Consensys recently responded to the Guidance Consultation on cryptoasset financial promotions published by the UK Financial Conduct Authority (FCA). The FCA’s proposal would classify Proof of Stake (PoS) staking mechanism as a ‘complex yield arrangement’ of an investment nature alongside cryptoasset lending and borrowing, and bring it within the existing financial promotions regime.
The financial promotions regime prohibits any invitation or inducement to engage in an investment activity (as specified in legislation), unless such promotion is pre-approved by an authorised entity or qualifies for one of the limited exemptions. The territorial scope of the regime is wide, covering all financial promotions that are capable of having an effect in the UK, including adverts from abroad that are targeted at UK investors.
We have summarised our response to the consultation below. We believe that PoS staking should remain widely accessible for the benefit of both cryptoasset holders and PoS network security. Consensys supports this through a range of products: Consensys Staking (a delegated self-custodial software-as-a-service), a staking marketplace for MetaMask Institutional users, and a feature enabling MetaMask users to stake ETH through the MetaMask interface using a third-party smart contract-facilitated liquid staking protocol.
Consensys believes that the FCA’s definition of staking activity is too broad, and all forms of PoS consensus staking should not be included in the scope of the financial promotions regime from 8 October 2023 for three primary reasons:
Staking is not inherently an investment activity. Staking is a technical/computational activity necessary to allow the blockchain system to function. Rewards are given for the service of supporting the network which is inherently different from investment activity. Staking should only be considered investment activity when it is packaged into an investment product with active discretionary management.
Staking’s inclusion would preempt the conclusion of the Treasury’s ongoing consultation on the future financial services regulatory regime for cryptoassets. Staking has no direct corollary in traditional finance, and its risk profile is very different from borrowing or lending. Given its novel and unique nature, we support the Treasury’s view in the consultation that “given the lack of data on the amount of staking that takes place in the UK, it may be sensible to initially seek data on staking to enable us to gather a fuller picture”, before capturing staking activities within the regulatory perimeter. A possible extension of the financial promotions regime to staking should follow, not precede, the conclusion of the Treasury’s consultation.
Generally, staking does not fit within any of the controlled activities in Schedule 1 of the Financial Promotions Order (“FPO”), so including staking would be an undue extension of the scope.
We develop these arguments in greater detail below. We use the term ‘staking’ to refer to PoS consensus staking. While there are many PoS chains, our response focuses on Ethereum’s application of that consensus mechanism. For simplicity we refer to ‘qualifying cryptoassets’ (note: this term is defined in legislation and includes most cryptocurrencies such as ETH and stablecoins) as ‘cryptoassets’ for the rest of this document.
Do you agree with our proposed guidance for financial promotions of complex yield models or arrangements? Please explain your answer, highlighting any other issues that would be useful to consider.
Staking is not an investment activity
Staking is inherently not an investment or financial activity; it is a data integrity mechanism that Ethereum and similar blockchain networks require to function. The FCA’s proposed definition of financial promotion for complex yield models/arrangements is, in our view, overly broad and does not distinguish between different staking models and their respective risk profiles. This would go against the same risks, same rules principles. The proposed guidance would severely restrict the marketing of purely technical staking services without a corresponding risk of consumer harm.
Many providers of technical staking services do not provide the services that require registration with the FCA for anti-money laundering purposes and therefore would be unable to approve their own promotions. Further, as the FCA is aware, existing authorised persons are not experienced in or willing to approve financial promotions relating to cryptoassets. Inappropriately classifying the marketing of a technical service as a financial promotion could prevent such providers from advertising their services without a feasible avenue for approval.
A better approach would be to carefully consider the different ways in which consumers can stake, and only apply the financial promotions rules to those offerings that package staking into a product with investment characteristics and that have a clear link to a controlled activity. We considered such characteristics, including their implications for the collective investment scheme classification, in our response to the Treasury’s recent consultation on cryptoassets and decentralised finance (DeFi).
We encourage the reader to read an article titled ‘Staking is Data Validation, Not Investment’ from Consensys’ Matt Corva and Bill Hughes, which goes into more detail as to the staking mechanism, demystifies where rewards come from, and explores some popular staking models.
Staking does not fit within any of the amended controlled activities
In our view, extending the financial promotions regime to staking through the FCA guidance would preempt and potentially contradict the Treasury’s approach to staking, as expressed in its recent consultations. The FSMA 2000 (Financial Promotion) (Amendment) Order 2023 amended four controlled activities following a thorough consultation process by the Treasury. In its consultation response, the Treasury noted that those activities “are the activities most associated with misleading cryptoasset promotions identified by the FCA”. The Treasury also noted that “the central activities causing consumer harm, and where misleading advertising is more commonly found, relates to the buying and selling of cryptoassets”.
We agree with this assessment. Staking does not involve buying or selling of cryptoassets, and carries a much lower risk of consumer harm (as highlighted in our response to the discussion questions below). Further, the risks associated with staking are mainly of a technical, as opposed to market or credit, nature. We also note the absence of any mention of staking during the Treasury’s consultation process, unlike other activities such as borrowing or lending.
In our view, the above shows that it was not the Treasury’s intention to include staking within the financial promotions regime at this stage, given the lower risk of consumer harm and the absence of sufficient data. In the absence of a clear link to a controlled activity, we would respectfully invite the FCA to reconsider the blanket inclusion of staking within the financial promotions regime.
