US SEC article: What kind of POS and pledge behaviors do not belong to securities?

Author: Department of Corporate Finance, U.S. Securities and Exchange Commission

Compiled by: Wu Shuo Blockchain

introduction

In order to further clarify the scope of application of the Federal Securities Law in the field of crypto assets, the U.S. Securities and Exchange Commission Department of Corporation Finance expressed its views on the so-called "staking" related activities, especially the pledge activities carried out in networks using Proof-of-Stake ("PoS") as a consensus mechanism (hereinafter referred to as "PoS Network").

This statement focuses on the following situations: that is, those crypto assets that are pledged are related to the procedural nature of public, license-free blockchain networks. Such assets are used to participate in the consensus mechanism of the network and gain benefits as a result, or to maintain the technical operation and security of the network and receive rewards as a result. In this statement, we call such crypto assets " Covered Crypto Assets " and their staking behavior in the PoS network " Protocol staking ".

Agreement pledge

Blockchain networks rely on cryptography and economic mechanism design to reduce dependence on centralized trusted intermediaries, thereby realizing verification of network transactions and providing settlement guarantees to users. The operation of each network is dominated by the underlying software protocol (composed of computer code), which executes specific network rules, technical requirements and reward allocation mechanisms in a programmatic manner. Each protocol embeds a "consensus mechanism", a method that enables distributed computer systems (called "nodes") that maintain a point-to-point network to agree on the "state" of the network. The so-called network status refers to the authoritative ledger records of address balances, transactions, smart contract codes and other data. Publicly owned, license-free networks allow users to participate in the network operation, including verifying new transactions based on the consensus mechanism of the network.

Proof of Stake (PoS) is a consensus mechanism that proves that the Node Operators participating in the network have contributed value to the network; in some cases, if their behavior is dishonest, that part of the value may be confiscated. In a PoS network, node operators must pledge the network's covered crypto assets before they can be automatically selected by the program through the underlying software protocol of the network, obtain permission to verify new block data and update the network's authoritative ledger records. Once selected, the node operator will serve as the "validator". In return for providing verification services, validators can receive two types of "rewards":

· New additions that are programmatically generated and distributed by the network according to its underlying protocol cover crypto assets;

· Transaction fees paid by users who wish to write their transactions to the network, part of which is paid to the verifier in the form of a covered crypto assets.

In a PoS network, node operators must commit and “stake” to cover crypto assets before they are eligible to participate in verification and receive rewards. This process is usually implemented through smart contracts, a smart contract, an automatic execution program used to automatically complete the required operations in the network. During the pledge period, the covered crypto assets will be "locked" and may not be transferred within a certain period of time according to the provisions of the applicable agreement. It is worth noting that the verifier does not actually possess or control the covered crypto assets pledged, which means that the ownership and control of the assets remain unchanged during the pledge period.

The underlying software protocol of each PoS network contains rules regarding the operation and maintenance of the network, including a method of selecting a validator from the node operator. Some protocols select validators in a random way, while others set specific criteria, such as choosing based on the number of crypto assets covered by the node operator. In addition, various protocols may set rules to prevent network security and integrity, such as preventing behaviors such as verifying invalid blocks or "double signatures". The so-called "double signature" refers to the verifier trying to write the same transaction to the network multiple times, which is actually equivalent to spending multiple times on the same crypto asset.

The rewards from protocol pledge provide financial incentives for participants to use crypto assets to ensure the security of the PoS network and maintain its continuous operation. The increase in the number of crypto assets covered by pledges helps to improve the security level of the PoS network and reduces potential risks, that is, malicious parties control the majority of the total pledged assets. If a malicious entity has mastered most of the staked crypto assets, it will have the ability to manipulate the PoS network, including affecting the transaction verification process, or even tampering with the network's transaction ledger records. Holders of covered crypto assets can receive rewards by acting as node operators and pledging their own covered crypto assets. When performing self-staking (also known as "independent pledge"), the holder always retains ownership and control over its covered crypto assets and their crypto private keys throughout the process.

