SafeStake

Gary Gensler (Chairman of the SEC) has, in recent months, been railing against the cryptocurrency ecosystem under the premise of ‘protecting investors.’Its most recent action against Kraken’s Staking-as-a-Service Program and the $30 million fine levied against the company for their staking program puts the DeFi ecosystem in a precarious position.<blockquote> Gensler says in the SEC white paper, “Whether it’s through staking-as-a-service, lending, or other means, crypto intermediaries, when offering investment contracts in exchange for investors’ tokens, need to provide the proper disclosures and safeguards required by our securities laws.”
</blockquote>With this ruling, the SEC has just <a href="https://www.wsj.com/articles/ethers-new-staking-model-could-draw-sec-attention-11663266224" rel="noopener noreferrer nofollow">defined</a> staking services as a type of security, which means that these types of centralized programs are now on the regulator’s radar as unregistered securities.According to the Howey Test, if there is an investment in a company of a third party with the expectation of generating a return and that return is generated by the effort of a third party (not by my own effort), then it is considered an issuance of securities. In other words, there is an investment contract.However, many industry experts believe the SEC applied the Howey Test incorrectly when analyzing these types of staking services and decided that they were unregistered securities, even though there is no clear regulatory framework or forms that companies like Kraken or Coinbase are required to submit.In practical terms, the SEC has acted under the practice known as ‘regulation by and forcement,’ which is nothing more than forcible regulation by regulatory requirements without the regulatory framework in place. Hard to understand, right?The truth is that the SEC’s fine against Kraken comes after the crypto exchange received another similar measure two months ago from OFAC, albeit much smaller in terms of the amount they were fined (approximately $300,000).For the time being, uncertainty continues to grip the staking industry, especially in the United States.<h2 id="header-0">More regulation for the staking industry: good or bad?</h2>While the SEC’s action against Kraken is seen by some as a negative, the truth is that the lack of clear regulatory framework around Staking-as-a-Service could end up scaring both retail and institutional investors away from the industry.The CEO of Coinbase, Brian Armstrong, has <a href="https://twitter.com/brian_armstrong/status/1623459203150131201?ref_src=twsrc%5Etfw%7Ctwcamp%5Etweetembed%7Ctwterm%5E1623459203150131201%7Ctwgr%5E65a2216d2ec1e781a1111536a52387956c927ec6%7Ctwcon%5Es1_&amp;ref_url=https%3A%2F%2Fcointelegraph.com%2Fnews%2Fstaking-ban-is-another-nail-in-crypto-s-coffin-that-s-a-good-thing" rel="noopener noreferrer nofollow">indicated</a> that if necessary, he will go to court to defend this type of service (SaaS), based on the idea that there is no clear regulatory framework regarding these types of services.Even Kraken’s CEO, Jesse Powell, has indicated that while they have opted to immediately suspend the service, it is still not entirely clear whether the SEC’s definition of ‘investment contract’ can actually be applied to their program.Perhaps the most paradoxical aspect of the whole thing is that Kraken cannot technically suspend the staking program, since it is impossible to withdraw ETH staked on the Beacon Chain until the new Shanghai update arrives toward the end of March.So, the ETH in Kraken’s SaaS program are still generating returns for investors. Who knows what will happen…From the point of view of investors and users with little technical knowledge, it seems logical to think that this type of regulatory action could have a devastating effect on the staking industry as more of these actions are replicated in actions against similar companies.The SEC’s move with Kraken may simply be the tip of the iceberg. Since, there has already <a href="https://cointelegraph.com/news/staking-ban-is-another-nail-in-crypto-s-coffin-that-s-a-good-thing" rel="noopener noreferrer nofollow">been open talk</a> that the SEC wants to block staking for all companies.Gary Gensler has <a href="https://www.youtube.com/watch?v=hmPpIjfC9DY" rel="noopener noreferrer nofollow">explained in a video</a> why the agency is against these types of services, whether it is called ‘staking,’ ‘APIs,’ ‘lending services,’ or ‘rewards’. And he issues a warning: “Remember, if you have a piece of cake for two and you cut it into three pieces, it’s still the same amount of cake.”Given the nature of blockchain PoS, any validator can cease to be a validator by simply withdrawing its funds staked in the respective staking contract for a particular project.Because the only way to secure a PoS blockchain network is through staking, as SEC actions become more widespread across the globe, there could be a withdrawal of investors (validators) in many PoS networks that could compromise their security, making them vulnerable to malicious actors.In addition, the general discouragement — in the worst case scenario — of some users to continue validating in PoS networks (at least in the US for now), could lead them to opt for investing in PoW solutions such as Bitcoin, throwing the rhetoric encouraging ‘green mining’ off the cliff.So who benefits from this type of action?For some the actions executed by the SEC against Kraken, <a href="https://www.wsj.com/amp/articles/crypto-firm-paxos-faces-sec-lawsuit-over-binance-usd-token-8031e7a7" rel="noopener noreferrer nofollow">BUSD</a> (Paxos), <a href="https://www.sec.gov/news/press-release/2023-32" rel="noopener noreferrer nofollow">Terraform Labs</a>, and most recently against veteran hall of fame player <a href="https://www.sec.gov/news/press-release/2023-34" rel="noopener noreferrer nofollow">Paul Pierce</a>, seem to indicate that 2023 will be a year of challenges, but also of opportunities to continue to build and deploy more decentralized solutions (like SafeStake) that will ultimately bring more protection to the average user.