The UK government appears to give a green light to the practice of 'staking', but this should be approached with extreme caution. The law change only means that staking as defined in the exemption from the extensive definition of a "collective investment scheme" (CIS) in the Financial Services & Markets Act 2000 (FSMA). Staking in this context is intended to refer to the concept in 'proof of stake' blockchains (e.g. Ethereum). This is not a feature of 'proof of work' blockchains (e.g. the bitcoin blockchain) and the exemption does not cover 'staking' (effectively lending) of bitcoin or other assets. The exemption is a helpful clarification and removes the serious overhead associated with setting up and running an investment fund for the activities that are within the scope of the exemption. But an apparently minor change in the facts (e.g. affecting the qualification of the underlying cryptoasset) could still result in the staking activity falling outside the definition in the CIS exemption, meaning the staking activity could still qualify as a CIS. In addition, other financial regulation could still be implicated in the way that staking is done under the CIS exemption (e.g. e-money or payment services regulation, even for a qualifying cryptoasset), and the government clearly intends that the financial promotions rules aimed at 'qualifying cryptoassets' will still apply to marketing. Below is a summary for information purposes only. If you need legal advice, please get in touch.
What regulation has been changed to allow staking?
The CIS exemption is deceptively short:
22.—(1) Arrangements for qualifying cryptoasset staking do not amount to a collective investment scheme.
(2) In this paragraph—
“blockchain validation” means the validation of transactions on—
(a) a blockchain [not defined]; or(b) a network that uses distributed ledger technology [not defined] or other similar technology;
“qualifying cryptoasset” has the meaning given [in the Financial Promotions Order (FPO) - see the end of this post]
“qualifying cryptoasset staking” means the use of a qualifying cryptoasset in blockchain validation.”
As the short Explanatory Note that accompanies the relevant regulation explains:
Staking is a consensus mechanism used by “proof of stake” blockchains. Blockchains are distributed ledgers on which various computers performing the function of “validator nodes” collaboratively enter and validate transactions to achieve consensus on the network’s state.
5.2 Staking is a consensus mechanism used by ‘proof of stake’ blockchains. It is an alternative to cryptoasset ‘mining’, which is the consensus mechanism used in a ‘proof of work’ blockchain. Blockchains are distributed ledgers on which various computers performing the function of ‘validator nodes’ collaboratively enter and validate transactions to achieve consensus on the network’s state. On proof of stake blockchains, participants earn the right to operate a validator node by staking a given amount of their cryptoassets (locking them down on a smart contract or via an alternative software solution). As an incentive to operate the node well, participants that are staking their cryptoassets receive rewards from the blockchain in the form of newly minted cryptoassets or a portion of transaction fees on the blockchain. This prospect of a financial return is a common focus of marketing around staking services. Participants who act in bad faith, for example by trying to add falsified transactions, risk losing the tokens they have staked.
5.3 On certain blockchains, stakers are required to stake a set number of their cryptoassets to earn the right to operate a validator node, and this minimum amount can be prohibitively high for individuals. Some firms have therefore offered a service whereby customers’ cryptoassets are ‘pooled’ to meet the minimum staking requirements. The firm will then undertake the staking on behalf of its customers, frequently delegating the actual operation of the validator node to a specialist third party. If the firm then receives additional cryptoassets it will transfer a portion of the reward to its customers.
If you need legal advice on the topic, please get in touch.
26F.— Qualifying cryptoasset
(1) Subject to sub-paragraph (3), a "qualifying cryptoasset" is any cryptoasset which is—
(a) fungible; and
(b) transferable.
(2) For the purposes of sub-paragraph (1)(b), the circumstances in which a cryptoasset is to be treated as "transferable" include where—
(a) it confers transferable rights; or(b) a communication made in relation to the cryptoasset describes it as being transferable or conferring transferable rights.
(3) A cryptoasset does not fall within sub-paragraph (1) if it is—
(a) a controlled investment falling within any of paragraphs 12 to 26E or, so far as relevant to any such investment, paragraph 27;(b) electronic money;(c) fiat currency;(d) digitally issued fiat currency; or(e) a cryptoasset that—
(i) cannot be transferred or sold in exchange for money or other cryptoassets, except by way of redemption with the issuer; and(ii) can only be used in a limited way and meets one of the following conditions—(aa) it allows the holder to acquire goods or services only from the issuer;(ab) it is issued by a professional issuer and allows the holder to acquire goods or services only within a limited network of service providers which have direct commercial agreements with the issuer; or(ac) it may be used only to acquire a very limited range of goods or services.
(4) In this paragraph—
"cryptoasset" means any cryptographically secured digital representation of value or contractual rights that—
(a) can be transferred, stored or traded electronically, and(b) uses technology supporting the recording or storage of data (which may include distributed ledger technology);
"digitally issued fiat currency" means fiat currency issued in digital form;
"electronic money" has the meaning given by regulation 2(1) (interpretation) of the Electronic Money Regulations 2011.
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