Staking in an EU Regulatory Setting

A week ago, The European Blockchain Association released a paper, featuring insights from prominent figures in the blockchain industry; including one of our valued portfolio projects, Blockpit. This publication delves into the intricacies of staking activities within the European regulatory landscape, examining various staking models.

While many regulatory aspects remain open-ended, awaiting further research and discussion, the paper has offered invaluable insights. In this summary, We present key findings from the paper and extend our gratitude to the contributors from IOTA, Dentons, INATBA and Tangany for their significant contributions.

AIFMD and Staking

AIF stands for Alternative Investment Funds, and one of the key regulatory frameworks associated with it is AIFMD (the Alternative Investment Fund Managers Directive). The AIFMD is designed to provide oversight and regulation for alternative investment funds.

Under certain specific criteria, staking activities can fall under the purview of AIF in accordance with the AIFMD. When investments are gathered collectively from multiple investors and adhere to a well-defined investment policy, they may qualify as alternative investment funds. Determining whether staking activities in DeFi protocols meet the “defined policy” criteria, can be challenging because DeFi protocols’ liquidity pools are automated and lack intermediaries. Some DeFi protocols that could potentially qualify as AIFs include Aave, Uniswap, and Compound Finance.

Classifying staking activities as AIFs under the AIFMD structures can sometimes be subjective. Technical or native staking, for instance, does not fall within the scope of AIF, as it does not involve coordinated strategic pooling of assets or centralized management. However, the regulatory landscape may differ for other forms of staking activities.

AIF amd StaaS Providers

The act of distribution within a StaaS (Staking-as-a-Service) provider’s operations, could potentially bring it into the realm of AIFs. Furthermore, these providers establish specific trigger points within their smart contracts, governing the distribution of rewards in the form of tokens. This setup might subject their distribution processes to AIF regulation.

However, it’s important to note that liquid staking stands apart from AIF classification. In liquid staking, token holders individually stake their assets and retain the ability to redeem them at any time. This characteristic lacks the pooling of investor assets typically associated with AIFs. Liquid staking operates in a decentralized manner, governed by smart contracts, without centralized management.

If an asset or a DeFi protocol’s staking activities are classified as AIFs, they would need to adhere to AIFMD requirements, including the appointment of a depositary. These depositaries must meet capital adequacy standards, conduct robust risk management, and handle disclosure and reporting obligations.

The primary distinction between traditional AIFs and DeFi protocols’ liquidity pools lies in their purpose and management. AIFs primarily aim to invest in assets based on predefined investment policies, involving professional management and decision-making by a manager. In contrast, DeFi protocols’ liquidity pools exist to provide liquidity for decentralized trading and operate automatically through smart contracts, eliminating the need for intermediaries.

AIF and Staking Pools

Staking pools have some of the features of Collective investment undertakings and can be addressed as AIFs. the pool-based structure does involve collective contributions from multiple users and The Capital is Raised from Multiple Investors. However, Staking pools don’t satisfy the 3rd criteria which is related to investing in Accordance with a Defined Policy. the interest rates of staking pools are determined algorithmically and may vary based on supply and demand dynamics.

DAC and Staking

DAC, an acronym for the Directive on Administrative Cooperation, encompasses pivotal tax transparency regulations governing crypto-asset transactions. Within the context of DAC8, staking has been officially categorized as a crypto asset service, marking a historic milestone as it represents the European Union’s inaugural inclusion of staking within a legal framework.

IOSCO and Staking

IOSCO, which stands for the International Organization of Securities Commissions, has officially recognized that liquid staking exhibits resemblances to derivatives. Derivatives, in essence, are securities whose values are derived from or contingent upon other underlying assets.

MiCA and Staking

MiCA, short for Markets in Crypto Assets, stands as a milestone in the world of regulatory frameworks for cryptoassets. Crafted with the purpose of safeguarding consumers and mitigating risks within the crypto market, this framework was formally adopted by the European Parliament in April 2023. It paves the way for comprehensive EU market regulations for crypto-assets. Notably, a substantial portion of crypto assets that do not currently fall under the purview of other regulatory regimes will be encompassed within MiCA’s scope.

