Why the Howey Test's Application to Staking Rewards Is Flawed

The SEC asserts staking pools create a 'common enterprise' where rewards depend on others' efforts. This ignores the cryptographic reality of proof-of-stake.

• Validator performance is individual: Slashing and rewards are tied to a node's own uptime and correctness, not the pool's aggregate profit.
• No horizontal commonality: Stakers delegate stake, not capital for a promoter's business venture. The protocol's success is not the service being sold.

In SEC v. LBRY, the court ruled that the sale of a token for consumptive use (access to a network) is not a security. This directly applies to staking.

• Stake-for-Service Model: Staking ETH to secure Ethereum is a consumptive use of the asset, akin to using compute resources.
• The reward is payment: Staking yields are protocol-dictated compensation for a service (validation), not profits from a managerial enterprise.
• Kraken's capitulation set a bad precedent, but the legal argument for native network staking remains strong.

Regulators claim stakers expect profits 'solely from the efforts' of the promoter (e.g., the protocol foundation). This mischaracterizes the source of value.

• Protocol rewards are algorithmic: Issuance and slashing are code-defined, not manager-discretionary. The 'effort' is automated.
• Primary profit driver is asset appreciation: A staker's main gain is from ETH's market price, a function of the broader ecosystem's utility, not a promoter's salesmanship.
• This conflates protocol governance (which can be decentralized) with profit-generating managerial effort.

Former SEC Director William Hinman's 2018 speech outlined a functional, decentralized network test. A sufficiently decentralized network where tokens are used for functionality is not a security.

• Ethereum's transition to Proof-of-Stake further decentralizes control, moving away from any single 'essential managerial effort'.
• The 'Staking-as-a-Service' (SaaS) model is the real target: Centralized SaaS providers like Coinbase or Kraken may implicate Howey; solo staking or decentralized pools like Lido/Rocket Pool do not.
• Regulation should target the service wrapper, not the underlying cryptographic act of validation.

The SEC presumes the staked asset is an 'investment of money.' This ignores that the staked asset is the functional key to the network.

• Staking is a prerequisite for participation: You cannot validate without staking ETH. It's a collateral requirement, not an investment in a third party.
• The 'money' is transformed: Staked ETH is cryptographically locked and utilized as a security bond. Its economic nature changes from a speculative asset to a productive, utility-bearing one.
• Applying Howey here is like calling a deposit for a rental car an investment in Hertz's profitability.

The Supreme Court's Major Questions Doctrine holds that agencies cannot decide issues of vast 'economic and political significance' without clear congressional authorization.

• Redefining a $100B+ staking industry as securities would be a massive expansion of SEC authority without a new legislative mandate from Congress.
• Creates regulatory arbitrage: Drives innovation offshore to jurisdictions with clear rules (e.g., EU's MiCA, which treats staking as a service, not a security).
• The path forward is congressional action (e.g., the FIT for the 21st Century Act) to create a tailored regulatory framework, not forcing a 1940s test onto 21st-century infrastructure.

The SEC argues staking pools constitute a common enterprise. This fails because:

• Validator autonomy: Node operators on Ethereum or Solana choose their own hardware, software, and uptime. No central promoter controls profits.
• Direct protocol rewards: Rewards are algorithmically issued by the protocol, not from the efforts of a third party like Lido or Coinbase.
• Non-passive income: Active slashing risk and technical operation negate the 'passive' investment premise.

Ethereum's consensus mechanism demonstrates staking is a utility service, not a security.

• Capital-at-risk slashing: Validators face direct penalties (~1 ETH) for malfeasance, aligning with operational liability, not investment.
• Decentralized yield source: 4-5% APR is minted by the protocol, not derived from a business's revenue.
• Client diversity: No single entity controls the network; clients like Prysm, Lighthouse, and Teku are independently maintained.

The SEC's own precedent with Bitcoin mining invalidates the staking claim.

• Analogous function: Both mining and staking are permissionless, competitive processes to secure a decentralized ledger.
• Reward structure: Bitcoin's block reward is a protocol issuance, identical in economic substance to staking rewards.
• Regulatory clarity: The SEC has consistently stated Bitcoin is not a security, creating a logical contradiction for Proof-of-Stake.

Solana's model highlights user agency, further undermining the 'investment contract' thesis.

• Delegator choice: Users freely choose from over 1,500 validators, directly influencing network decentralization.
• Variable commission: Validators set their own fees (0-100%), creating a competitive market, not a pooled profit scheme.
• No custody: Native staking never transfers asset custody; tokens remain in the user's wallet, controlled by their private key.

The SEC lacks clear congressional authority to redefine fundamental internet infrastructure.

• Major questions doctrine: Recent Supreme Court rulings (e.g., West Virginia v. EPA) require clear statutory authority for economically significant rules.
• $100B+ industry: Reclassifying staking would unlawfully regulate a core function of global blockchain networks.
• State-level acceptance: States like Wyoming have explicitly defined staking as a non-security service, creating regulatory arbitrage.

Despite regulatory pressure, major institutions are building staking infrastructure, signaling long-term confidence.

• BlackRock's BUIDL: The world's largest asset manager launched a tokenized fund on Ethereum, embracing its native yield.
• Custodian services: BNY Mellon, Anchorage, and Fidelity offer staking, relying on legal analysis that it's not a security.
• Futures markets: CME Group listing Ethereum futures is a CFAC-regulated acknowledgment of its commodity status.

The SEC's broad-brush application ignores the fundamental difference between passive investment and active network participation. This creates a chilling effect on protocol development.

• Legal Precedent: Sets a dangerous precedent for any protocol with a token reward mechanism, from Lido to Rocket Pool.
• Innovation Cost: Stifles development of novel consensus mechanisms like Solana's proof-of-history or Avalanche's subnets.

Courts must distinguish between a passive security and an active utility service. The key is whether rewards are derived from the managerial efforts of a third party or from the participant's own computational work.

• Active Participation: Solo staking or running a DVT-enabled node on the Obol Network is a service, not an investment.
• Passive Delegation: Services like Coinbase Earn or Kraken's former program may fit Howey, creating a necessary legal distinction.

Regulating staking as a security forces centralization. Compliance costs will push users towards large, regulated custodians, undermining the core value proposition of blockchains.

• Centralizing Force: Only Fidelity or BlackRock could afford the legal overhead, reversing years of decentralization progress.
• Network Security: Concentrates validation power, increasing risks of censorship and reducing the resilience seen in networks like Bitcoin and Ethereum.

The CFTC's classification of Bitcoin and Ethereum as commodities underlines the inconsistency. Staking is the native function of the Ethereum protocol post-Merge, not a separate enterprise.

• Regulatory Arbitrage: Creates a fractured landscape where the same protocol activity is a security in the US and a commodity elsewhere.
• Global Disadvantage: Pushes core infrastructure development to jurisdictions with clearer frameworks, like the EU's MiCA.

Howey requires an expectation of profits solely from the efforts of others. A validator choosing clients, managing keys, and facing slashing risks is providing a critical network service.

• Direct Control: Validators use clients like Prysm or Lighthouse, not a promoter's management.
• Risk of Loss: Slashing penalties and technical failure prove capital is at risk from the participant's own actions, not a promoter's failure.

Regulation should target the service layer, not the protocol. Focus on consumer protection at the point of fiat on-ramps and custodial interfaces, not the cryptographic process itself.

• Service-Based Oversight: Regulate centralized exchanges (Coinbase, Kraken) offering staking-as-a-service, not the underlying Ethereum protocol.
• Protocol Neutrality: Follow the Commodity Exchange Act model, ensuring the base layer remains open and innovation-friendly.