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Home»Regulation»Due diligence on crypto staking providers
Insights: Due diligence with crypto staking providers
Regulation

Due diligence on crypto staking providers

2023-10-15No Comments7 Mins Read
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With the blessing of Proof-of-Stake networks in the crypto industry, staked crypto assets have emerged as an increasingly attractive financial instrument for individual and corporate investors. DefiLlama data shows that the value of assets tied up in liquid deployment services increased 292% to $20 billion by September 2023. This growth has not gone unnoticed among institutions looking to explore the crypto space – with 74% of companies committed to exploring digital assets. and more than 63% report a positive view of the broader crypto space.

However, the lack of compliance and due diligence remains a major stumbling block for potential investors. Recent findings from UK crypto firms show that only one in five (17%) consistently verify new customers, with half admitting to carrying out these checks sporadically.

With the increasing adoption of digital assets and staking services, it is therefore critical for investors to assess counterparty risk to thoroughly protect their portfolios. For EU-based or offshore institutional investors from any other jurisdiction, asking the right questions of their staking provider is essential. So here are five critical questions that will help you determine the veracity of your staking provider.

Does your staking provider expose you to US law and/or SEC jurisdiction?

One of the most important aspects to consider when choosing a staking provider is the legal jurisdiction in which they operate. In particular, users should inquire whether the staking provider exposes them to U.S. statutory jurisdiction and/or the jurisdiction of regulatory authorities such as the Securities and Exchange Commission. Exchange Commission (SEC). This is important to note as staking providers operating under US legal jurisdiction may pose a counterparty risk to investors.

In contrast, the EU has a clear regulatory framework for crypto assets, which provides investor protection and sets requirements for Crypto Asset Service Providers (CASPs). Some countries also have capital controls or bans on crypto companies that could impact the ability of international investors to use certain staking services.

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Local laws also impact onboarding processes and anti-money laundering regulations, impacting access and compliance risks for investors. Finally, jurisdictions also influence the legal ownership of staked crypto assets and what would happen in scenarios such as bankruptcy or government seizures. As evident from the above factors, better jurisdiction laws influence a wide range of factors such as asset safety, market liquidity and investor tax requirements.

In the meantime, as regulations continue to be removed, investors should be aware of the potential consequences of operating in obscure jurisdictions such as the US. Depending on their course of action, they may choose to avoid such countries entirely or continue operating. under the unrefined legislation in place to ensure they don’t draw the ire of local regulators. Investors could also benefit from following the example of other players operating in said jurisdictions, who have acquired greater industry expertise in ensuring compliance in times of uncertainty.

Has your staking provider audited financials and received regular third-party audits or assurances on their operational conduct?

Transparency and compliance are also crucial factors when selecting a staking provider. To gain confidence in their operations, it is important to verify that the staking provider has audited financials and undergoes regular audits or third-party assurance of their operational conduct. Staking providers based in the EU or the US typically follow accounting standards such as US Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), which require audited financial statements.

Additionally, staking providers can provide further documentation for their anti-money laundering (AML) and compliance systems by registering as Crypto Asset Service Providers under the Markets in Crypto Assets (MiCA) regulations. This registration ensures that they have internal controls, policies and procedures in place to identify, assess and manage risks, including money laundering and terrorist financing risks, as well as a business continuity plan.

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How does your staking provider ensure that funds – inadvertently or otherwise – have not helped generate staking rewards that may have benefited sanctioned entities?

Investors should also be cautious about exposure to sanctioned entities or jurisdictions. Investors need clarity from staking providers on the potential use of funds to inadvertently contribute to the generation of rewards that could benefit sanctioned entities.

Direct exposure to sanctioned entities may result in legal obligations for investors to report such exposure to relevant authorities, such as the Office of Foreign Assets Control (OFAC) or Financial Crimes Enforcement Network (FinCEN) in the US, the European Banking Authority (EBA) in the EU, or the Office of Financial Sanctions Implementation (OFSI) in the UK. Therefore, it is essential to ensure that the staking provider has strategies and processes in place to meet these obligations and mitigate potential risks.

How does your staking provider ensure that there is no mixing of funds and segregation of funds?

Another important aspect to consider is the manner in which the separation and segregation of funds is carried out. Institutional investors often require custodians who can ensure that funds are segregated and held in accordance with regulatory requirements, such as the Markets in Crypto Assets (MiCA) regulations in the EU. However, in some cases, upon initiating staking, funds must leave the custodian and be committed to the chain via a transaction.

This process can lead to commingling of funds using smart contracts or protocols, which should be carefully monitored and assessed by the staking provider or custodian. Understanding how the staking provider ensures the separation and segregation of funds is critical to minimizing the risks associated with commingling and ensuring compliance with regulatory standards.

What counterparties does your staking provider expose you to?

The counterparties involved in a strike may vary from provider to provider. Obtaining a detailed view of counterparty risk exposure, such as with smart contracts or decentralized autonomous organizations (DAOs), is essential to assess the associated risks. Decentralized staking providers, organized as DAOs or using smart contracts, require thorough risk assessment, including financial stability, operational security, code and governance review, and regulatory compliance.

See also  The president of the European Central Bank says her son has lost 60% of his cryptocurrency investments

On the other hand, centralized staking providers must comply with current and future crypto regulations, as well as anti-money laundering and anti-terrorist financing (AML/CTF) laws and securities laws.

So it is important to confirm that the staking provider carries out thorough checks on proof of the origin of the funds and the Ultimate Beneficial Owners (UBOs) of their customers. This ensures compliance with AML requirements and helps prevent investments from benefiting from illicit funds. Stringent AML practices, policies and systems should be a minimum requirement for deployment providers, similar to other alternative investment service providers.

Setting standards

While staked crypto assets offer an attractive financial opportunity, investors should thoroughly research staked providers and continue to impose appropriate requirements on them. Because there are so many factors at play, asking probing questions such as those outlined above will help potential investors fully understand how their funds will be treated and what protections are in place.

Staking promises a strong foundation for the continued institutional adoption of digital assets. Although lured by the prospects of high income and additional value generation, investors must be well informed about the risks associated with staking practices. This burden should increasingly fall on the shoulders of staking providers, who must ensure that potential investors are given the clarity, direction and strategies to capitalize on the sector and its growth, driving its adoption in the years to come.

Disclaimer: The information in this article is for educational purposes only and should not be considered financial or investment advice. Always conduct thorough due diligence and consult a professional advisor before making any investment decisions.

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