Careful analysis of MiCA regulations does reveal mentions of mechanisms that can be related to staking activities. However, it’s important to note that staking is not explicitly addressed within the text of MiCA Regulations, leaving its stance toward staking activities somewhat ambiguous.

MiFID II and Liquid Staking Receipt Tokens

MiFIDII, an acronym for the Markets in Financial Instruments Directive 2, holds a significant role within the German securities trading landscape as one of the legislative acts overseen by BaFin, the German financial regulatory authority. This directive is applicable to cryptocurrency businesses operating in Germany and scrutinizes whether crypto assets meet the criteria to be categorized as financial instruments. Having MiFID II permission is necessary for trading activities.

Liquid staking receipt tokens, on the other hand, are cryptoassets generated through programmatically minted processes. These tokens symbolize an individual’s direct stake or ownership in a specific blockchain protocol that employs Proof of Stake Consensus Mechanisms.

Contrary to MiFID’s definitions, liquid staking receipt tokens do not align with the classification of financial instruments. MiFID’s description of transferrable securities is broad, encompassing various assets such as equity securities, bonds, and derivatives. In contrast, liquid staking receipt tokens lack the intricate structure characteristic of traditional securities; they merely represent the underlying staked assets.

POSA

POSA, short for The Proof-of-Stake Alliance, emerges as a set of industry guidelines that took shape following the engagement of several blockchain projects with The SEC in 2019. These principles serve to champion proof-of-stake-based technologies and innovations while Enhancing transparency within the ecosystem. Notably, POSA advocates for precise terminology usage, cautions against offering investment advice, and underscores the importance of security.

In line with POSA’s recommendations, StaaS providers are encouraged to facilitate protocol access without implying undue control over the network’s inflation rate. Furthermore, POSA opposes the issuance of guarantees concerning the ‘rewards’ one may earn.

SINO

SINO, an acronym for Staking in Name Only, is a term coined to highlight processes that, despite being labeled as staking, effectively qualify as lending activities. This designation encompasses certain yield-generating activities and earnings programs that are incorrectly categorized as staking.

In the realm of taxonomy and regulatory frameworks, it is essential to exercise caution when employing the term ‘Staking.’ The use of this term should be more deliberate and precise in identifying the specific activities it refers to. By introducing the concept of SINO, a clear distinction is established between genuine staking and other activities labeled as ‘Staking,’ thereby ensuring that they are subject to distinct regulatory principles.

CCP and Staking

CCP, short for Central Counterparty Clearing House, serves as a crucial component within the realm of Financial Market Infrastructures. It facilitates transactions involving securities, derivatives, or goods, acting as an intermediary between the original counterparties. A notable example of a CCP in the industry is LCH.Clearnet.

The question at hand is whether liquid StaaS providers or liquid staking receipt tokens can be considered CCP and fall under the regulatory frameworks of Central Counterparty Clearing Houses. The answer, however, is No! they don’t. CCPs serve a pivotal role in ensuring the terms of a trade by amassing funds from both the seller and buyer, thus mitigating counterparty risks and ensuring smooth trade settlement. On the contrary, staking protocols primarily focus on securing the blockchain rather than undertaking risk management.

CCPs fulfill the roles of clearing and settlement, whereas liquid staking protocols do not engage in these transactional functions. CCPs are subjected to rigorous capital and operational requirements, with oversight provided by ESMA (The European Securities and Markets Authority). Conversely, liquid staking protocols do not fall under direct regulatory scrutiny.

Future Regulations

Despite the considerable efforts made by the EU to enhance regulatory frameworks within the blockchain ecosystem, numerous important discussions remain unresolved. It is crucial for experts in the web3 industry and EU regulators to continue collaborating and engaging in ongoing dialogues. This collaborative effort is necessary to establish a comprehensive and unambiguous taxonomy for staking activities.

Furthermore, there is a pressing need to delineate the tax principles applicable to CASPs (Crypto Assets Service Providers) and determine the specific regulatory provisions that govern their operations. Additionally, defining the regulatory treatment for the microservices provided by StaaS providers is equally essential.

Sustained cooperation between industry experts and regulators will play a pivotal role in creating a well-defined and fair regulatory landscape for the blockchain and staking ecosystem, providing clarity and stability for all stakeholders involved.