Coinbase plunges 14% as regulators crack down on on-chain staking

Bitcoin's rebound at the beginning of the year has given a shot in the arm to the anxious cryptocurrency community. But now, with the heavy blow from US regulators, the outlook for crypto assets has become unclear again.

SEC finally takes action on pledge

On February 10, Eastern Time, the stock price of Coinbase, the world's second largest cryptocurrency exchange, fell by more than 14%, marking the biggest drop in more than six months, stimulated by the suspension of on-chain staking services by its competitor Kraken by US regulators.

Kraken was previously accused by the U.S. Securities and Exchange Commission (SEC) of illegally providing on-chain staking services. The SEC believes that Kraken's sale of on-chain staking products constitutes illegal sale of securities.

According to media reports, Kraken has reached a settlement with the SEC on the case, agreeing to stop providing staking services and pay $30 million in disgorgement, prejudgment interest and civil penalties.

After the news came out, Bitcoin fell 4.6% and fell back below $22,000 per coin.

Staking is a mining method widely used in the cryptocurrency world. Unlike Bitcoin mining, Staking uses a proof-of-work mechanism (POW), which requires nodes to continuously perform hash calculations to verify the validity of transactions.

Staking does not require much computing power and does not have such a high hardware threshold. It is based on the Proof of Stake (POS) and Delegated Proof of Stake (DPOS) mechanisms, requiring users to prove that they own a certain amount of digital currency. Users only need to lock a certain amount of cryptocurrency in a digital wallet or exchange and run it for a period of time to get income. The income includes the block rewards generated by the smart contract, which is generally a certain digital currency. It is similar to depositing money in a bank and then collecting interest.

In addition, if a smart contract with a lending function is used, when others need to borrow a certain digital currency, the investor, as the lender, will receive lending interest income.

Kraken’s staking service offers up to 20% annual interest and promises to send staking rewards to customers twice a week.

Pledges have always been a thorn in the side of the SEC. SEC Chairman Gary Gensler believes that pledges and loans are just different terms, but they are essentially the same thing.

Is regulation that cuts off people’s financial resources a blow to innovation?

According to media reports, Coinbase CEO Brian Armstrong learned about the settlement agreement between Kraken and the SEC on Wednesday night. He accused the SEC of wanting to completely deprive retail investors of the opportunity to participate in on-chain staking, and called staking "a very important innovation."

The exchange’s chief legal officer, Paul Grewal, told the media:

“It is clear from today’s announcement that Kraken is in fact offering a yield product. Coinbase’s staking service is fundamentally different and is not a security.”

As the collapse in crypto asset prices has led to a decrease in trading volumes, on-chain staking has become an important source of revenue for exchanges such as Kraken and Coinbase.

In the third quarter of 2022, Coinbase's revenue, mainly from staking, accounted for 11% of the company's net income, up from 8.5% in the second quarter. Coinbase is the second largest depositor of Ethereum. Speculators have staked billions of dollars worth of Ethereum through exchanges and decentralized trading platforms such as Lido and Rocket Pool to earn returns.

Now, with the SEC's heavy blow, the once wildly growing staking service has a bleak future. Marc Arjoon, a research assistant at cryptocurrency investment company CoinShares, said:

“Kraken’s case serves as a warning sign for other exchanges that offer similar services.”