Evan Thomas

Since Ethereum’s transition from proof-of-work to proof-of-stake, some have suggested this makes ETH, or at least staking ETH, a security.&nbsp;



These arguments don’t stand up to scrutiny.&nbsp;



Properly understood, staking ETH is a technical service to ensure transactions on the Ethereum network are processed properly and securely, rather than as an investment subject to securities laws. This is the case even where third parties, like node operators or exchanges, facilitate the staking of ETH. Stakers’ expectations of profit come from staking rewards and the market for ETH, not the administrative and technical services provided by third parties.



<h2 class="wp-block-heading">The legal framework: Defining &#8220;investment contract&#8221;</h2>



Whether or not an instrument or activity is subject to securities law depends on the definition of “security.”



Under US federal securities law, a security is defined to include a number of instruments, including an “investment contract.” Various court decisions have refined the meaning of this term, but an “investment contract” generally means a contract, scheme or transaction where there is an investment of money; (2) in a common enterprise; (3) with the reasonable expectation of profits; (4) derived substantially from the efforts of others.&nbsp;



This meaning originates from the US Supreme Court’s decision in the Howey case, which involved orange groves and their profits. The court concluded that if a third party sold orange groves along with a contract to manage the grove and share its profits, this was an investment contract subject to securities laws — purchasers were not merely buying land, but were instead investing money to earn profits based on the third party’s efforts in growing and selling oranges.&nbsp;



Decisions since Howey have clarified that the “efforts of others” must be “the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.” Efforts that are administrative or “ministerial” do not create an investment contract.



With this concept of “investment contract” in mind, Ethereum’s transition to proof-of-stake clearly did not turn ETH itself into an investment contract. Holding ETH does not, on its own, entitle the holder to staking rewards, and so the transition to proof-of-stake did not give rise to an investment contract.



A more nuanced argument is that staking ETH is an investment contract, but this argument also does not withstand scrutiny.



As a technical matter, staking ETH means that ETH is sent to the Ethereum deposit contract and associated with a specific validator; that is, an instance of software designed to process transactions on the Ethereum network. If there is a hardware or software failure that causes the validator to break Ethereum’s rules for validating transactions, the network applies a penalty to the staked ETH (referred to as slashing) associated with that validator. The ETH staked to a validator essentially stands as a financial guarantee that the validator will perform as expected.



The case where the ETH staker operates the validator themselves — sometimes referred to as solo staking — is the simplest case to analyze. As there are no “others” exerting efforts, there can be no investment contract.



<h2 class="wp-block-heading">Staking with a provider, through a liquid staking protocol or exchange</h2>



Some ETH stakers may prefer to have other parties operate validators on their behalf.&nbsp;



More complex situations —&nbsp;like node operators, liquid staking protocols or a centralized exchange’s staking services — require further analysis of whether this relationship creates an investment contract.



Read more from our opinion section: <a href="https://blockworks.co/news/ether-commodity-or-not">Ether is the Schrödinger’s cat of crypto</a>



Typically, staking with a node operator does not involve actually transferring staked ETH to the node operator. Instead, the staker associates their ETH with a validator operated by the node operator and specifies the staker’s own address as the withdrawal address for the staked ETH and any rewards. All staking rewards and the original ETH can only be withdrawn to an address controlled by the staker, not the node operator. This ensures the staker always retains ownership and control of their ETH; there is no investment or other transfer of value to another party.



Similarly, with liquid staking protocols, the protocol — that is, a smart contract deployed on Ethereum — programmatically associates staked ETH with validators run by node operators willing to operate validators on behalf of stakers. When ETH is staked using the protocol, the staker receives a transferable token that can be redeemed for the staker’s ETH as well as any accrued rewards.&nbsp;



Again, this is programmatically facilitated by the protocol rather than a third party. Importantly, neither node operators nor any other third parties acquire ownership or control of the staked ETH or staking rewards.



Users of centralized exchanges with staking services can also instruct the exchange to stake their ETH on their behalf. The exchange then arranges for users’ ETH to be staked to validators operated by the exchange or a third party. Although custodial exchanges do have custody of their users’ ETH, their terms of service are generally explicit that the staked ETH belongs to their users. The exchange’s role is arranging for ETH to be staked to validators and accounting for the rewards.



