Coinbase Warns of ‘Staking’ Crackdown. The Stock Is Tumbling.

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The CEO of

Coinbase Global

warned the Securities and Exchange Commission might be considering cracking down on a process called staking. Any potential move would be bad for the cryptocurrency broker’s business and likely hurt

Ether,
the largest crypto after

Bitcoin
.
Coinbase stock was tumbling on the news.

Staking refers to a process that both underpins blockchain networks and offers investors a way to earn yield on their crypto holdings.

While staking doesn’t exist for Bitcoin, it does for Ethereum, one of the biggest blockchains. Holders of Ether—Ethereum’s token—can lock up or stake their tokens as collateral in a process that validates transactions and secures the network, earning money in the process. Current yields for staking Ether are upward of 5%. “Validators” must lock up at least 32 Ether, or about $52,000, to participate in staking on Ethereum.

Enter Coinbase (ticker: COIN), which is itself a validator and has a service that lets investors stake smaller amounts of Ether. There is no minimum amount needed, thus opening up the yield opportunity to a wider pool of people. 

Investors earn crypto yield that would otherwise be out of reach, and Coinbase receives a fee: 25% of the Ether yields. Analysts say that is the type of diversification that Coinbase needs, given that revenue from crypto trading has tumbled in tandem with Bitcoin prices over the past year.

This business model, however, could be under review by regulators

“We’re hearing rumors that the SEC would like to get rid of crypto staking in the U.S. for retail customers,” Armstrong said Wednesday on Twitter. “I hope that’s not the case as I believe it would be a terrible path for the U.S. if that was allowed to happen.” 

The SEC declined to comment.

In its second-quarter financial filings last summer, Coinbase disclosed that its staking program was under scrutiny from the SEC, which it said had sent investigative subpoenas and other document requests.

A potential ban on staking would be negative for both Coinbase and Ether. Coinbase would lose a source of high-margin revenue that looks poised to be a pillar of growth. Ether would lose out on the participation of U.S. retail investors—a group that played a big role in cryptos’ latest bull run—in staking. It wouldn’t be crushing to Ethereum’s ability to operate, but rather a hit to the wider adoption of the network, which would support prices.

Armstrong, on his part, doesn’t want this to happen.

“Staking is a really important innovation in crypto,” the Coinbase CEO said on Twitter. “It allows users to participate directly in running open crypto networks. Staking brings many positive improvements to the space, including scalability, increased security, and reduced carbon footprints.”

Armstrong, and others, say that staking doesn’t make Ether a security, which would put the coins under the purview of the SEC. But the agency and the broker have had this argument before: The SEC has said that some tokens Coinbase says aren’t securities are just that.

With no confirmation from the SEC, these concerns are just concerns for now, but the market is taking them seriously. Coinbase stock has tumbled 11% Thursday as the worries add to uncertainty for cryptocurrencies and crypto companies that are already facing threats from a bear market in prices, other regulatory pressures, and waning investor interest.

Write to Jack Denton at [email protected]