Hi everybody, this is Charles Hoskinson broadcasting live from warm, sunny Colorado. Today is February 14th, Valentine's Day, 2023, and I wanted to make a video to talk a little bit about contingent staking, regulation, KYC, and all this other stuff. Like most things in the contingent staking world, I will do this as a whiteboard video.
So, let's go ahead and present. Wow, there we go. Okay, I mentioned I had some comments on the Kraken crackdown and what's going on in the industry as a whole. I refreshed a concept that I brought up originally in 2021. Oops, let me just erase that. There we go. Sorry, new pens, so I have to get used to it.
In 2021, I introduced the idea of contingent staking. The problem with being a Stake Pool Operator (SPO) right now is that, unlike a normal business, you have to think of SPOs as businesses. When you run an SPO, either as an individual or a company, you usually have some sort of say with your customers.
As a thought experiment, let's imagine that you own a franchise, and we'll call it "Charles's Chicken." Imagine a customer comes into Charles's Chicken, strips naked, sets fire to one of your tables, and then takes a dump on your floor. There you go. We'll use red for fire and a smiley face for stripping naked.
So, this absolutely crazy person comes in and does all this stuff. The very next thing that customer does after those three actions is come up to your counter and say, "Give me some food." Any normal business owner would look at this and say, "Get the [__] out. Call the police because you’re a crazy person. You’ve stripped naked, set fire to one of my tables, and pooped on my floor. This is very traumatic, and I don’t want to do business with you."
Effectively, what does the business have? They have the right to refuse service. That’s it. What contingent staking is at its core is a code-level realization of this concept. It is not a compliance protocol; it’s not about giving the U.S. government control over things. All it is saying is that you, as a business owner, an SPO, right now have zero control over who you do business with.
People can delegate to you, and you don’t know those delegation transactions. For example, let’s say you’re a Ukrainian SPO and one of your delegators is the Russian government. You’re now in business with them, and as a result of the work your pool is doing, the blocks they’re making, you have to pay them. They get paid by the protocol, and you’ve partnered with that government. Does that make your values align? Maybe some, maybe not. The problem is you have no say; you cannot get rid of this crazy customer.
At the core of contingent staking, what we’re really talking about is a multi-signature transaction. That’s it. You have the SPO and the potential delegator. They set a transaction through TX pending, and you, the SPO, have to sign it and say, "Yes, I agree to this."
That pattern can be used to fire bad customers; it can be used to get rid of customers that don’t conform to your values, and yes, that pattern can be used for KYC. Why? Because there are people using today, not hypothetically, but today, stake pools for ISPOs, and it’s dangerous to enter into a business relationship with someone where you don’t have a contract with them.
Think about the concept of that ISP. How preposterous it is otherwise. With an ISPO, you have these terms and conditions (T&Cs). The problem is the person giving you the use of their resource, their ADA plus rewards, never signed those terms and conditions. They never signed that contract. So basically, what you’re doing is saying, "Let’s do all this work together, and then after the fact, we’re going to sort it all out." What if they disagree? What if they turn out to be in a jurisdiction you don’t like, and then you cut them off, and they say, "Well, that’s not fair; you’ve stolen from me"?
The point of contingent staking is saying, "Well, prior to us having a business relationship together, we’re going to sign a contract." You could think about staking payloads in this future. You can talk about delegation plus plus, and you could do things in the metadata, like for example, include a DID. You could do things in the payload, like say you’re a charity pool and you want an email address from that person so that you can contact them and send them information about your distributions and your charity. You can include contact info in the payload, encrypted by the way.
What’s nice about the contingent staking idea is that we’d have to create a new certificate specifically for contingent stake pools, which can include cryptographic credentials. So when somebody sends a payload with their delegation transaction, they can encrypt and include all of this information for a business relationship. This does not mean that the U.S. government or OFAC is now in charge of Cardano. It just means that you can decide and have a say in who your customers are and what the terms and conditions are.
Every business will have signs like "shirts and shoes." You ever go into a business and they have a sign that says you have to wear a shirt and shoes if we’re going to serve you? That’s the terms and conditions. That’s an entry condition to do business with this business. Some businesses have moral reasons why they don’t want to do business with certain people; other businesses would like to have a contractual relationship with somebody before they enter into business with those people. You need something to sort all this out.
This is the simplest possible design pattern to enable that. A potential delegator delegates to the SPO. The SPO checks the payload; they say it doesn’t meet our business logic. If it does, we sign it; if not, we don’t. But then at that point, it behaves just like Cardano does, and everything’s hunky-dory.
