Is Stablecoin Staking a Security?

Stablecoin staking is a way to earn income with stablecoins, which are cryptocurrencies pegged to a fiat currency or another asset. However, regulatory challenges can arise as some stablecoins may be considered securities by the authorities. These challenges depend on how stablecoins are issued, backed and governed and what rights and obligations stakeholders have. 

Is stablecoin staking a security? This article considers this crucial question and explores the relevant factors. It also looks into what the implications are for investors and platforms that offer stablecoin staking.

Is Stablecoin Staking a Security?

Stablecoin staking involves investors locking up their tokens and receiving a return based on the interest rate of the underlying asset. For example, MakerDAO is a platform that supports the DAI stablecoin, which is pegged to the U.S. dollar. The system is backed by the MKR token, which investors stake to participate in governance and risk management. By staking MKR, investors can earn rewards through fees and savings rates from the MakerDAO network. They can also exchange their MKR tokens for other cryptocurrencies or DAI tokens on decentralized exchanges (DEXs).

Whether stablecoin staking is a security depends on how the U.S. Securities and Exchange Commission (SEC) applies the Howey test, a legal framework for determining if an investment contract is a security. The Howey Test determines whether a transaction should be considered an investment contract subject to U.S. securities laws. The criteria include:

• A common enterprise
• Monetary investment
• Reasonable expectation of profits  
• Primarily derived from the efforts of others

According to a Wall Street Journal article, SEC chair Gary Gensler has suggested that cryptocurrencies that stake their coins could pass the Howey test and, therefore, be considered securities. 

The SEC could argue that stablecoin staking involves an expectation of profit from the work of a third party, a key criterion of the Howey test, which could be the stablecoin issuer, the staking platform or the network that secures the transactions. The SEC could also compare stablecoin staking to crypto lending, which requires registration with the SEC or an exemption.

However, stablecoin stakers may counter these arguments. They could assert that they are active participants in the network rather than passive investors and rely on the blockchain's code and consensus mechanism of the blockchain rather than the efforts of a third party. They could also point out that stablecoin staking is not lending but rather a form of collateralization that ensures the stability of the peg. 

The question of whether stablecoin staking constitutes a security remains up for debate. If the SEC decides to regulate stablecoin staking as a security, it could result in disclosure requirements, trading restrictions and enforcement actions. This decision could impact the liquidity, innovation and adoption of stablecoins and other cryptocurrencies. If the SEC exempts stablecoin staking from securities laws, it could foster growth and innovation in the crypto space. Still, stablecoin staking could raise consumer protection, market integrity and systemic risk concerns. Many of these concerns usually lead regulators to want some type of regulation. 

Stablecoin staking is a popular and profitable way to use cryptocurrencies that also faces legal uncertainty and risks. The current lack of clear and consistent guidance on whether stablecoin staking is a security or not leaves the crypto industry in a state of limbo. Questions over how the product should be regulated mean that investors may have to deal with future enforcement actions or changes in the rules. Before you get involved, you’ll need to understand the risks and rewards and choose a reputable and compliant platform.

Risks Facing Stablecoin Stakers

Stablecoin staking can be profitable, but it's not without risks. Here are some of the main hazards facing stakers.

1. Stablecoin peg failure: Stablecoins are designed to maintain a 1:1 ratio with their underlying asset, but this is not always the case. Sometimes, stablecoins can deviate from their peg because of market fluctuations, technical issues or regulatory actions. For example, in October 2018, Tether (USDT), the largest stablecoin by market cap, briefly untethered from its peg and traded below $1 for a few days. This event could result in losses for stakers who hold or receive the devalued USDT stablecoins.
2. Platform hacks or exploits: Staking platforms, especially decentralized ones, are at risk of being hacked or exploited, which could potentially compromise the funds or smart contracts. In 2020, Harvest Finance, a decentralized platform that enables users to stake stablecoins and other tokens, was hacked in a flash loan attack, resulting in a loss of $24 million worth of investors' funds. 
3. Platform fees or penalties: Staking platforms often charge fees or impose penalties for staking or withdrawing stablecoins. For instance, Stake is a decentralized platform that enables users to stake their cryptocurrencies and stablecoins and receive rewards as STAKE tokens. Users can withdraw their staked stablecoins anytime, but there is a minimum withdrawal limit and a withdrawal fee depending on the network used and the type of stablecoin. Stakers who need to access their funds quickly or frequently may suffer decreased net returns.
4. Regulatory uncertainty: Stablecoins are subject to regulatory scrutiny and uncertainty, as they could pose risks to the financial system or the monetary policy. In 2021, the U.S. Treasury Department issued a report calling for stricter regulation of stablecoins, including requirements for stablecoin issuers to be monitored like banks and comply with anti-money laundering and consumer protection rules. Such restrictions could affect the availability, legality or functionality of stablecoins and staking platforms, causing them to become less accessible or even illegal.
5. Opportunity cost: When staking stablecoins, there is a potential opportunity cost as stakers may lose out on higher returns or a more diversified portfolio if they choose to invest in other assets or strategies. For instance, staking stablecoins might provide lower returns than staking other cryptocurrencies, investing in stocks or bonds or trading in cryptocurrency.

Benefits of Stablecoin Staking

Despite the risks, stablecoin staking also offers some benefits for investors who are looking for a low-risk, passive income strategy.

1. Stable and predictable returns: Stablecoin staking is a way to earn predictable and stable returns. Compared to other cryptocurrencies, stablecoins are less volatile and more consistent. Depending on the platform and market conditions, stablecoin staking can offer annual percentage yields (APYs) ranging from 5% to 25%. These rates are higher than most traditional savings accounts or fixed-income instruments.
2. Low entry barrier and high liquidity: Stablecoin staking can be a simple and accessible way to invest in cryptocurrencies, with the added benefit of liquidity. Stablecoins, which are easy to acquire, exchange and withdraw, are commonly used for staking. They are readily available on different platforms and can be purchased using fiat currency or other cryptocurrencies. Most staking platforms offer the flexibility to stake or unstake stablecoins anytime, without minimum amounts or locking periods.
3. Diversification and hedging: Stablecoin staking can provide diversification and hedging benefits. It helps to reduce the exposure to the volatility and risk of the cryptocurrency market. Investors may preserve their capital, earn interest and hedge against inflation or currency devaluation by staking stablecoins. Stablecoins can also diversify a portfolio of other assets, such as stocks, bonds or commodities.

Compare Stablecoin Staking Platforms

If you are looking for reliable stablecoin staking platforms, Benzinga offers comprehensive insights and reviews on various players in this field. Here’s a breakdown of key entities assessed based on their features, rates, security and reliability, so you can select the one that best suits your needs and preferences.

Navigate Stablecoin Staking Carefully

Stablecoin staking may be an effective way to earn returns, but it operates in a dynamic regulatory landscape. The income generation may appeal to investors, but it will likely come under some form of official regulation in the future. Being classified as a security may trigger a cascade of implications, impacting everything from investor disclosures to platform operations and costs.

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