The Four Cracks in the Crypto Business Model

The four horsemen of the crypto apocalypse are currently trampling over the sector’s 2023 aspirations.

This, as the post-FTX digital asset landscape finds itself facing brute-force regulatory pressures in the U.S., increasingly disinterested retail investors, a potentially unbanked future, and now, per the Security and Exchange Commission’s (SEC) latest settlement, a dire threat to staking, an innovative product many crypto companies have “staked” their future retail hopes to.

Even nominal crypto asset Bitcoin’s recent rebound has cooled, with the coin’s price sinking to a three-week low below $22,000 as the broader cryptocurrency market itself sheds $40 billion in value.

Read More: In 2023, Crypto Must Focus on Transparency and Security

On its fourth quarter 2022 earnings call, retail trading platform Robinhood, which lost almost a million monthly users near the end of the year, told investors that its crypto business has hit the buffers as retail investor appetite for speculative assets continues to be sapped by both panic around a looming crypto crackdown and higher interest rates.

It is also getting harder for crypto businesses to gain access to traditional banking services, as even those emergent financial institutions that previously centered their business models on catering to the industry are now cooling on it after suffering steep losses.

Custodia Bank, a new institution founded to specialize in digital asset payment and custody solutions for U.S. commercial customers and which is not yet in operation, recently had its application for membership in the U.S. Federal Reserve denied.

As reported by PYMNTS, Binance, the world’s largest cryptocurrency exchange, temporarily suspended U.S. dollar bank transfers earlier this week (Feb. 8), a move that observers speculated was related to the exchange’s difficulty accessing banking services.

Cici Lu, founder of blockchain adviser Venn Link Partners, was quoted in a Bloomberg report (Feb. 9) as saying there is “wild speculation going around that the crypto sector is going to find it harder to access banking services in the U.S.”

What’s at Stake With Crypto Staking

But it is the SEC’s $30 million settlement with U.S.-based crypto exchange Kraken around its staking product that many observers consider to be the biggest recent development in the crypto sector, and one that could have a far-reaching impact on an industry already sweating under regulatory skepticism tied to the collapse of FTX.

“Whether it’s through staking-as-a-service, lending or other means, crypto intermediaries must provide the proper disclosures and safeguards required by our laws.” SEC Chairman Gary Gensler said.

Major crypto exchanges, including Coinbase and Binance, have themselves waded into providing crypto-staking products to diversify their revenues. Coinbase is the second-largest depositor of staked Ether, according to tracker Etherscan.

The SEC alleged that Kraken’s staking service was an illegal sale of securities and that its crypto-staking products broke the rules. Kraken did not admit or deny the allegations but agreed to pay a $30 million fine and discontinue its products in the U.S. as part of its settlement.

Coinbase shares fell the most in more than half a year on the news.

Staking works by letting holders of tokens that allow staking — and not all cryptocurrencies do, for example, Bitcoin uses a proof of work mechanism, not proof of stake, making it ineligible — generate yields by allowing their tokens to be used to facilitate transactions on a blockchain.

According to the SEC complaint, Kraken offered its users yields as high as 21%.

“Staking is a really important innovation in crypto … We need to make sure that new technologies are encouraged to grow in the U.S., and not stifled by lack of clear rules. When it comes to financial services and web3, it’s a matter of national security that these capabilities be built out in the U.S.,” tweeted Coinbase CEO Brian Armstrong.

“Regulation by enforcement doesn’t work. It encourages companies to operate offshore, which is what happened with FTX,” he added.

At least one SEC Commissioner disagrees with the agency’s own allegations.

Commissioner Hester Peirce dissented in a statement, “Today, the SEC shut down Kraken’s staking program and counted it as a win for investors. I disagree and therefore dissent … Instead of taking the path of thinking through staking programs and issuing guidance, we again chose to speak through an enforcement action.”

“Most concerning, though, is that our solution to a registration violation is to shut down entirely a program that has served people well … A paternalistic and lazy regulator settles on a solution like the one in this settlement,” she added.

Coinbase’s Chief Legal Officer Paul Grewal separately alleged that the SEC is taking a brute-force approach to classifying cryptocurrencies as securities with its recent actions.

“The term ‘investment contract’ requires — as the statute says — a contract. But here there are no contracts, written or implied. The developers who created the tokens at issue have no obligations whatsoever to purchasers who later bought those tokens on the secondary market. And with zero contractual relationship, there cannot be an ‘investment contract,’” reads a recent legal filing from the company.  

The rule of law matters, and crypto companies are starting to wise up and make their case. What happens for the industry next remains to be seen.

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