SEC’s enforcement action against Kraken
The Securities and Exchange Commission (SEC)’s complaint against Kraken alleges that Kraken sold an investment contract to the general public where investors transferred certain assets to Kraken for staking in exchange for annual investment returns (Kraken Staking Program). Kraken settled this action with a $30 million fine, 66.6% of its revenue from American users.
Kraken’s Custodial Staking Program. Kraken was touting specified investment returns for staking eligible crypto assets on the kraken.com website, on social media, and through advertisement emails. Kraken was determining the returns, not through the underlying blockchain protocols, and the returns advertised were not necessarily dependent on the actual returns that Kraken received from staking. Investors lost possession and control over their crypto assets when they transferred them to Kraken and took on the risks associated with the Kraken platform. Kraken benefited from having a big pool of assets and advertised that their efforts provided investors with a higher return than investors could achieve if they implemented the staking strategy on their own.
Kraken took investors’ assets, pooled them, staked some to obtain rewards, and distributed a portion back to investors.
Kraken offered instant reward accrual, the ability to instantly unstake, automatic weekly payout dates, and custom and steady returns with promised minimum returns.
Not all tokens were staked, which is how Kraken offered instant liquidity.
Investors in the Kraken Staking program did not participate in the staking protocols directly.
Kraken did not require any minimum threshold number of tokens to be able to participate.
Kraken marketed the staking as an investment opportunity.
The fortunes of the investors and Kraken are tied together in a common enterprise because the larger the staking pool, the higher likelihood of obtaining rewards, which benefits all investors and Kraken.
Kraken was not following Protocol rules. Kraken did not force its users to adhere to the protocol rules, such as bonding/unbonding periods, minimum staking requirements, or validator fees. Rather, Kraken only staked a portion of the users’ assets and kept the rest in a liquidity pool.
The SEC’s argument. The SEC asserts that Kraken sold an investment contract without registering the offer or sales with the SEC as required by federal securities laws, and no exemption from registration was applied. This left investors without certain material information about the Kraken Staking Program, including Kraken’s business and financial conditions, fees charged, the extent of Kraken’s profits and losses, and other specific and detailed risks of the investment, including how defendants determine to stake tokens or hold them in a liquidity reserve. Investment contracts are instruments through which a person invests money in a common enterprise and reasonably expects profits or returns derived from the entrepreneurial or managerial efforts of others.
Jesse’s response. Kraken’s former CEO, Jesse Powell, responded on Twitter with some gems.