In all of these situations, it is debatable whether there is an “investment of money” in a “common enterprise.” Stakers retain legal ownership of their staked ETH, and — except in the case of custodial staking services — do not even transfer their ETH to another party. This contrasts starkly with an investment scheme where money or other assets are transferred to a “promoter” who has considerable discretion over how those investments will be used to earn profits.



However, even assuming ETH staking does involve a common enterprise when involving node operators or exchanges, stakers&#8217; profit expectations aren&#8217;t primarily linked to third-party efforts.&nbsp;



Staking rewards consist of consensus layer rewards, generated by the Ethereum network itself when validators propose or attest to new blocks. They also consist of execution layer rewards, essentially payments from users to validators for prioritizing their transactions.&nbsp;



The timing and amount of these rewards depend on factors like the total number of validators, Ethereum users’ willingness to pay for transaction prioritization and Ethereum network conditions. As rewards are received in ETH, stakers&#8217; profits may also be influenced by the market price of ETH in their currency.&nbsp;



What this means is that stakers must anticipate earning profits based on network and market dynamics, rather than the efforts of node operators or exchanges facilitating staking.



In addition, the activities undertaken by node operators or exchanges are not “entrepreneurial” or “managerial,” as explained in the case law. Although node operators or exchanges may perform technical and other services that allow the stakers to earn rewards, these third parties typically use similar hardware infrastructure, run open source software and follow similar best practices for securing and operating their systems. They do not have proprietary methods or special expertise that allow their users to earn more rewards than others providing similar services. In fact, the reward rates for validators operated by different node operators tend to be very close to one another, rarely different by more than a tenth of one percent.&nbsp;



<h2 class="wp-block-heading">Lessons from recent SEC cases</h2>



All of the above doesn’t mean that staking could never be part of a broader investment scheme that is subject to securities laws.



In February 2023, Kraken settled with the US Securities and Exchange Commission over charges that Kraken’s staking services in the US were contrary to federal securities laws. And more recently, in late March 2024, a US district court judge declined to dismiss claims by the SEC with respect to Coinbase’s staking services.&nbsp;



In the case against Kraken, the SEC alleged that the exchange retained discretion over rates of staking rewards received by users, smoothed out payment of rewards to users and maintained a pool of unstaked tokens so that users could effectively bypass lock-up periods applicable to their staked tokens. Similarly, the Coinbase decision refers to allegations that, at one point, Coinbase maintained a liquidity pool similar to Kraken’s. Critically, these alleged features are specific to how these exchanges provided staking services. They are not attributes of ETH or staking generally.



Importantly, neither of these cases is a definitive legal decision that these (or any other) staking services are an offering of securities under US securities laws. Kraken settled the charges without admitting or denying the SEC’s allegations and agreed to wind down its staking services within the United States. The Coinbase decision only establishes that the SEC’s allegations are plausible enough to continue through the litigation process.&nbsp;&nbsp;



<h2 class="wp-block-heading">Conclusion: Staking as a technical service, not a security offering</h2>



Even when stakers work with other parties like node operators and exchanges to stake their ETH, stakers’ profit expectations come from network and market conditions that are independent of the efforts of these third parties. The economic reality is that these third parties are more like administrative or technical service providers than promoters or managers of an investment scheme.



The fact that ETH can be staked does not mean it is a security, and staking ETH to earn staking rewards does not necessarily give rise to a securities offering.&nbsp;



<hr class="wp-block-separator has-alpha-channel-opacity"/>


<div class="wp-block-post-author-biography">Evan Thomas is General Counsel for Alluvial, a software development company supporting the Liquid Collective liquid staking protocol. He was previously at Wealthsimple, Canada’s largest consumer fintech, where he was Head of Legal for Wealthsimple’s crypto trading platform. While at Wealthsimple, Evan helped launch Canada’s first regulated staking product. Before Wealthsimple, Evan was a litigator at Osler, Hoskin &amp; Harcourt LLP for nearly 15 years. Among other notable cases, Evan was hearing counsel to 3iQ Corp. in its appeal securing regulatory approval for Canada’s first publicly traded bitcoin fund in 2019.</div>


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Staking or not, ETH is no security

David Canellis

Bitcoin block space looks set to be the hottest commodity in crypto.



