There is a lot of debate about the scope of the Markets in Crypto-Assets Regulation (MiCAR). Especially concerning topics such as staking, lending, decentralised protocols and some others. Does MiCAR regulate it or not? This post will look into staking. Let’s begin our analysis, shall we?
Article 4 of MiCAR says Title II of MiCAR does not apply to offers of a “[…] crypto-asset [that] is automatically created as a reward for the maintenance of the distributed ledger or the validation of transactions”. In Recital 93, the legislator provides further guidance that MiCAR does not regulate staking. It reads that validating transactions and registering transactions on the blockchain should be regarded as the regulated service of “providing transfer services for crypto-assets on behalf of clients” So, pretty clear, right? Well, not so fast. The thing is, the term staking is never mentioned in MiCAR.
The industry holds that staking is allowed. You can stake your own crypto and you can also stake on behalf of clients without the need for a MiCAR license. Most prominent service providers of the crypto industry state that staking is out of the scope of MiCAR. They say that staking is similar to other services and types of crypto-assets mentioned that are exempt, such as financial instruments or fully decentralised applications. But are they correct? Especially because, for example, crypto-assets that are financial instruments are specifically mentioned as not regulated by MiCAR.
The thing is, staking is not regulated by MiCAR, meaning that the concept of staking, from a legal perspective, does not exist. In other words, it’s not legal, but it’s also not illegal. It is simply not mentioned. This means that you should “look through it”. Ignore staking as a concept and look at what happens when someone stakes crypto. In other words, each individual event and/or service that is part of what the industry calls staking should be assessed in isolation to see if each individual event and/or service is in or out of the scope of MiCAR.
That sounds a bit complicated, right? Well, let’s illustrate what this means. Let’s look again at Article 4 of MiCAR. It reads that title II of MiCAR does not apply to offers of a “[…] crypto-asset [that] is automatically created as a reward for the maintenance of the distributed ledger or the validation of transactions”. So, does this exempt staking? No! It exempts crypto-assets that are automatically created as a reward for maintenance of the distributed ledger and those that are automatically created as a reward for validating transactions. The article refers to staking but doesn’t mention it.
So, what happens if we take a closer look at staking and dissect it “MiCAR-style”?
- A blockchain (distributed ledger technology, Art. 3,1(1)) has validators (DLT network node, Art. 3,1(4)) that stake crypto (crypto-assets, Art. 3,1(5)) to become eligible to validate transactions and register transactions on the blockchain by creating new blocks.
- The staked crypto come from the validator and, commonly, from delegators. The delegators (clients, Art. 3,1(39)) transfer the crypto to the validator for staking. The validator then stakes the delegated crypto on behalf of the delegators (providing custody and administration of crypto-assets on behalf of clients, Art. 3, 1 (17)).
- A validator processes transactions of the users (clients, Art. 3,1(39)) of the blockchain (providing transfer services for crypto-assets on behalf of clients, Art. 3,1(26) or reception and transmission of orders for crypto-assets on behalf of clients, Art. 3,1(23)) by combining them in a new block and propagating this block to the network (i.e. blockchain).
- If the block is deemed valid, the block is added to the blockchain and the validator that created the block is rewarded with the transaction fees of the transactions that are in the block and the newly minted crypto issued (offer to the public, Art. 3, 1(12)) by the blockchain protocol (issuer, Art. 3, 1(10) and offeror, Art. 3, 1(13)). If the validator has delegators, some of these newly minted crypto will be rewarded to the delegators (placing of crypto-assets, Art. 3, 1(22)).
- This process is called staking (industry term) and is a fundamental part of a blockchain’s consensus mechanism (consensus mechanism, Art. 3, 1(3))
So, now back to the law. It’s clear that Article 4, 3(b) of MiCAR exempts the offering of newly minted crypto-assets through staking, and Recital 93 of MiCAR exempts the services related to the processing of transactions. The other services and events, however, the ones that are the result of validators accepting crypto from delegators, are a completely different story. Therefore, it’s safe to state that these services, are in the scope of MiCAR and can only be provided after obtaining a license.
The most prominent or perhaps the most important service part of staking is providing custody and administration of crypto-assets on behalf of clients, Art. 3, 1 (17). When a validator only stakes its own crypto, all is fine and MiCAR doesn’t care. But when a validator takes the crypto of delegators, it becomes a whole different story and MiCAR does care. When a validator takes crypto from a delegator (you, for example), the validator takes custody of the delegator’s (your) crypto, and providing custody and administration on behalf of clients (you) is a licensed service under MiCAR.
Looking back at the Crypto Winter (that time during 2022 when everyone went bankrupt), we can see the damages that can be done when someone else holds custody of your crypto. Now imagine that a validator stakes your crypto on your behalf. Do you have any control other than the right to unstake your crypto? Not really. It’s up to the validator to make sure that staking is done properly. A decent blockchain has made sure that a validator cannot steal your crypto, but if the validator messes up, your crypto will still be slashed. Even more so, if you don’t directly delegate your crypto via a non-custodial wallet, but use an intermediary (a CEX, for example) to do so, you won’t even be able to get your crypto back when this intermediary goes bankrupt. As a matter of fact, this intermediary could actually steal your funds. So, wouldn’t it be better if your local financial market authority keptan eye out?
Better or not, regardless of how you feel about the need for regulation, based on the text of MiCAR, it is safe to argue that when a validator or another party wants to take your crypto and stake it on your behalf they need to apply for a MiCAR license first. Simple, because doing so means that they are taking custody of your crypto and MiCAR dictates that providing custody requires a license. So, when the validator only stakes its own crypto, no license is required. But when delegators come into play, the validator does need a license.
To conclude, is staking in or out of the scope of MICAR? Well, it depends, but it very well can be.