reimbursement provided by Service Providers to staking clients for losses incurred due to errors made by node operators when slashing penalties occur. This protective mechanism against node errors is similar to guarantees provided by service providers in traditional commercial transactions.

· Early Unbonding: Refers to the allowance by Service Providers for the early return of Covered Crypto Assets to asset holders before the end of the unbonding period set by the protocol. This service is essentially a convenience that shortens the actual unbonding period for Covered Crypto Asset holders, reducing the time cost of having their assets frozen.

· Alternate Rewards Payment Schedules and Amounts: Refers to situations where the timing frequency or amount of rewards paid by Service Providers differs from what is set by the protocol. For example, rewards may be paid early or at a lower frequency than stipulated by the protocol, provided that the reward amounts are not fixed, not guaranteed, and do not exceed the total rewards set by the protocol. This service is similar to "Early Unbonding," merely providing administrative convenience to Covered Crypto Asset holders in the reward distribution and payment process.

· Aggregation of Covered Crypto Assets: Refers to the function provided by Service Providers to aggregate assets for Covered Crypto Asset holders to meet the staking thresholds of the protocol. This service is part of the validation process, which itself has administrative or ministerial characteristics. Without other factors, the act of aggregating assets solely for the purpose of staking is fundamentally an administrative or ministerial operation.