The SEC Isn't Sure About Staking Crypto ETFs. But That's Changing

Nowhere is the Trump administration's pro-crypto stance more apparent than at the Securities and Exchange Commission (SEC). The organization shook off its crypto caution and appears fully on board. It's dropped cases against crypto exchanges and looks set to approve a slew of crypto ETFs.

But before the SEC can go to the crypto moon, it still has some issues to resolve. One of those issues centers around staking. The SEC recently announced that paying staking rewards doesn't make a crypto into a security. However, it's been more circumspect on approving staking ETFs -- though that may change very soon.

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The sticky question of staking

Staking is a way that proof-of-stake cryptos like Ethereum (CRYPTO: ETH) and Solana (CRYPTO: SOL) reward network participants for contributing to network security. To qualify, holders need to tie up their tokens, through solo staking, delegated staking, or on a centralized exchange. At time of writing (June 16), Coinbase pays around 2% annual percentage yield (APY) on Ethereum staking, and Solana pays 5% APY. That makes it an attractive -- and relatively low-risk -- proposition for investors.

Staking is different from crypto lend-earn schemes, such as those offered by the now-defunct Celsius and Voyager Digital. These generate yield by lending out your assets, and carry a lot more risk. In contrast, staking is baked into the individual blockchains.

It was still a bone of contention for the old SEC, which brought charges against crypto exchanges like Kraken for offering staking services in 2023. The new SEC is taking a different approach. At the end of May, it announced that most staked cryptos and staking services are not securities. For U.S. investors, this paves the way for crypto holdings to generate returns.

Staking ETFs are more complicated

The SEC is still hesitating on approving staking ETFs. There's concern over potential financial and security risks. Plus, ETFs need to qualify as investment companies, which means being in the business of securities -- and the SEC has just said that staked cryptos are not securities. It is a difficult circle to square. That's why the existing Ethereum ETFs do not give staking benefits.

At the end of May, the SEC wrote to ETF Opportunities Trust, the company behind the Ethereum and Solana ETFs that would have been the first to offer staking rewards. It raised several unresolved issues, one of which was whether the funds would meet the definition of an investment company.

Even so, change is in the air. Last week, the SEC asked seven funds to update their Solana ETF filings with clarified language about staking. The SEC has not yet approved any spot Solana ETFs. Experts think approval is a stone's throw away. Indeed, Bloomberg Intelligence ETF analyst James Seyffart says staking ETFs are a "matter of when, not if."

What staking ETFs mean for investors

Crypto ETFs make cryptocurrency more accessible to retail and institutional investors alike. If you want to add a small amount of crypto to your portfolio, spot ETFs mean you can do it from most brokerage accounts. You don't need to create an account with an exchange or worry about how to store digital assets. We're likely to see SEC approval for spot altcoin ETFs in the coming months, so more digital assets will be available in ETF form.

However, if those ETFs don't pay staking rewards, investors are missing out. As such, a shift in regulatory tides could be great for U.S. crypto investors.

In the meantime, if you stake crypto, it is not the same as earning interest on a savings account or dividend-paying stocks. And there are some risks to consider.

• Slashing penalties can cost you your stake. Networks occasionally punish malicious players through something called "slashing." It is extremely rare, and centralized exchanges may reimburse slashed crypto. Even so, some (or all) of the staked crypto could be at risk.
• Centralized exchanges often use third parties for their staking. It is important to understand how your platform stakes, specifically what staking provider it will use, and how you'll be compensated if anything goes wrong.
• It can take time to unstake your crypto. Since staking is a security mechanism, blockchains enforce a buffer period on unstaking. The time varies depending on the crypto.

If you are new to crypto or don't plan to actively manage your staking, it is better to use a centralized exchange. Decentralized platforms take work and knowledge and are not set-it-and-forget-it yield generators.

Bottom line

If the SEC approves staking ETFs for Ethereum and Solana, the most obvious benefit would be that all investors could earn yield on proof-of-stake assets. Wider approval of altcoin ETFs could encourage more institutional crypto investment, as we have already seen with Bitcoin. An uptick in staking could bring a third benefit: Reduced volatility. The lockup periods and staking incentives encourage long-term holding, which can stabilize prices.

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Emma Newbery has positions in Ethereum and Solana. The Motley Fool has positions in and recommends Bitcoin, Ethereum, and Solana. The Motley Fool has a disclosure policy.