Bitcoin once again occupies more than half the entire crypto market, having outperformed ether by nearly double so far in 2023. Now, the long-prophesied “flippening” of ether over bitcoin is even further in the future.



The market currently values Bitcoin three times higher than Ethereum. Bitcoin’s market cap, at $727 billion, has swelled by $400 billion in 2023 — a figure bigger than Mastercard’s entire stock valuation and about twice that of Netflix’s.



Ethereum’s valuation has grown by $100 billion, jumping from under $145 billion in January to nearly $245 billion today.&nbsp;



Some anticipate that Ethereum’s market cap will one day eclipse Bitcoin’s, despite the latter’s half-decade head start.&nbsp;



Things were looking good coming out of the 2019 bear market and into 2021’s explosive bull cycle. DeFi summer and NFT mania boosted interest in Ethereum, at times driving up fees for certain actions beyond $250.



<ul class="wp-block-list">
<li><a href="https://blockworks.co/tag/bitcoin">Bitcoin</a>&#8216;s market value was 925% of <a href="https://blockworks.co/tag/ethereum">Ethereum&#8217;s</a> — $130 billion to $14 billion — at the end of 2019 (bottom of the bear market).</li>



<li>That figure had shrunk to under 200% by the end of 2021 (peak bull market).</li>



<li>Bitcoin&#8217;s market value is now 300% of Ethereum&#8217;s.</li>
</ul>



<figure class="wp-block-embed is-type-wp-embed is-provider-flourish wp-block-embed-flourish"><div class="wp-block-embed__wrapper">
<iframe loading="lazy" class="wp-embedded-content" sandbox="allow-scripts" security="restricted" title="Interactive or visual content" src="https://flo.uri.sh/visualisation/15819231/embed#?secret=7P1yBenbDx" data-secret="7P1yBenbDx" frameborder="0" scrolling="no" height="575" width="700"></iframe>
</div><figcaption class="wp-element-caption">The Bitcoin rally has widened the gap</figcaption></figure>



The case for flippening has recently taken a hit by a different flip: The Bitcoin network now rakes in more fees than Ethereum for the first time since December 2020.



Over the past four days, Bitcoin users have paid miners about $40 million to have their transactions processed.&nbsp;



Ethereum users, meanwhile, forked out less than $27 million ether (most of those fees have been burned, slightly reducing Ethereum’s overall supply).



Layer-2 Ethereum networks <a href="https://blockworks.co/tag/arbitrum">Arbitrum</a> and <a href="https://blockworks.co/tag/optimism">Optimism</a> haven’t bridged that gap as they each generate less than $200,000 in fees per day right now.



The fee-flippening (flee-pening?) is awkward when you consider the sheer amount of use cases supported by Ethereum. Decentralized exchanges, DAOs, memecoins, NFTs, stablecoins, DeFi and GameFi all run atop Ethereum.



Read more: <a href="https://blockworks.co/news/ethereum-bitcoin-merge">Ethereum’s Justin Drake is unconcerned despite ether’s middling year pricewise: Q&amp;A</a>



Bitcoin, on the other hand, had for the longest time mostly had one application — bitcoin transactions. But the rate of on-chain transactions had until recently sustained very little growth since 2015. Perhaps due to its “digital gold” narrative and the rising ubiquity of alternative cryptocurrencies.&nbsp;



<figure class="wp-block-embed is-type-wp-embed is-provider-flourish wp-block-embed-flourish"><div class="wp-block-embed__wrapper">
<iframe loading="lazy" class="wp-embedded-content" sandbox="allow-scripts" security="restricted" title="Interactive or visual content" src="https://flo.uri.sh/visualisation/15816806/embed#?secret=ANeyQ4Cjzu" data-secret="ANeyQ4Cjzu" frameborder="0" scrolling="no" height="575" width="700"></iframe>
</div><figcaption class="wp-element-caption">Over the past five years, Ethereum users have paid $17 billion in fees, Bitcoin users just $2.9 billion</figcaption></figure>



All that changed with Ordinals — a protocol for inscribing individual units of bitcoin (<a href="https://blockworks.co/price/btc">BTC</a>) with unique data to create digital collectibles, first launched in January.