<h2 id="header-1">Status of ETH2 Staking</h2>Looking at Beacon Chain metrics, we can see that after ‘The Merge’, there has been a huge concentration of power over the Ethereum network in the hands of a few centralized staking pool platforms such as Kraken, Lido, Coinbase, and Binance.These four companies alone concentrate more than 48% of the entire ETH staked, putting <a href="https://thecapital.io/article/the-centralization-woes-of-ethereum-NNqdvDbExQP4UmNSeIU" rel="noopener noreferrer nofollow">Ethereum’s decentralization</a> at risk. This means that these four platforms have just over 250,000 active validators in the Ethereum network, out of a universe of 520,252 validators on the Beacon Chain.<img src="https://academy-public.coinmarketcap.com/srd-optimized-uploads/232029428df54f1e8302f8ede012d479.png">The consequences of this type of centralization could be devastating to the entire Ethereum ecosystem and even other blockchains, given its dominance and relevance to the industry, if these four entities were to cease operations or be compromised.That’s why staking restrictions are just the latest example of the challenges facing the crypto industry as it navigates the complex regulatory landscape.In Q4 2022 alone, total staking valuation amounted to over $40 billion, with annualized staking rewards of $3 billion. In fact, staking rewards amounted to more than 10% of Coinbase’s revenue last year. Being a multi-billion dollar industry, the SEC has indicated that it has an interest in preventing situations like Celsius, BlockFi, or FTX from happening again with ETH2 staking with centralized options like Kraken, for example.However, without a clear regulatory framework, the crackdown we have seen from the U.S. securities regulator on cryptocurrency staking could have unintended consequences for the decentralized finance sector.With the increased risk of the SEC definitively concluding that no U.S. citizen can interact with staking services, the solution seems to logically extrapolate through the use of decentralized, non-custodial options such as SafeStake.<h2 id="header-2">Decentralized Staking: An alternative to SEC censorship</h2>As we have been pointing out throughout the post, decentralized options continue to gain traction as regulators lash out at centralized crypto staking options like Kraken.For many enthusiasts, staking with an embedded, centralized company is the antithesis of what makes cryptocurrencies special — decentralization.The obvious shift towards centralization seen with ‘The Merge’ means that securing the most important blockchain network in terms of Dapps results in an obvious dissonance between centralized protocols and the staking used to secure Ethereum.If the SEC continues, it is normal that we will continue to see a significant shift from centralized staking to more decentralized options, especially those protocols that are using DVT as the core foundation of their technology.Despite the uncertainties there are still options that centralized exchanges such as Kraken can take to implement decentralized staking through DVT-based solutions such as SafeStake.By delegating to a decentralized pool, investors can avoid the risks associated with centralization while still earning staking rewards, and the Staking-as-a-Service (SaaS) provider would avoid being penalized by regulatory bodies such as the SEC since it would not be allowing the investment of assets to generate a return on investment.On the contrary, with SafeStake, it would behave as a node operator to establish a broader validator base for Ethereum through mini-pools started by 8 ETH deposits, a role that we have defined as ‘initiators.’<img src="https://academy-public.coinmarketcap.com/srd-optimized-uploads/dd58ac0f54fb46039de1ac5944fd708c.png">The integration of distributed validator technology (DVT) through providers like SafeStake would allow CEXs to create specific operators for their staking service, thus forming an ultra-secure fault-tolerant set of distributed validators.By nature, SafeStake enables a broad base of high-quality distributed validators due to the use of the HotStuff consensus mechanism, which considerably reduces downtime that validators may experience due to connectivity problems, hardware failures, etc, and the associated penalties (or missed earning opportunities) for being offline. It also reduces the potential for slashing.SafeStake’s middle-layer solution allows for the creation of operator sets (initially 4-operator configurations with a threshold of 3) to create entries in its node operator registry.Through coordinated distributed key generation (DKG) ceremonies, the shared keys would be created without relying on any one party to distribute them and allow the distributed validator to remain online despite a subset of nodes going offline.The implementation of DVT facilitates the involvement of several Node Operators in running distributed validators, resulting in a reduction in single points of failure and providing a range of benefits that include decentralization, infrastructure resilience, and security. SafeStake also anticipates that DVT will be critical in enabling permissionless validation for the SaaS providers.In this way, DVT can be a key component in helping centralized exchanges manage regulatory concerns until the SEC (and similar bodies) define guidelines for staking providers to follow.Finally, if you want to read more about the advantages of using DVT-based options over centralized options, please check out this post: https://medium.com/ethereum-on-steroids/the-threat-of-centralization-in-ethereum-safestake-and-the-use-of-dvt-5d644e976935 About ParaStateParastate is participating in ETH 2.0 PoS with a new tech stack called SafeStake, a trust-minimized middle layer that promotes decentralized ETH 2.0 staking. SafeStake is the first Ethereum liquid staking pool protocol written in Rust that implements distributed validator technology (DVT). It utilizes HotStuff consensus and BLS Threshold Signature architecture to provide robust security and reliability, so validators can maximize their ETH staking rewards.<a href="https://www.parastate.io/" rel="noopener noreferrer nofollow">Website</a> | <a href="https://medium.com/ethereum-on-steroids" rel="noopener noreferrer nofollow">Blog</a> | <a href="https://twitter.com/_ParaState" rel="noopener noreferrer nofollow">Twitter</a> | <a href="https://t.me/ParaState" rel="noopener noreferrer nofollow">Telegram</a> | <a href="https://discord.com/invite/zFS3Mnfpwj" rel="noopener noreferrer nofollow">Discord</a> | <a href="https://github.com/ParaState" rel="noopener noreferrer nofollow">Github</a>

DVT with SafeStake as an option to SEC censorship against ETH2 Staking

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SafeStake

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