Overview
This article explains the basics of crypto staking and key elements of staking contracts between staking service providers and token holders in Canada and internationally.
Basics
Staking promotes the informational integrity of blockchain networks by appealing to the self-interest of token holders. Staking involves pledging tokens as collateral to the blockchain network and proposing the addition, and validating the addition by other validators, of serial blocks of information to the blockchain ledger. In exchange for the work, blockchain networks pay tokens denominated in the native tokens of the network.
Staking is characteristic of networks like Ethereum and Solana that use the proof-of-stake (PoS) consensus model of information validation. Proof-of-work (PoW) networks like Bitcoin do not involve pledging tokens and use different informational validation processes. In PoS networks, the proposal and validation work is performed by computer nodes in the network called validators.
PoS networks generally use a carrot and stick approach to promote network security. The network will pay tokens (called rewards) to a token holder if the validator to which its tokens are pledged produces the same result as a critical mass of other validators. Alternatively, the network takes away a portion of the staked tokens if the validator produces a different result or refuses to work when selected by the network (called slashing).
Given the open architecture of public networks, token holders can generally either freely launch their own validator to the network or stake their tokens to a third party validator.
This article canvasses key terms in contracts between token holders and third party validators. While staking is a computer-level process that does not require a legal contract, both customers and service providers alike often seek the deal certainty afforded by a well drafted contract.
Staking contracts
Staking contracts between third party validators (service provider) and token holders (customer) are sometimes called Staking-as-a-Service contracts or Platform-as-a-Service contracts.
Key terms of staking contracts may include:
- Delegation and nomination – the contract should specify that the token holder can nominate the service provider to perform validation work in respect of the holder’s tokens. Depending on technological integration of the holder’s wallet and the service provider’s infrastructure, the service provider may provide a copy of its validator node’s public key to which the holder can bond or stake its tokens.
- Custodial or non-custodial – the contract should indicate whether or not the service provider will have custody of the staked tokens. Staking is non-custodial in that validators do not need custody of the holder’s tokens to stake the tokens. However, a service provider may offer both custodial and staking services to a single customer in respect of the same tokens, which changes the commercial and legal relationship between the customer and service provider.
- Withdrawal or unstake – the contract should indicate whether or not the customer can withdraw its staked tokens at any time. Depending on the network, the withdrawal or unstake periods range from immediate to 28 days. Accordingly, tokens might not be transferable immediately after a customer initiates a withdrawal. Separately, the service provider might impose its own withdrawal period, especially if it holds custody of the staked tokens.
- Description of services – the contract should articulate that the service provider will perform the validation work in respect of the staked tokens. This imposes the duty to validate on the service provider.
- Service standard – the contract typically requires that the service provider perform the services at a service standard such as using appropriate technology and skill.
- Representations and warranties – service providers and customers often make representations including those that are, among others and as applicable: (1) similar to technology service contracts outside of blockchain regarding formation, existence, capacity, no conflict, and compliance with law; (2) similar to financial services contracts regarding sanctions, AML, ATF, and financial licensure; (3) related to securities law issues including acknowledgments that the staked tokens are not an equity investment; (4) acknowledgments that the staked tokens are not a loan; and (5) bonus points for customers who ask that the service provider represent that its nodes satisfy the network’s requirements for inclusion in the network’s active set of validators.
- General indemnities – each party may promise to indemnify the other party for breaches of representations and warranties, failures to perform contractual duties, and for third party liabilities including, in the case of the service provider, intellectual property infringement. As with most service agreements, the service provider is more likely to be asked to payout an indemnity than the customer.
- Coverage or indemnity for slashing penalties – slashing coverage, if any, can fall under the indemnity or a separate section. Slashing is catch-all term for penalties applied by the network following a performance failure by the validator (typically validating the double spending by a single wallet of the same token). If the validator is slashed, a portion of the tokens staked to the validator are automatically forfeited to the network and generally burned (removed from existence). The contract may require that the service provider reimburse the customer for slashed tokens.
- Coverage or indemnity for missed rewards – missed reward coverage, if any, can fall under the indemnity or a separate section. Rewards are “missed” when a validator fails to perform the validation work required to generate rewards. Missed rewards coverage addresses opportunity costs suffered by customers. The contract may require that the service provider reimburse the customer for missed rewards.
- Limits on liability – liability limits vary. Service providers typically seek to cap direct damages under the contract generally including the indemnity and slashing and missed rewards coverages at an absolute value expressed in fiat money or tokens or a relative value expressed, for example, as a percentage of the tokens staked or service fee earned by the service provider over a defined period of time. Service providers sometimes seek to exclude liability for, among other things: (1) indirect or consequential damages; (2) damages caused by network failures (like software bugs); and (3) reductions in the market value of the staked tokens. The force majeure provision, if any, is a backdoor liability limit as it usually disclaims liability related to events that arise outside of a party’s control (read the boilerplates carefully). Some service providers offer uncapped slashing and missed rewards coverages to win deals with sophisticated, high value customers (so-called whales).
- Pricing – service providers generally charge a service fee calculated as a percentage of the rewards generated (example: eight percent of rewards) or sometimes a flat fee. The service fee is usually payable in tokens but can be payable in fiat money. Market service fee rates typically vary on a network by network basis. If the parties intend for the service fee to increase or decrease during the term of the contract depending on the dollar value of the tokens staked by the customer, the contract should articulate the time at which the dollar value is calculated and the source of the exchange rate used.
- Payment details (funds flow) – networks generally either pay directly (i) all the rewards to the customer or (ii) the amount of rewards equal to the service fee to the validator and the balance of the rewards to the customer. The specific funds flow generally happens automatically following the performance of successful validation work and is hardwired into the protocols of the network. Note that if the hardwired fee differs from the contractually agreed upon service fee, then the contract should provide covenants regarding and processes by which the parties settle up.
- Term and termination – the contract should indicate how long it remains in effect and processes for ending it. Consider specifying that the contract does not end until the completion of the withdrawal period. Also, service providers might seek to require that customers withdraw their tokens upon their receipt of notice of termination from the service provider or otherwise at the end of the term.
- Governing law – pay close attention to the law that governs the contract and its interaction with the law applicable to the service provider and the customer. As regulators grapple with this evolving field, laws can change quickly with significant positive or negative outcomes for the network participants.
- Independent contractor – the contract should indicate that the service provider is an independent contractor of the customer, if that is the intention of the parties. As with many aspects of the blockchain ecosystem, old legal concepts are sometimes clumsily applied to novel arrangements like staking, which creates risk that courts or regulators could determine that the relationship between the parties is different than they intended.
- Taxation – the contract should state that each party is responsible for remitting taxes on its share of the rewards, with the service provider bearing responsibility for the portion of the rewards equal to the service fee and the customer bearing responsibility for the balance of the rewards. Staking contracts sometimes include tax indemnities.
- And – so much more!
There is no one-size fits all staking contract. As each network has its own unique protocols, staking contracts should address the specific technology at issue, not to mention jurisdictional legal and market differences as well as the idiosyncratic commercial concerns of the contractual counterparties. Crypto, including staking, offers opportunities and risks. Seek assistance from experienced counsel when negotiating and drafting staking contracts.
Kirk Emery is a Partner in the Toronto office of Miller Thomson. He was formerly the Executive Vice President of Legal & Business Development at a leading global staking company. Should you have any questions or concerns, please feel free to reach out to Kirk Emery via email.
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