Music, text, art, video and <a href="https://blockworks.co/news/play-doom-bitcoin">even code for browser-based</a> DOOM clones have since been inscribed to Bitcoin, resulting in an on-chain collectibles market worth thousands of BTC. Bitcoin users trade Ordinals as Ethereum or Solana users would trade NFTs.



Today, anywhere from around a third to one half of Bitcoin transactions contain Ordinals, driving up demand for blockspace as well as transaction fees. At times today, “medium priority” <a href="https://mempool.space/">transactions</a> went for around $11 compared to around $2.30 for the <a href="https://etherscan.io/gastracker">same</a> on Ethereum (more priority generally means faster processing), although those prices have since come down.



<figure class="wp-block-embed is-type-wp-embed is-provider-flourish wp-block-embed-flourish"><div class="wp-block-embed__wrapper">
<iframe loading="lazy" class="wp-embedded-content" sandbox="allow-scripts" security="restricted" title="Interactive or visual content" src="https://flo.uri.sh/visualisation/15818011/embed#?secret=CUyCOwRuzE" data-secret="CUyCOwRuzE" frameborder="0" scrolling="no" height="575" width="700"></iframe>
</div><figcaption class="wp-element-caption">Tron comes in third overall for monthly fees, mostly thanks to stablecoin Tether</figcaption></figure>



So is Bitcoin netting more fees than Ethereum good for Bitcoin? Maybe not.&nbsp;



Some Bitcoin insiders <a href="https://blockworks.co/news/play-doom-bitcoin">worry</a> the network isn’t properly equipped to handle Ordinals and potential influxes of interest in its original use case, BTC payments.



The CryptoKitties incident in December 2017 — during which a NFT game grew so popular that it spectacularly <a href="https://consensys.io/blog/the-inside-story-of-the-cryptokitties-congestion-crisis">clogged</a> Ethereum — first showed that Ethereum probably couldn’t handle serving as the “<a href="https://www.youtube.com/watch?v=j23HnORQXvs">World Computer</a>” just yet.



Then, the 2021 bull market saw NFT mint costs soar to $250 at <a href="https://www.coindesk.com/tech/2021/11/22/ethereums-fees-are-too-damn-high/">times</a> — a reminder of how necessary it was to port activity to smaller chains, including rollups. Still, <a href="https://blockworks.co/news/pepe-memecoin-red-flags-abound">memecoins and low quality token projects</a> ratcheted up fees beyond $20 earlier this year, drastically reducing Ethereum’s <a href="https://blockworks.co/news/ethereum-deflationary-model">usefulness for non-critical tasks</a>.



The NFT craze of 2021 made Ethereum block space the hottest commodity in crypto. Even while tanking its utility.&nbsp;



Ordinals may end up having the same effect on Bitcoin, especially if demand keeps up and the bull market truly hits.



At that point, it would seem reasonable to value Bitcoin and Ethereum more similarly. It might just take another run.



Updated Nov. 16, 2023 at 4:25 pm ET: Corrected reference to percentages in bullet points.



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Ethereum won’t flip Bitcoin anytime soon, but Ordinals could change that

Bessie Liu

Following the introduction of ERC-4626, tokenized vault deployments have remained steady.



ERC-4626 is a standard that is designed to introduce implementation techniques and parameters for yield-bearing vaults in crypto. The standard was introduced in early May.



<a href="https://dune.com/queries/2641987/4389806">Data</a> compiled by Dragonfly data scientist Hildebert Moulié shows that every week following the introduction of ERC-4626, over 50 tokenized vault deployments have occurred across EVM-compatible blockchains.&nbsp;



<figure class="wp-block-image"><img decoding="async" src="https://lh6.googleusercontent.com/ENb3fIooPdyQRszYXFkclInEJMDT5OImDj960O-GbJ0-J3sLyeQsQI3-GJOhR6GRnVN_3CVkhOXhOT7QPIpxpfvEMy9PHmQ--WxhGL8CG49KSE4ju6fp5CaiEMOMXX1IHt2ksCyeW_EXBgTs5b9PDgw" alt=""/></figure>



In a previous interview with Blockworks, Superform co-founder Blake Richardson contended that this new standard would be as important to DeFi as ERC-20 — a commonly used token standard — is to the <a href="https://app.blockworksresearch.com/glossary#initial-coin-offerings-icos">ICO boom</a>.



