Regulation of Staking ETFs and Staking Services: Lessons from Canada

What other jurisdictions can learn from the Canadian regulatory approach to staking, for both custodial staking services and ETFs.

By Evan Thomas, General Counsel, Alluvial / Last Updated: January 17, 2025

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• As market participants, regulators and policymakers globally consider the regulation of staking, the Canadian regulatory approach, which has been established since 2022-23, can provide valuable insights.
• Custody of staked assets provides a useful distinguishing factor for identifying products and services that should be subject to regulatory requirements, and Canada has effectively used custody to define the regulatory perimeter for staking.
• The core elements of Canada’s regulatory approach to staking are adequate disclosure, initial and ongoing due diligence, and appropriate controls to safeguard staked assets within the custody of providers of staking products and services.

Introduction

Market participants, regulators and policymakers in the United States, the European Union, the United Kingdom and other jurisdictions are increasingly considering how regulatory regimes should address staking in crypto-focused exchange-traded funds/exchange-traded products (ETFs/ETPs) and staking services available to users of custodial crypto exchanges.

The Canadian regulatory approach to staking provides instructive lessons for policy-making in other jurisdictions. Canadian securities regulators have permitted regulated crypto trading platforms operating in Canada to offer staking services to retail clients since October 2022, and the first Ether staking ETF launched in Canada in October 2023. Canada now has multiple custodial staking services operating subject to regulatory oversight and two Ether ETFs with staking exposure, demonstrating that it is feasible to introduce innovative staking products and services within a regulatory framework that effectively mitigates risks.

This article provides an overview of the Canadian regulatory approach to staking for both custodial staking services and ETFs, the core elements of which are adequate disclosure, initial and ongoing due diligence, and appropriate controls and other safeguards where staked assets are held in custody on behalf of users or investors.

Benefits and Risks of Staking Products and Services

Staking allows crypto owners to earn staking rewards, protects them against dilution as new tokens are issued to reward stakers, and contributes to the security of the underlying network. Products and services that integrate staking can simplify staking participation for users and provide additional benefits such as liquidity for staked positions and protection against slashing or other penalties.

Any product or service that integrates staking also introduces various risks for its users. Participating in staking may expose participants to:

• technical risk, such as bugs in how the staking mechanism is implemented in underlying software;
• operational risk, such as downtime or failure of validator operators for business or operational reasons, and including the risk of slashing or other protocol-imposed penalties if validators fail to follow protocol rules;
• liquidity risk, to the extent there are exit queues, unbonding periods or other restrictions on the transferability of staked assets; and
• counterparty risk, to the extent custody of staked assets is transferred to another party.

These risks may lead to a loss of some or all of participants’ staked assets or reduce the staking rewards earned.

Of the risks identified above, the most significant risk is the counterparty risk where staked assets are transferred to or held by parties other than the beneficial owners of the assets. The failure of a counterparty with custody of staked assets can result in a complete loss of those assets.

Custody therefore provides a useful distinguishing factor for identifying products and services that should be subject to regulatory requirements, and Canada has effectively used custody to define the regulatory perimeter for staking. To date, Canadian regulatory authorities have not imposed any regulatory requirements on staking itself. Canadians are free to operate validators or stake their assets directly to validators. Infrastructure providers that operate validators for customers without taking custody of the staked assets are not subject to regulatory requirements.

By contrast, platforms offering custodial staking services to retail users or publicly traded crypto ETFs that wish to stake the fund’s assets are subject to various regulatory requirements, as described below.

Regulation of Staking Services in Canada

Background

Custodial crypto trading platforms that offer services to Canadian residents must register with Canadian securities regulators, who coordinate through a body known as the Canadian Securities Administrators (CSA). The eventual goal is for all platforms serving retail clients to be members of the Canadian Investment Regulatory Organization (CIRO), the self-regulatory organization of Canadian investment dealers¹.

The CSA first introduced requirements for staking services in October 2022². In January 2024, CIRO introduced its own staking requirements for crypto platforms that are members of CIRO³. CIRO’s requirements generally mirror the CSA requirements, with certain additional requirements, primarily to address potential prudential risks of custodial staking services.

Due Diligence and Monitoring

A key element of the regulatory framework is a requirement for initial and ongoing due diligence, consistent with the obligations of Canadian investment dealers to perform due diligence both on the products offered to clients and service providers used to provide services.

Platforms must perform due diligence on the proof-of-stake blockchain itself, including the staking mechanics and the risks of loss. As platforms generally use validators operated by third party service providers, platforms must also perform due diligence on the operator, taking into consideration the operator’s management, reputation, security and reliability measures, financial status, operational history, history of slashing or other penalties, and insurance or guarantees against the risks of loss.

