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Cryptocurrencies are facing another potential issue which is undermining the verification process. Rumors are floating through the industry that the U.S. Securities and Exchange Commission wants to ban cryptocurrency staking. Unfortunately, staking is at the core of some of the most widely traded cryptocurrencies, such as Ether. The focus of the SEC seems to be on banning cryptocurrency staking for U.S. retail customers. In past comments, the head of the SEC Chairman, Gary Gensler, has remarked that cryptocurrencies that allow retail customers the ability to perform staking should be designated security even though it’s currently classified as a commodity by the Commodity Futures and Trading Commission. A significant amount of money is at stake if the SEC moves forward with the idea that they will ban staking. The notional value of the assets that undergo staking was above $42 billion in Q4 2022, with rewards from this process of $3 billion, according to a report from Staked.
What is Crypto Staking?
Cryptocurrency trading staking is lending your cryptocurrency assets for a period to help support the blockchain operation. When you stake your cryptocurrency, you earn interest in additional cryptocurrency. The process is similar to putting your money in a savings account and making interest. The bank will use your money to lend to others and continue to help build their operation. Some popular cryptocurrencies such as Solana and Ethereum, use staking as part of their process.
Proof of Work and Proof of Stake
Staking can play a pivotal role in helping the verification process. Two main methods are used to prove that a cryptocurrency transaction is verified. The most common is called proof of work. During this process, individuals called minors will work to solve a complex problem using high-caliber computers. The first miner to solve the problem will be the one that verifies the transaction and receives a reward for the verification process. Bitcoin is a proof-of-work digital currency. Before a block is verified and placed on the Bitcoin blockchain, the protocol involves a mechanism that is proof of work. Miners solve a problem to validate the transactions providing a decentralized mechanism to the process.
An alternative to proof of work is proof of stake. Someone staked in the enterprise can verify the transaction in this verification mechanism. The process enables the blockchain to process new transactions using a consensus mechanism to validate transactions. The proof of stake methodology will enable owners to validate block transactions based on the number of cryptocurrency coins they own. The process was created as an alternative to proof of work and is considered less risky when it comes to an attack on the network as its structures the compensation in a way that makes an attack less advantageous.
Proof of stake reduces the amount of computation that is needed to verify blocks. The owners of the coins are essentially offering their coins as collateral for the chance to validate transactions. The validators in the proof of stake process are selected randomly to confirm the transaction and earn coins. Instead of racing to solve a problem to become the verifier of the record, the random process allows anyone who wants to stake to become a transaction verifier. The lack of computation power needed significantly reduces the amount of energy required to verify a transaction. The proof of stake method aims to reduce network congestion and the environmental concerns surrounding the energy needed to run a proof of work process.
How Does Staking Work?
If you own specific cryptocurrencies, you can participate in staking on a blockchain that uses proof of stake as a verification method. Staking locks up your assets for a particular period to help maintain the security of the blockchain. Similar to a certification of deposit at a bank, you cannot take your money back without incurring a penalty. The lockup ensures the system can work properly if there are any issues. If you have coins in your wallet that are stakable, you can designate those coins for staking. You can then pick a validator. The token commingled with others who want to stake increases your chances of receiving rewards.
A stake program will provide information about the staking reward you can receive from participating in the process. Some cryptocurrency exchanges have offered 5-20% ranges for Ethereum 2.0 staking. Some benefits include receiving passive income on your cryptocurrency, especially if you plan to use a buy-and-hold strategy and not trade actively in that particular cryptocurrency.
You can stake a cryptocurrency with a digital wallet to perform these transactions. If you are trading futures contracts on cryptocurrency or contracts for differences, you cannot stake.
Types of Trading Strategies that are Geared for Staking
When combined with staking, the most effective strategies are trading strategies where you plan to own cryptocurrency that can be staked for a defined period. Stocking will be less effective if you want to set risk limits and use risk management tools such as a stop loss level. Buy-and-hold strategies or long-term trend-following strategies will likely keep you in the market long enough to benefit from staking.
Why Can’t You Stake with Futures and CFDs
Cryptocurrency staking is relatively straightforward when you use a digital account to exchange fiat currency for cryptocurrency. If you are trading a security that tracks the movements of a cryptocurrency, such as a CFD or futures contract, you are not eligible to stake a cryptocurrency. Since a futures contract and CFD tracks the movements of specific cryptocurrencies, you do not own a cryptocurrency, and therefore you cannot lend that cryptocurrency as proof of stake.
Why does the SEC think About Banning Staking?
The focus of the SEC is that by allowing investors to earn income from a cryptocurrency, the product resembles a security that receives either income or dividends. According to sources, on February 13, the SEC issued a Wells Notice to Paxos Trust Company. This entity issues the Binance USD stablecoin. The Wells notice is a document sent to a company or individual likely to be sued by the SEC. The movement by the SEC has led to rumors that the SEC will try to stop companies from using staking as a way to incentivize ownership as a way to earn passive income.
How Would a Ban on Staking Impact Cryptocurrency Advancement?
The benefits of staking include decreasing the carbon footprint that is evident in proof of work cryptocurrency verification and has helped build scale. According to a quote from Coinbase Chairman Brian Armstrong, he does not believe that staked cryptocurrencies are security. The SEC is also investigating Kraken for the sale of unregistered securities. While it’s unclear which cryptocurrencies at Kraken the SEC is investigating, it is known that Kraken allows investors to stake cryptocurrency and earn rewards from the process. There now appears to be a coordinated movement by prominent cryptocurrency community members to push back on the idea that the SEC would consider banning the staking of cryptocurrencies.
The Impact of a Staking Ban
The rumors of a staking ban would only impact retail investors and allow institutional investors to stake cryptocurrencies. You would need to be an accredited investor to participate, which in theory, works against the concept of decentralization. An accredited investor is a business or individual allowed to trade securities that might not be registered with financial regulators. Under regulation D, accredited investors are financially savvy and therefore have a reduced need for protection by the SEC.
The Bottom Line
Staking a cryptocurrency is attractive, mainly if you use a buy-and-hold strategy. The process of staking is similar to owning a stock and receiving a dividend. Staking means owning a stake in the digital coin and receiving rewards in the form of cryptocurrency. Because the concept is similar to owning a stock and receiving a dividend, the Securities and Exchange Commission in the United States wants to ban staking for retail investors. The agency believes staking can remain an unregulated asset if institutional investors participate.
Currently, cryptocurrencies and activities that pertain to their own are regulated by the Commodity Futures Trading Commission and are treated like a commodity. You can not receive a stake in a digital coin if you trade derivatives such as futures or contracts for differences. You must own a digital coin and apply for staking using your wallet at the exchange where your cryptocurrency is transacted and stored.
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