Read more: <a href="https://blockworks.co/news/tokenized-vault-standard-ethereum">Tokenized vault standard on Ethereum set to ‘kick off new DeFi summer’</a>



“I think the compound benefit of standardization will lead more people to adopt DeFi because they can start to trust it more,” Richardson said.



To a certain extent, Richardson was right. Although tokenized vaults already existed before ERC-4626, it wasn’t until these principles were introduced that their implementations became more consistent.



Prize savings protocol PoolTogether was one of the most recent to make use of the standard. PoolTogether revealed during a private beta launch that v5 of its protocol introduces the permissionless use of any token that has a 4626 yield source.&nbsp;



Users can deposit tokens into PoolTogether’s standard ERC-4626 vault in order to win prizes or customize their own vault. These vaults will create yield and liquidate the yield into POOL tokens, the protocol’s native asset, reflecting the vault’s likelihood of winning a prize.



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Tokenized vaults see steady deployments after ERC-4626 adoption

Darren Kleine

“The more broken a staking model and design is,” Chorus One chief information officer Xavier Meegan says, “the more urgent a liquid staking solution is needed for that network.”



“Necessity is the mother of invention” might be a nicer way to put it.



A key reason for the success of liquid staking on Ethereum, Meegan says, is that staked ether (ETH) was locked up and inaccessible until the long-awaited Shapella upgrade. This makes liquid staking an effective escape for eager DeFi users. 



Read more: <a href="http://blockworks.co/news/ether-price-predictions-after-shapella">How did ether price predictions fare after Shapella upgrade?</a>



On the Bell Curve podcast (<a href="https://open.spotify.com/episode/3kOAHbkbaRtWudoVvjp4Cg?si=ndqtco39SDuWw9zcksgN9w">Spotify</a>/<a href="https://podcasts.apple.com/us/podcast/what-ethereum-can-learn-from-easy-solana-staking-lucas/id1641356619?i=1000626067852">Apple</a>), Jito Labs CEO Lucas Bruder says this has never been the case on <a href="https://blockworks.co/tag/solana">Solana</a>, where <a href="https://blockworks.co/news/solana-defi-ready-rebirth">new liquid staking innovations</a> might offer opportunities on the nimble network.



Whereas staked <a href="http://blockworks.co/price/eth">ETH</a> might have been locked up for as long as two years, providing a strong value proposition for <a href="https://blockworks.co/tag/liquid-staking">liquid staking</a> tokens, Bruder notes that Solana has allowed for withdrawals “from day one.”



During the <a href="https://blockworks.co/news/will-defi-summer-return">DeFi summer of 2020</a>, <a href="http://blockworks.co/tag/ethereum">Ethereum</a> users witnessed a boom in protocols popping up, Bruder says, solving the chicken-egg problem for the network — “I have liquid staking tokens, but where am I gonna use them?”



Solana isn’t quite there yet, Bruder says, with far fewer DeFi applications in the wild. The chicken-egg problem persists: As DeFi protocol builders look at network’s lower liquid staking activity and total-value-locked (TVL) statistics, they <a href="https://blockworks.co/news/ethereum-rivals-doa">may be dissuaded from launching on Solana</a> at all.



But Bruder is optimistic. “I think we&#8217;ll see that change, especially when you look at what happened with MarginFi and Jito.” He says the MarginFi borrowing and lending service, along with Jito, saw “<a href="https://blockworks.co/news/solana-defi-new-users">a massive growth of TVL during the month of July</a>.”



“I think we doubled TVL in terms of SOL,” he says. Bruder expects many protocol builders might find the network more attractive following the recent boost. “Liquid staking tokens (LSTs) are one of the strongest base assets that you can have in a DeFi ecosystem,” he says. “We&#8217;ll see more protocols start to cater towards that.”



<h2 class="wp-block-heading">Building trust takes time</h2>



According to Bruder, one issue that’s holding things back is trust in Solana as a secure DeFi ecosystem, but he expects that will come with time. “The more TVL these ecosystems have and the more battle-tested they are,” he says, “the more people trust in them.”



