Ether Liquid Staking Platforms Will Benefit as SEC Actions Likely Fail to Deal DeFi's Knockout Blow

Crypto exchange Kraken and the U.S. Securities and Exchange Commission (SEC) have settled over staking.

The regulated Kraken exchange has to pay a $30 million penalty and immediately cease its U.S. service. But, more importantly, staking continues in the United States. Staking refers to locking tokens for a set period of time to help support the operation of a blockchain. Liquid staking, on the other hand, issues a derivative token that represents the amount of locked tokens to user, allowing them to access decentralized finance (DeFi) services such as lending and borrowing.

The way Kraken offered staking was unique, which is why the exchange’s service was shuttered and the SEC didn’t go after Coinbase or make a move on decentralized liquid staking protocols.

As Coinbase Chief Legal Officer Paul Grewal explained in a statement: “What’s clear from today’s announcement is that Kraken was essentially offering a yield product. Coinbase’s staking services are fundamentally different and are not securities.”

On Coinbase, rewards paid out are based on the protocol and the exchange discloses its commissions, Grewal explained in a statement.

Lack of staking transparency affects Kraken

Central to the SEC’s statement is a lack of transparency on Kraken’s part. Yes, on-chain data shows that Kraken is one of the largest validators, operating a big staking pool. But the SEC seems to be concerned about fund flow: Is ether deposited into Kraken intended for staking really going to staking? Or is it being lent out?

Liquid staking protocols such as Lido and Rocket Pool wouldn’t have that same problem. One could track their ether from their wallet into the pool via a block explorer or other chain monitoring tools.

In the initial hours after the market learned about the SEC’s interest in going after staking, via a Brian Armstrong tweet, liquid staking tokens such as Lido’s LDO surged and surged again when Kraken’s U.S. staking shop closed its doors.

Some have argued these tokens surged because their decentralized nature would make them immune from American rules and mandate.

As crypto lawyer Preston Byrne pointed out in 2021 when analyzing the social network project BitClout, most decentralization is just theater.

There’s usually a server controlled by someone who pays the bills and has admin privileges. In an interview last year with CoinDesk, the co-founder of Ethereum mixer Tornado Cash said the protocol is autonomous and unstoppable. Yet, developers working on the protocol have been arrested on charges of facilitating money laundering.

A more reasonable explanation of the surge could come down to the SEC’s current "Yellow Light" towards staking. Staking as an investment strategy is not allowed, but staking as a technical service is.

As crypto lawyer Gabriel Shapiro tweeted: “Validation-as-a-service is not like an ‘earn’ program, not like taking capital into a business or fund. It’s a ministerial tech service.”

TVL gains remain muted

One thing that’s rather telling is that the total value locked of liquid staking protocols like Lido or Rocket Pool didn’t rise in the aftermath.

Since the start of the year, the total value locked in Lido has remained stable: It began the year at 4.9 million ether on Jan. 1, and is now around 5.19 million ether. Rocket Pool staked ether rose from around 472,000 to 608,000 during the same time period.

Meanwhile, LDO and RPL are up 13.2% and 17.4% respectively, a sign that staking is here to stay.