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What crypto ‘staking’ really means

The cryptocurrency exchange Kraken made big news last month when it announced a groundbreaking settlement with the Securities and Exchange Commission, shutting down the firm’s “staking-as-a-service” business in the U.S. and paying a $30 million settlement.

The news came as a jolt, in part because of the reputation of the defendant. Kraken is one of the more responsible actors in an industry characterized by reckless business practices. But a bigger shock came in the form of the SEC’s interpretation of “staking.”

To technologists, staking has a straightforward definition based on its purpose in a cryptocurrency network. In proof-of-stake consensus mechanisms, networks are secured by actors running specialized software who are typically required to put funds “at stake” to deter them from acting maliciously. Under this incentive scheme, funds are destroyed (“slashed”) by the network if a participant acts dishonestly. Staking refers to using one’s funds to participate in the security of a decentralized cryptocurrency network by running software—rather than burning electricity, like in a proof-of-work consensus chain.

Staking by exchanges, as pioneered by Coinbase, involves a service-based approach. This is where the practice should have begun and ended—exchanges could act as savvier participants to secure a blockchain network on behalf of some token holders, passing along to them any rewards accrued in the process. On the Tezos platform, Coinbase acts as a delegate for token holders to assign rights to validate and vote on the blockchain. Coinbase makes money by taking a portion of the rewards accrued by running software on their customer’s behalf. This is a modest but consistent revenue steam, and an easy option for less-technical token holders to participate in the Tezos network.

At the peak of the 2020 speculative frenzy, known as “DeFi summer,” however, the definition of staking as a technical practice—a security-ensuring mechanism for a network paired with a small incentive structure—morphed into a catchall phrase to describe everything from risky lending practices to providing liquidity to decentralized exchanges. Some even began invoking staking to describe the “returns” for Ponzi-esque projects like the Terra protocol. The upshot is that many protocols and tokens no longer employ “staking” to describe securing a network, but rather as a marketing term for a dodgy reward system for new users. This has led to many crypto participants, especially less sophisticated ones, conflating “yields” and “stakes” and believing that staking implies double- or triple-digit returns on recently minted tokens.

As Sam Bankman-Fried described in his now-infamous money box analogy, this “weird box staking thing starts out as just this sort of like side show to the bigger story of we’re gonna change the world with the protocol that we just built.” It’s no surprise, given Bankman-Fried’s history with the disgraced FTX exchange, that the “weird box staking thing” propping up crypto markets in 2020 and 2021 proved to be unsustainable.

This is why we can’t have nice things.

Conflating securing a network with marketing a token through the common use of “staking” is a microcosm of what’s plagued the industry rhetorically for the last decade. In blurring the lines between activities like lending, token distribution, Ponzi economics, and…technical security, “staking” now means nothing at all. Like all security measures, the concept was at its best when it was boring. 

Once, there was a rhetorical distinction between the creation of tokens for network security and the creation of tokens as a distribution strategy to promote a new project. Unfortunately, too many projects appropriated the language of network security to describe a distribution scheme that would create good feelings through unsustainably high yields for early participants. While the market capitalization of the industry expanded, nobody felt the need to clarify these two radically different activities. Now that numbers have gone down, the folks who succumbed to peer pressure have started to watch their chickens come home to roost. (My guess is that “stablecoins” will be the next meaningless word to invite scrutiny from regulators.)

A call for precise language in the cryptocurrency space has always felt like a shout into the void. The recent “staking-as-a-service” settlement feels like validation of that lament, and it will be far from the last.

Kathleen Breitman is a cofounder of Tezos. The opinions expressed in commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.

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