Regarding the controlled activities, none of the staking models involves ‘dealing in [cryptoassets]’. More specifically, staking does not involve ‘buying, selling, subscribing for [cryptoassets]’ because, as a precondition to staking, one must already own a certain amount of cryptoassets. Any purchase of cryptoassets would take place prior to, and separately from, staking. Staking rewards clearly do not involve the purchase or sale of cryptoassets either, as they are merely a compensation for helping to secure the network. For the same reasons, none of the staking models involve ‘arranging deals in [cryptoassets]’.
In respect of the activity of ‘managing [cryptoassets] belonging to another person, in circumstances involving the exercise of discretion’, it is important to distinguish between different types of staking offerings. On the one hand, some types merely provide technical/administrative support with validation activities without any ability to exercise discretion or deviate from the predetermined constraints of the software. For example, the purely technical/administrative type of services automatically distributes any staking rewards generated by the protocol directly to stakers (minus a predetermined service fee). Delegated self-custodial software-as-a-service staking is an example of this type of service. Another example is smart contract-facilitated liquid staking, where there is no scope for human discretion as the functionalities of the software suite are determined by smart contracts.
In contrast, a custodial offering that goes beyond the provision of technical services and involves the exercise of discretion (for example, as to in which protocols the funds are used to stake, or as to when or what amount of staking rewards is distributed to users) might properly be characterised as ‘managing’, depending on the specific facts. Lastly, the activity of ‘advising on investments [in cryptoassets]’ is clearly unrelated to staking.
Today, a user can generally stake in four ways - solo staking, delegated custodial staking, self-custodial software-as-a-service staking, and smart contract-facilitated liquid staking.
What are the benefits and opportunities of cryptoasset borrowing, lending and staking models/arrangements for consumers?
The benefits and opportunities of cryptoasset borrowing, lending and staking are fundamentally different and should not be compared to each other.
Staking provides an opportunity for consumers to participate in securing the relevant PoS network, which is an essential element for creating a robust environment for the internal economy and ecosystem. This means that it is possible to establish and maintain large and complex applications on the network in an environmentally sustainable and economically distributed way. There are many such crypto-native examples, however, it is noteworthy that the security of certain networks (Ethereum for example) attracts companies such as Reddit or PayPal to deploy projects. This catalyses value accrual to the network and across its whole ecosystem.
There are more direct benefits and opportunities. Engaging in staking allows consumers who already hold certain cryptoassets to provide a service and get rewarded for this effort - effectively putting their cryptoassets to productive use without needing to dispose of them. Staking rewards tend to be predictable and are transparent as they are determined by rules of the protocol and transaction fees paid by participants transacting on the network. In this respect, staking does not lend itself to speculation or expectations of unrealistic returns.
As the Treasury noted, the central activities causing consumer harm relate to the buying and selling of cryptoassets. Thanks to its predictability and transparency, staking poses a lower risk of consumer harm compared to speculative investments in new tokens or complex trading strategies. Furthermore, consumers can withdraw their staked assets at any time (subject to technical unbonding periods set by the protocol).
Which type of cryptoasset borrowing, lending and staking models/arrangements provide the greatest benefit to consumers?
Leaving the comparison to borrowing and lending to the side, it is not possible to say which staking model provides the greatest benefits to consumers in general. The answer will vary for each consumer depending on factors such as their familiarity with blockchain technology, their desired level of involvement in validation activities, and their desired customer experience.
However, staking software-as-a-service offerings are beneficial to consumers because they offer a process through which a consumer can participate in a PoS staking protocol without having to custody their tokens with a third party or rely on a third party’s discretionary judgement. This is in notable contrast to offerings where a consumer must transfer his or her tokens to the custody of a third party service provider who then exercises discretion on how the tokens will be staked.
What are the risks associated with cryptoasset borrowing, lending and staking models/arrangements for consumers?
As staking is a technical activity, there is a risk of a malfunction of the staking software which may result in a loss of rewards. In such circumstances, the service provider will likely have a service level agreement in place with the customer that sets forth the consumer’s recourse. Additionally, there is the risk of malfunction of the staking smart contract or the underlying blockchain network. Consensys has set out the general risks of staking, as well as specific risks associated with MetaMask Staking, in a voluntary risk disclosure available here.
Apart from the general technical risks, there are risks specific to each staking model. Solo staking gives the consumer complete control over validation activities, but it requires the greatest amount of effort and involvement on the part of the user. It therefore carries the greatest risk of a mistake or oversight on the part of the user, which can lead to loss of private keys or slashing penalties due to inactivity or failure to upgrade validation software when required.
The main risks of delegated custodial staking relate to custody, especially in the absence of a comprehensive regulatory framework for cryptoasset custody in the UK. Delegated self-custodial software-as-a-service staking removes the counterparty risk as the provider never has the private key to access the staked assets or staking rewards, while still allowing users to benefit from a professional staking software and infrastructure.
The main risks associated with smart contract-facilitated liquid staking relate to a potential bug in the smart contract, which, if exploited by a malicious actor, could lead to loss of staking rewards or loss of staked funds. Comprehensive smart contract audits, together with bug bounty programmes, are designed to reduce these risks.
Which types of cryptoasset borrowing, lending and staking models/arrangements present the greatest risks to consumers?
Similarly as with the benefits of staking, the risks differ depending on the staking model. It is not possible to say which model presents the greatest risks without assessing a user’s individual situation and preferences. In general, staking exposes consumers to operational risk, whereas lending exposes consumers to credit/default risk. If staking is intermediated though a delegated custodial staking provider, then the operational risk of the intermediary and counterparty failure risk are added.