What’s at Stake?
Here’s how custody battles will shape crypto’s future.
As proof-of-stake (PoS) enters into prominence with the completion of Ethereum’s “merge”, regulators such as the SEC and the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) are taking interest. FinCEN has a history of regulating digital assets by enforcement and has previously applied Bank Secrecy Act (BSA) guidelines to BTC mining. Given this history, one can assume the next discussion could involve potential BSA obligations on staking–especially for stake pool operators (SPOs).
Although not legally binding, FinCEN’s 2019 guidance provides insight into the regulator’s approach to Money Service Business (MSB) regulation and cryptocurrencies. Section 5.4 addresses mining pool leaders and situations where they could be money transmitters subject to MSB regulation. Under this section, a mining pool leader is not a money transmitter if their relationship with the members of the mining pool is non-custodial, meaning the leader is not in control of others’ assets. Therefore, we can likely infer the custodial relationship between SPOs and staker’s will play a similar role in FinCEN’s impending interpretation of stake pools.
The nature of custodial relationships can vary greatly depending on the PoS network. Some staking mechanisms allow non-custodial–assets to remain in the staker’s wallet, providing complete autonomy. Other staking pools require custodial relationships, such as turning over private keys. This relationship will likely be a major factor in FinCEN’s analysis of staking pools for MSB purposes.
What does this mean? If a staking pool operator is in essence hosting a wallet they would very likely be deemed a money transmitter, necessitating the acquisition of a Money Transmitter’s License.
How exactly this will play out is unclear, but it is important for the industry and SPOs to start preemptively considering these interpretations and taking steps to ensure any pending regulatory interpretations from FinCEN do not cause a chilling effect on staking pools. Failing to do so could create some less than ideal situations for operators and participants alike.
To comply with BSA obligations an entity–in this case the staking pool operator–would have to complete KYC (Know Your Customer) verification of its stakers. Detailed and consistent record keeping of pool activity would likely be required as well, possibly necessitating human intermediaries to vet stakers joining the pool. This type of data collection violates one of the fundamental principles of cryptocurrencies; the establishment of trustless peer-to-peer networks governed by code rather than fallible human intermediaries. Indeed, there is no legitimate business or regulatory purpose for a SPO to need the personal information provided by KYC compliance, because only a staking address or wallet address is necessary for the operation of the protocol and because the public ledger reduces information asymmetries. This is unlike traditional financial systems which require personal information to conduct transactions. Essentially, this collection of data would serve no purpose but to satisfy government audits when prompted.
A proactive and realistic approach to these regulatory concerns is likely to prove wise. The fact remains regulators and legacy financial institutions would love nothing more than to see crypto bend and adhere to the traditions built deep into the foundations of Wall Street. We must remain cognizant of this and stay light on our feet; lest we become what we have fought to leave behind.
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