In addition, crypto asset holders can also choose not to run nodes themselves, but participate in the verification process of the PoS network through a " self-hosted stake " method that directly cooperates with third parties. In this case, the asset holder entrusts its verification rights to the third-party node operator. When using third-party node operators, covered crypto asset holders can receive part of the pledge reward, and third parties providing verification services will also receive corresponding proportions of rewards for their transaction verification services. When performing self-custodial pledges directly with third parties, the holders of covered crypto assets still retain ownership and control over the covered crypto assets and private keys.

In addition to self-pled (or independent pledge) and self-hosted pledge directly through third parties, agreement pledge also includes a third form, namely the so-called "custodial pledge". In this way, a third party (i.e., the “custodian”) custodies the covered crypto assets of the asset holder and performs pledge operations on behalf of the asset holder. When the asset holder deposits its covered crypto assets into the custodian, the custodian saves the assets stored in a digital "wallet" controlled by it. The custodian performs pledge operations on behalf of the asset holder with the prior agreed reward ratio. The method can be by using its own node or through its selected third-party node operator. During the entire pledge process, the escrowd covered crypto assets are always controlled by the custodian, and the ownership of the covered crypto assets is in principle still owned by the asset holder.

In addition, the escrowd covered crypto assets must meet the following conditions:

1. It shall not be used by the custodian for operational or other general commercial purposes;

2. Do not be loaned, mortgaged or re-pled for any reason;

3. It must be kept in a manner that does not cause a third party to claim rights.

For this purpose, the custodian shall not use the custodian covered crypto assets for leverage operations, trading, speculation or other autonomous activities.

The views of the Ministry of Finance on the pledge activities of agreements

The Ministry of Finance believes that the “Agreement Pledge Activity” (as defined below) related to Agreement Pledge does not constitute securities issuance and sale under Section 2(a)(1) of the Securities Act 1933 or Section 3(a)(10) of the Exchange Act 1934. Therefore, the Department of Finance believes that parties involved in pledge activities of agreements do not need to register transactions with the Securities and Exchange Commission (SEC) for such pledge activities under the Securities Act, nor do they need to rely on the registration exemption clause established by the Securities Act.

Agreement pledge activities covered by this statement

The opinions of the Company Financial Department apply to the following activities and transactions related to agreement pledge (broadly "Agreement Pledge Activity" and individual "Agreement Pledge Activity"):

· Staking covers crypto assets on the PoS network;

· The roles and behaviors of third parties involved in the pledge process of agreements, including but not limited to the roles and behaviors of third-party node operators, validators, trustees, delegates and nominators (collectively referred to as “service providers”) in obtaining and distributing rewards;

· Providing affiliated services (definitions below).

This statement applies only to agreement pledge activities related to the following types of agreement pledges:

· Self-staking (Solo Staking): refers to the node operator using its own resources to pledge crypto assets it owns and controls. The node operator can be one person or multiple people who jointly operate nodes and pledge their crypto assets.

Self -Custodial Staking Directly with a Third Party: refers to the verification rights obtained by the node operator to cover the owner of the crypto assets under the terms of the agreement. Under this structure, the reward may be distributed directly by the PoS network to the covered crypto asset holders or indirectly through the node operator.

Custodial Arrangements: refers to the custodial party performing pledge operations on behalf of the owner of the crypto assets. For example, a crypto asset trading platform holds its deposited crypto assets on behalf of the customer. If the PoS network allows entrusted pledges in the name of the customer and obtains the customer's consent, the platform can pledges on behalf of the customer. The custodian can pledge it through self-operated nodes or select a third-party node operator. In the latter case, the custodian is only responsible for the decision to choose nodes during the pledge process.

Discussion on agreement pledge activities

Article 2(a)(1) of the Securities Act and Article 3(a)(10) of the Securities Exchange Act define the term "securities" by listing a variety of financial instruments (such as "stocks", "bills", "bonds", etc.). Since crypto assets do not fall within the category of financial instruments explicitly stated in these provisions, we apply the “Investment Contract” standards established in the SEC v. WJ Howey Company when analyzing certain agreement pledge transactions involving crypto assets. The Howey test is applicable to the examination of arrangements or financial instruments that are not explicitly listed in relevant legal provisions, and its core basis is the "economic substance" of transactions or arrangements.