CIRO requirements more specifically require review of service providers’ audited financial statements, business continuity plans, disaster recovery plans and assurance reports on internal controls. In addition to this initial due diligence, a platform has an ongoing obligation to monitor validators and their operators.

Platforms or their affiliates may operate their own validators, but under CIRO requirements, permission is required. Although there are no explicit conditions for such permission, it is reasonable to expect that permission would only be granted if the platform can demonstrate its operation of validators would be comparable to operation by a qualified third party and that any conflicts of interest are adequately addressed.

Client Eligibility and Appropriateness

Clients using platforms’ staking services retain control over whether their assets are staked. A platform cannot stake client assets unless the client instructs it to do so. When a client wants to stop staking, their assets must be unstaked, subject to any lock-up or unbonding periods that may be imposed by the protocol.

If a platform offers staking services to clients, the platform must review whether it is “appropriate” for a client to access staking. This is an extension of the platform’s broader regulatory obligation to ensure that a crypto trading account is appropriate for a client, taking into account the client’s financial circumstances and experience. This review must take place when the client first wishes to access staking and at least every 12 months. If a platform determines it is not appropriate for the client to stake, the platform must inform the client.

Disclosure

Before the client can participate in staking, the platform must provide the client with disclosure, which the client must acknowledge reading and understanding. The disclosure must include the following in plain language:

• Details of the staking services provided and the parties involved
• The diligence performed by the platform
• Details of the operators of the validators and the diligence performed on them
• How custody of staked assets differs from custody of unstaked assets
• General risks of staking and the services, including risks of reliance on third parties, technical errors, protocol bugs and hacks or thefts
• Details of how slashing or other losses will be allocated
• Details of lock-up or unbonding periods
• Calculation of rewards and how they are paid out, including any discretion of the platform to change rewards

There are also specific requirements to warn clients about how market volatility may affect their returns, that there is no guarantee of staking rewards and that past rewards are not indicative of future rewards. Platforms have a positive obligation to update these disclosures in the event of material changes and provide copies of updated disclosures to clients.

Custody Requirements

Under the general requirements for registered platforms, platforms are required to use acceptable custodians for at least 80% of client assets by value. Generally, an acceptable custodian is a regulated trust company or other financial institution, with sufficient financial assets and a current assurance (SOC 2 Type 2) report regarding its internal controls. Although the custodians are typically third parties, a platform may use an affiliated custodian with regulatory permission.

To facilitate client deposits and withdrawals or trade settlement with other parties, platforms may hold up to 20% of client assets directly, provided they have the appropriate internal controls. To protect clients in the event of a bankruptcy of the platform or its custodians, assets held with a custodian or by the platform must be held in trust for the benefit of the platform’s clients.

When offering staking services, the platform or its custodians must retain control of staked assets at all times; in particular, assets cannot be transferred to a validator or other third party. Staked assets under the control of a custodian must be segregated from assets of the custodian’s other clients, from the assets of the platform’s other clients who are not participating in staking and from the platform’s own assets.

Liquidity

If the platform provides any sort of liquidity for staked assets—that is, the platform allows a client to access their assets despite any lock-up or unbonding periods at the protocol level—the platform must have written liquidity procedures, including maintaining an inventory of liquid assets or reserving cash to provide liquidity. Both the CSA and CIRO explicitly prohibit using the unstaked assets of other clients to provide liquidity for clients participating in staking.

Under CIRO rules, any liquidity can only be provided on a best efforts basis. The platform cannot guarantee liquidity to its clients, as that may expose the platform to solvency risk in the event it could not satisfy a liquidity guarantee.

Slashing Guarantees

Under CSA requirements, a platform that offers any sort of guarantee to clients against slashing losses or other penalties must have appropriate policies and procedures for managing the risks of such a guarantee. CIRO rules prohibit the platform itself from providing guarantees due to concerns it would expose the platform to solvency risk in the event of a major slashing loss. A platform may, however, arrange for guarantees or other protections against slashing from third parties, provided the platform itself does not assume any primary liability to clients for slashing losses.

Rewards and Fees

Platforms must regularly calculate each client’s share of staking rewards, reconcile against expected rewards and promptly distribute rewards to clients upon receipt. The platform must clearly disclose how rewards are calculated, as well as what fees apply.

Regulatory Reporting

On a quarterly basis, platforms must report to regulators on various matters, including the number of clients using the staking services, how much has been staked, rewards earned, names of third parties providing services, any instances of slashing or other penalties.

