Staking and Securities Laws

From a bird’s eye view, node operators may look like shareholders: a person invests ~90$k USD in cryptoassets (DASH) via staking to be a ‘Masternode’ operator, which confers the right to collect block rewards (~564$ per month). These rewards one might conceive as a kind of dividend— a dividend with a ~7% yield compared to the more typical 3-5%, though not factoring in node operating costs. Direct management of protocol development, marketing, research, PR, etc falls on various teams, with masternodes voting to retain or change teams through funding decisions, a relationship analogous in respects as that of shareholders to company directors.

It is of little wonder then that authors like Grant Gulovsen ask “do masternodes involve investment contracts.” The question is at once familiar and novel; arguments whether a given cryptoasset passed or failed the Howey test, hence whose token sale would be regulated as a security, abounded in 2017, and ongoing legal rulings, like that on Telegram, are determining sales’ legal status, with substantial implications for industry practice. Yet, past discussions of securities laws have typically focused on the initial sale or distribution of a cryptoasset— the notion that certain staking arrangements might constitute investment contracts is largely new territory.

In general, staking can confer risk to investors (stakers) in that it can make illiquid staked cryptoassets: where staked cryptoassets are ‘locked’, an investor cannot exit a position when the staked asset changes in value. Staking, of course, is not homogenous in function across protocols—arguments that staking categorically constitute security investments are hardly worth entertaining. The nature of staking rewards is different across types of networks, with such details providing context crucial for interpreting whether rewards from staking constitute profits derived from the efforts of others. For example, in protocols like Bitcoin, Monero, and Dash, which function as monetary networks, blockrewards constitute a certain distribution of inflation rather than profits, while in certain DeFi protocols staking is promoted as revenue sharing.

Legal classifications have been and likely will continue to be a challenging exercise in the blockchain industry. While the discussion here does not do the topic of staking and securities laws full justice—there is plenty more to say on the subject—the topic is nevertheless worth pondering for those developing staking token functions.