Why 'Expected Profits' from Staking Are Legally Problematic

Promised returns are securities. The Howey Test defines an investment contract by the expectation of profits from the efforts of others. When a protocol or validator markets APY or rewards as a primary feature, it directly triggers this legal framework, inviting SEC scrutiny as seen with Lido and Rocket Pool.

Staking is not a yield product. The core function is network security and consensus, not generating passive income. Rewards are a variable incentive for service provision, not a guaranteed return. Framing it otherwise conflates utility with financial yield, creating regulatory risk.

The legal burden is operational. Protocols must structure their messaging and tokenomics to emphasize participation over profit. This requires clear disclaimers, avoiding fixed-rate promises, and architecting systems where rewards are a byproduct of work, not an entitlement.

Expected Profit from Others' Efforts is the legal trigger. The SEC's Howey Test defines a security as an investment of money in a common enterprise with a reasonable expectation of profits from the efforts of others. Staking rewards are not passive income; they are a direct financial return for delegating network security to validators.

The Validator's Managerial Role creates the 'common enterprise'. Stakers rely on the protocol's governance (e.g., Ethereum's EIP-1559) and the validator's operational skill for reward generation. This is not a simple service fee; it's profit-sharing from a managed enterprise, mirroring the structure of an investment contract.

Contrast with Pure Utility Tokens clarifies the line. A token used solely for gas fees (e.g., Ethereum pre-Merge) is a commodity. A token that earns yield via Lido or Rocket Pool is a security. The SEC's actions against Kraken's staking service established this precedent by targeting the expectation of profit, not the underlying asset.

Profit from Others' Efforts: The SEC argues staking rewards constitute an 'expectation of profit' derived from the managerial efforts of the protocol. This is the critical prong of the Howey Test that transforms a simple asset into a security. The legal risk is not the token itself, but the structured financial promise around it.

Centralized vs. Decentralized Staking: The SEC's case against Coinbase and Kraken specifically targeted their centralized staking-as-a-service products. The legal distinction is the degree of managerial control; a user delegating to Lido or Rocket Pool still relies on a third party's operational efforts, creating a similar legal vulnerability despite the decentralized branding.

The Technical Counter-Argument: Protocols like Ethereum post-Merge and Solana frame staking as a network security service with variable compensation, not a guaranteed yield. The reward is for validating work, not a passive return. This is the foundational technical defense against the Howey Test's 'efforts of others' prong.

Evidence: The SEC's 2023 settlement with Kraken forced the shutdown of its U.S. staking service and imposed a $30 million penalty, establishing a clear enforcement precedent for centralized offerings.

Expectation of profit is the primary legal vulnerability. The SEC argues that staking-as-a-service providers like Coinbase and Kraken create this expectation through marketing and pooled reward distribution, framing the activity as an investment contract.

Technical decentralization is insufficient. A protocol like Lido or Rocket Pool can be decentralized, but the front-end service offering pooled staking still centralizes the profit expectation. The legal focus is on the promoter's actions, not the underlying tech.

The counter-argument fails. Proponents claim staking is essential work, like mining. However, the SEC distinguishes passive delegated proof-of-stake from active proof-of-work, viewing delegation as a surrender of effort that heightens profit reliance.

Evidence: The Kraken settlement. In 2023, Kraken paid $30M and shut its U.S. staking service, establishing the SEC's enforcement precedent. The order explicitly cited the offering of 'easy-to-use services' that led investors to expect profits.

The 'Utility' label fails because the primary economic driver for stakers is profit expectation, not service consumption. This aligns with the Howey Test's 'expectation of profits' prong, which the SEC applied to Lido and Rocket Pool staking services.

Variable rewards are still investment returns. The mechanism of distribution (algorithmic vs. fixed) is irrelevant if the asset's value is derived from the network's success, a common enterprise. This is the core argument in the SEC vs. Coinbase lawsuit regarding staking-as-a-service.

The precedent is set. Regulators analyze economic reality over marketing terms. The SEC's 2023 Kraken settlement established that offering staking services constitutes the sale of unregistered securities, regardless of reward variability.

Evidence: The SEC's complaint against Coinbase explicitly states its staking program satisfies Howey because users 'pool their assets... and share in the rewards.' The legal distinction between 'reward' and 'dividend' has collapsed.

Advertised APY is a target. The Howey Test's 'expectation of profit' prong is satisfied by protocol marketing and user intent. Platforms like Lido and Coinbase explicitly promote yield, creating a paper trail for regulators.

Staking is not a service contract. The legal defense that staking is a 'service' (like AWS) fails because the primary user motivation is financial return, not network security. This distinguishes it from pure infrastructure plays.

The 'common enterprise' is the protocol. Decentralized staking pools, including Rocket Pool and Frax Finance, create a shared economic fate between all stakers and the protocol's success, satisfying another key Howey criterion.

Evidence: The SEC's 2023 lawsuit against Kraken centered on its staking-as-a-service program, which the agency described as an 'investment program' offering 'advertised returns.' This is the precedent.