Regulation of Staking in Canadian ETFs

Background

Unlike crypto trading platforms, which must comply with specific terms and conditions applicable to their staking services, there are no specific requirements for staking assets held within a Canadian crypto ETF. Instead, fund managers have addressed staking within existing regulatory rules, and the CSA has published guidance outlining staff expectations.⁴

Assessment of Staking

CSA guidance notes that, depending on how it is conducted, staking may involve the issuance of a security or derivative. Under the guidance, managers of crypto ETFs must assess whether staking involves the issuance of a security and/or derivative.

As well, existing requirements for funds restrict funds from lending portfolio assets or guaranteeing obligations of other parties. The guidance notes that depending on how staking is performed, staking could be viewed as lending or acting as a guarantor. Further, if the assets are securities, staking the assets could be considered securities lending, which is subject to restrictions under other rules applicable to ETFs.

Disclosure

Canadian ETFs must make “full, true and plain disclosure of all material facts” by way of a prospectus. The prospectuses of Canadian staking ETFs typically address the following:

• How the fund will stake fund assets
• Risk of illiquidity during unbonding periods
• Short-history risk of proof-of-stake blockchain networks
• Risk of reliance on third party validators
• Risk of slashing and missed rewards
• Risk of insufficient due diligence on validators or the blockchain network itself
• Risk of unclear tax treatment of staking
• Risk of no guarantee of rewards
• Risk of adverse regulatory changes

Custody

All Canadian ETFs must hold all of the fund’s assets with a qualified custodian, which must be a Canadian bank or trust company with minimum equity of at least $10 million CAD⁵. The qualified custodian may use foreign sub-custodians, provided they are also regulated as banks or trust companies and have minimum equity of $100 million CAD⁶.

Alignment with Requirements for Platforms

The CSA’s guidance notes that staking by ETFs should be done within a framework similar to the requirements applicable to crypto trading platforms. In particular:

• The fund manager must demonstrate sufficient proficiency and knowledge of staking.
• The fund manager must have written agreements with proficient and experienced third parties that support staking by the fund.
• The fund manager must perform adequate due diligence on the staking protocols and third party validators.
• The fund’s custodian must remain in control of the staked crypto assets at all times.
• The fund manager must monitor validators for downtime or slashing.

Use of Affiliated Validators

The first Canadian crypto ETF to stake fund assets used validators operated by an affiliate of the fund’s manager, and the CSA’s guidance indicated neither funds nor fund managers should operate validators. The CSA’s guidance expressed concern that operating validators would be akin to exerting control over or being involved in the management of the protocol, which could be inconsistent with the restriction on investment funds becoming involved in the management of companies in which they have invested.

This concern appears to have been mitigated since the release of the CSA guidance in July 2023. The second crypto ETF to offer staking, which launched in June 2024, does use validators operated by an affiliate of the fund manager, subject to a qualification that the affiliate’s validators will only be used where the staking rewards earned by the fund by using the affiliate’s services are at least as much as could be earned if an acceptable third-party staking service provider was used instead.

Liquidity

Existing requirements for Canadian ETFs restrict how much of a fund can consist of “illiquid assets”. The CSA guidance explicitly notes the potential impact of lock-up or unbonding periods on liquidity for fund assets and requires the fund manager to conduct due diligence on the effect of staking on liquidity and manage any liquidity risk. To manage liquidity needs, both Canadian Ether ETFs that offer staking disclose that they are initially planning to stake up to 50% of the fund’s Ether.

Conclusion

The core elements of Canada’s regulatory approach to staking are adequate disclosure, initial and ongoing due diligence, and appropriate controls and other safeguards where staked assets are held in custody on behalf of users or investors.

As regulated staking services and staking ETFs have operated successfully in Canada for over two years, this suggests that the Canadian regulatory framework adequately mitigates the associated technical, operational and counterparty risks. The Canadian model provides a thoughtful starting point for other jurisdictions considering how to regulate similar products and services.

Opportunities for enhancement of Canada’s approach include permitting additional liquidity measures that would allow crypto ETFs or users of staking services to exit staked positions without going through lock-up periods. This would allow ETFs to increase investor returns by staking more of their assets and give users of custodial staking services immediate access to their staked assets.

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About

Evan Thomas, Alluvial’s General Counsel, drives Alluvial’s legal and policy initiatives. He was previously at Wealthsimple, Canada’s largest consumer fintech, where he was Head of Legal for Wealthsimple’s crypto trading platform. While at Wealthsimple, Evan helped launch Canada’s first regulated staking service. Before Wealthsimple, Evan was a litigator at Osler, Hoskin & Harcourt LLP for nearly 15 years. Among other notable cases, Evan was hearing counsel to 3iQ Corp. in its appeal securing regulatory approval for Canada’s first publicly traded bitcoin fund in 2019.

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Footnotes

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