Solana is “finally rounding the turn,” Bruder says, with more protocols increasing their TVL. He adds that protocols “are taking security very, very seriously.”



“As we see protocols taking security more seriously, some of these TVL numbers rise and these protocols get more adoption,” Bruder explains. “As we see some larger institutions start to deposit more SOL into LSTs, I think a lot of that will get this thing kick-started.”



Meegan notes that branding is critical in the “liquid staking arena,” noting that Jito Labs is building “cutting edge protocols in Solana,” <a href="https://blockworks.co/news/solana-spam-problem">focused on MEV and liquid staking</a>. “These are really at the core of security of any network,” he says.



“If there&#8217;s a team building there that you trust anyway, you trust that they have the best interests at heart.”



<iframe loading="lazy" frameborder="0" height="200" scrolling="no" src="https://playlist.megaphone.fm/?e=BWG7706265842" width="100%"></iframe>







“Lucas and his team at Jito have a bunch of experience running validators and speaking with validators like us as well,” Meegan continues. “That really gives an element of trust with not just validators and node operators, but also delegators.”



“As Solana gets past this phase of the network that it&#8217;s in right now, as performance gets better,” Meegan says, “<a href="https://blockworks.co/news/solana-defi-frees-developers">people will be more willing</a> to provide liquidity into the network.”



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Liquid staking is building momentum on Solana, say Bruder and Meegan

Casey Wagner

<div id="highlights-block_62aa0cf6bfc2e" class="highlights">
 <ul>
 <li>European Central Bank holds rare unscheduled meeting as market conditions worsen</li>
 <li>S&amp;P and Nasdaq hold steady while BTC and ETH fall ahead of interest rate announcement</li>
 </ul>
 
</div>



The pullback in crypto markets continued Wednesday as firms cut staff while investors assess the damage from Celsius’ withdrawal halt and the <a href="https://cms.blockworks.co/crypto-fund-three-arrows-capital-facing-potential-insolvency-report/" target="_blank" rel="noreferrer noopener">apparent insolvency</a> of longtime digital assets hedge fund firm Three Arrows Capital.&nbsp;



The Federal Reserve is slated to announce an expected 0.75 percentage point interest rate hike Wednesday afternoon following the end of its two-day policy meeting. The European Central Bank, which was not scheduled to meet, issued a <a href="https://www.ecb.europa.eu/press/pr/date/2022/html/ecb.pr220615~2aa3900e0a.en.html" target="_blank" rel="noreferrer noopener">statement</a> saying it would “apply flexibility” going forward to combat increasingly turbulent markets.&nbsp;



“It&#8217;s become very clear that central banks are going to have to be very aggressive in countering mounting price pressures around the globe and that the probability of recessions has increased,” Craig Erlam, senior market analyst at OANDA, wrote in a note Wednesday. “Stagflation is not yet here but the risks around it have risen considerably in recent months which makes central bank responses all the more critical.”&nbsp;



Many more rate hikes will be demanded in the short term to get a degree of control over runaway inflation, Erlam said — and markets are not reacting well.&nbsp;



Bitcoin inched lower toward $20,000 early Wednesday while ethereum slid closer to $1,000. The tech-heavy Nasdaq and the S&amp;P 500 were both trading slightly higher ahead of Fed Chair Jerome Powell’s press conference, signaling the market has largely priced in a 75-point hike, according to Erlam.&nbsp;



“There is still a huge gap between nominal rates and real rates, so there is much more room for the Fed and other central banks to hike in the months to come,” said Mikkel Morch, executive director at digital asset hedge fund ARK36. “Investors can’t realistically expect risk assets to have a more sustained uptrend until the Fed pivots.”



The risk-off sentiment is likely not going to dissolve anytime soon, in Erlam’s estimation.&nbsp;



“Risk appetite has been obliterated and the days of ultra-low rates are behind us, there isn&#8217;t the same speculative mood that existed when bitcoin was exploding higher,” Erlam said. “There may still be a belief that bitcoin can thrive in the future but something that offers little now beyond speculative rallies is going to continue to struggle. Especially when we&#8217;re seeing headlines like those around Celsius and Binance.”




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