When evaluating the economic essence of a transaction, the criteria for judgment are whether there is a capital invested in a common enterprise and that investment is based on reasonable expectations of profits from entrepreneurial or management efforts made by others. Since the Pride case, the federal court has further explained this standard, pointing out that when efforts made by other parties other than investors are undeniable key efforts, that is, those core management efforts that have a decisive impact on the success or failure of a company, they can meet the requirements of "efforts of others" in the Howe Test. In addition, the federal court also made it clear that administrative or transactional activities do not constitute management or entrepreneurial efforts that meet the "other's efforts" requirements in the Howe Test.

1. Self staking (self or Solo staking):

The self-pled (or independent pledge) of node operators is not based on reasonable expectations of profits brought about by entrepreneurial or management efforts by others. Instead, node operators invest their own resources and pledge their own covered crypto assets to ensure the security of the PoS network and promote its operation by verifying new blocks, so as to be eligible for rewards issued by the PoS network according to the provisions of the underlying protocol of the network. In order to receive the reward, the behavior of the node operator must follow the protocol rules. By pledging its own cover crypto assets and participating in agreement pledge, node operators are only engaged in administrative or transactional behaviors that ensure network operation and promote block verification. The expectation of a node operator to receive a reward does not depend on any third party's management or entrepreneurial efforts to successfully make the PoS network; on the contrary, the economic incentives are entirely derived from the transactional behavior of agreement pledge. Therefore, such rewards are essentially the consideration of the services provided by the PoS network to the node operators, rather than the distribution of profits from the efforts of others.

2. Custodial Arrangements:

In a custodial arrangement, the custodian (whether it is a node operator or not) does not provide entrepreneurial or management efforts to the covered crypto asset holders it serves. Such arrangements are similar to those in which the aforementioned holder grants his right to a third party, but also involves the asset holder entrusts the covered crypto assets deposited by him to the third party for custody. In this arrangement, the custodian does not decide whether to pledge, when or how much of the covered crypto assets are pledged. The custodian only represents the asset holder as an agent and performs pledge operations on the covered crypto assets it deposits. In addition, the custodian's custody of covering crypto assets and the behavior of selecting node operators in some cases is administrative or transactional operations in nature and does not constitute the management or entrepreneurial efforts required by the "other's efforts" requirements in Howey's test. Further, while the custodian may deduct fixed or prorated fees from the rewards due to the crypto-asset holders, it does not guarantee, set or the specific amount of the rewards the fixed holders deserve.

3. Ancillary Services:

Service Providers may provide the services described below to covered crypto assets holders (collectively, “Affiliated Services”) to assist them in participating in the pledge of agreements. All the above types of affiliated services are essentially administrative or transactional operations and do not involve entrepreneurial or management efforts. These services constitute a common behavior—that is, agreement pledge—that is, agreement pledges, which themselves are not entrepreneurial or management-oriented.

· Slashing Coverage: When a service provider occurs, it compensates or compensates the pledged customer for losses caused by the error of the node operator. This type of protection mechanism provided to prevent node errors is similar to the guarantee provided by service providers in traditional commercial transactions.

Early Unbonding: refers to the service provider allowing the service to return covered crypto assets to the asset holder in advance before the unbinding period set by the agreement. The service is essentially for convenience only, shortening the actual unbinding cycle of the agreement to cover crypto asset holders to reduce the time cost of their assets being frozen.

· Alternate Rewards Payment Schedules and Amounts: refers to the situation in which the service provider has a difference from the time frequency or amount of the time and amount of the reward issued by the service provider. For example, the reward is paid in advance or the payment frequency is lower than the agreement setting, but the premise is that the reward amount is not fixed, no guarantee is made, and shall not be higher than the total reward amount set by the agreement. This type of service is similar to "advance unbinding", and only provides administrative convenience in the process of reward distribution and issuance for crypto asset holders.

· Aggregation of Covered Crypto Assets: refers to the function of service providers to provide aggregation of their assets to meet the agreement pledge threshold for covered crypto asset holders. Such services are part of the verification process, and the verification process itself is administrative or transactional. If there are no other factors, the act of achieving the purpose of pledge only through asset aggregation is essentially an administrative or transactional operation.