Do staking services require a banking license under Swiss law?
The Swiss Financial Market Supervisory Authority (FINMA) recently expressed the opinion that "staking activities usually require a banking license". This statement, which is causing quite some upheaval in the Crypto Valley, was essentially justified with the slashing risk as well as the lock-up of staked cryptocurrencies typical for staking protocols. FINMA therefore seems to qualify staking as a deposit-taking activity, which requires authorization as a bank. This view is not correct in this generality.
Staking is a process common to Proof-of-Stake (PoS) consensus mechanisms, which include Cardano, Solana, BNB Chain, Avalanche, Polygon, and Polkadot and last, but not least, Ethereum. PoS consensus mechanisms require validators to deposit a certain amount of cryptocurrencies, known as a "stake," with the protocol in order to participate in the network. As payment or remuneration for protocol-compliant behavior, the PoS protocol distributes so-called staking rewards to the validators, usually in the form of the respective cryptocurrency. PoS consensus mechanisms are considered promising for the future because they require significantly fewer energy resources than the proof-of-work (PoW) consensus mechanism, such as the one underlying the Bitcoin protocol.
Lock-up and Slashing
Depending on the PoS protocol, the cryptocurrencies must be blocked for the entire staking period (so-called lock-up). The lock-up periods vary greatly depending on the protocol. For most protocols, the lockup lasts a few minutes or hours; while the Polkadot blockchain has a lockup period of around 28 days. Validators can lose all or part of their stake if they behave in a way that is contrary to the protocol, e.g., by intentionally validating transactions incorrectly (known as slashing). Again, there are significant differences between protocols. Depending on the protocol, a staker can lose only part or all of the rewards and, in extreme cases, even the staked position.
Staking can be carried out by the owner of the token or coin in question (self-staking). In addition, the owner can also use staking services, whereby two main types are possible: non-custodial staking and custodial staking. In non-custodial staking, the owner keeps the private keys in his own wallet, but uses the services of a staking provider to validate transactions and blocks. The services of the staking provider are usually limited to providing the necessary hardware and software. In custodial staking, the staking provider not only performs the validation of the transactions on the blockchain itself, but also holds the crypto-based assets in custody for the client. The staking provider thus holds the private keys of the owners in its wallet. The client has no way of directly accessing its assets and staking or unstaking them himself, and all interactions with the staking protocol are performed by the staking provider.
A licensing requirement under the Banking Act is out of question both in the case of self-staking as in the case of non-custodial staking. In the case of custodial staking a licensing requirement only comes into consideration if the crypto assets are held in collective custody within the meaning of Art. 16 para. 1bis subpara. b Banking Act exists. Staking from individual custody can therefore in principle be offered without a banking license. However, individual custody is not always a practicable solution because certain protocols provide for a "minimum stake" (e.g. Ethereum to the extent of 32 ETH). Participation in staking programs therefore effectively requires pooling.
FINMA seems to justify the licensing requirement for custodial staking of crypto assets held in collective custody with the view that, due to the lock-up period and the slashing risk, those assets cannot qualify as “held at the custody client’s disposition at any time” (“für den Depotkunden jederzeit bereitzuhalten”). If true, this would mean that staking assets would not be subject to segregation in the staking provider’s insolvency but would rather qualify as as deposits from the public (unless an exception under article 5a(2) Banking Ordinance applies, including the exception for institutional investors with a professional treasury). Providing custodial staking services of crypto assets held in collective custody would then not only require a banking license, but also have to be supported with capital at a tune of 800%. Importantly, a fintech license under article 1b Banking Act would not suffice, since fintechs are prohibited to invest deposits or crypto assets or to pay interests (article 1b(1)(b) Banking Act).
In our view, there is nothing that would warrant such a result. Depending on the protocol, the lock-up period for staked assets is only a few minutes or hours, i.e. significantly shorter than, for example, the delivery periods for many cold storage solutions or in the traditional securities business. The slashing risk is also mostly negligible and only materializes in any case only if a staker does not comply in accordance with the rules of the relevant protocol. In the case of custodial staking liability the staking service provider will be responsible for non-compliance, resulting in its liability under agency law. FINMA’s view is by no means warranted by the legislative purpose of the requirement that crypto assets be “held at the custody client’s disposition at any time”. This requirement tries to draw a broad line between the custody and the deposit taking business. Deposit-taking or banking business invariable involves the taking of deposits in order to undertake some form of transformation business -- maturity, lot-size and risk transformation. Staking services have nothing to do with transformation business if provided - as is customary - for the account and at the risk of the customer.
As a result, staking services should be considered to qualify as a deposit-taking activity if, and only if, the service provider is staking crypto assets in its own name and on its own account (proprietary staking). On the other hand, proprietary staking for banks and other state-supervised entities (Art. 5a para. 2 let. b Banking Ordinance) as well as for institutional investors with professional treasury (Art. 5a para. 2 let. c Banking Ordinance) does not qualify as acceptancing deposits from the public and therefore does not require a license as a bank.
The position recently put forward by FINMA seems like an excellent idea if the purpose is to drive the staking business out of Switzerland and leave it to foreign service providers. Whether regulated or not, foreign firms can provide financial services to clients in Switzerland – both retail and institutional – in full compliance with Swiss law as long as they have no permanent presence in Switzerland. Whether this is the best way to live up to FINMA’s statutory mandate, which includes the “protection of creditors [and] investors” and to “contribute to sustaining the reputation, competitiveness and sustainability of Switzerland’s financial centre” (article 4 Financial Market Supervisory Act, FINMAG), seems rather doubtful.