You might say, "But doesn’t this mean that some people will become regulated?" Sure, because what if you decide you want to do some regulated stuff with your stake pool? Here is a stake pool of the future, SPL plus plus. You say, "Hey guys, give me 100 percent of ADA rewards, and then I’m going to invest those in DeFi, and I’m going to give you a chunk of that yield." So you get my DeFi yield plus your original rewards, and we both benefit because I now can get a higher yield.
But now there’s risk because they have custody of your assets. That is what some of these exchanges have been doing, and what the SEC has been yelling about. They’re saying this is a regulated business activity. I’d agree with them; it is because you’re trusting them. There’s trust plus custody. You’re trusting them not to mess up the job, and you’re trusting them not to steal your money because, at the end of the day, that ADA doesn’t actually belong to them. They’re just taking it and doing something with it, and you get a higher return because you’re willing to accept the risk.
Whenever that happens, generally speaking, that’s a regulated actor. Well, if that’s the case, they now need a mechanism to get you to sign that agreement, to do disclosures, and they need to do compliance. These are the bedrocks of regulation.
Let’s say there’s no KYC at all, just the general active staking. A lot of people are going to want to run pools like this because this is a way to make more money, and that’s what exchanges are doing right now in practice with some people’s money while staking. The regulators are coming in saying that’s a regulated activity. Okay, well, if it is, there are at least some regimes and jurisdictions that are going to let you do that if you’re an SPO.
I want to make sure that you, as a business owner, have every single tool so that you can run your business in full compliance. The problem is, let’s say you’re offshore; let’s say you’re in the UK. But what happens when a U.S. person delegates to you, and this is 2025, and they’ve passed some horrible law saying you’re now a regulated actor? You say, "Oh, I’m a UK entity; I’m a UK citizen." Well, the U.S. has global regulation, and they say that if you do business with a single U.S. person, you are now going to be treated from a regulatory perspective as if you are entirely in the United States.
It’s wrong; it’s unethical, but this is what the U.S. regulators say. So maybe as a UK entity, you want to double-check that people aren’t under U.S. jurisdiction because you don’t want to take that risk. As an individual business owner, you have the right to do that, just like you have the right to get rid of this crazy guy who’s messing up your table and setting it on fire. You have every right as a business owner to say, "I don’t want this person in my business."
Similarly, if you don’t want to be under U.S. jurisdiction, you have every right to say, "Well, I need to know who’s delegating to me." Now, other SPOs won’t do that, and you, as an ADA holder, can always set up a private pool and stick with your own ADA. The SPOs are not the only gatekeepers for how the system operates; you have the ability to run a private pool.
This is what we talk about as the maturing of the industry. You have to treat people for what they are. An SPO is a business in partnership with delegators, and every one of those delegators has different facts and circumstances. Right now, the canonical way that we do these things is to operate the protocol. But what some SPOs are doing is they’re getting very clever, and they’re realizing that they can reuse this mechanic to do business plus more than what is described in the Cardano protocol.
That’s a good thing; it’s a beautiful thing. But then that requires some more batteries included to reuse some foundational things to be able to sort all that out. Unfortunately, some people have gone to Twitter, especially within the Cardano community, and they have decided to misrepresent this entire thing as the U.S. government being in control. They say, "I’m never going to use Cardano again because now it’s a fully compliant chain, and this is forcing regulation upon us."
I just sit here with my head in my hands, saying, "How did you get that from this?" It’s not an honest conversation. You debate and engage with people when you aren’t debating about the facts at hand; you’re just debating about the philosophy and values behind those facts. But in a debate, you absolutely do not engage with people when you cannot agree on the set of facts. If they’re living over here and I’m living over here, we’re not talking about the same thing. There’s no common ground; there’s no way to bridge this. It can’t be done.
If they are saying, "Well, this feature is about compliance, and it’s about putting the U.S. government in control of the protocol," they’re not talking about doing something good for business owners. They’re talking about something completely else. Yes, it’s absolutely true that this feature could be used for a slice of compliance, but they’re failing to acknowledge the universe of discourse, this whole other thing.
After repeatedly saying that there’s this other thing, let’s talk about that, and pretending it doesn’t exist, then what happens is you’re not having an honest debate. You’re having a political debate; it’s dishonest, and I don’t have a lot of tolerance or time for that. I don’t care if you’re an OG in the community and you’ve been around for a long time; you’ve done some great things, you will get called out on it.
This is not about silencing people; this is about honesty. At its core, there is a process now in Cardano called the SIP process. After SIP 1694 or something like it gets through, you guys vote on that, and somebody’s going to make the case that as business owners, stake pool operators need this fundamental capability for their own risk management policies and their ability to fire customers, remove people that don’t agree with their values, and yes, of course, be able to comply with local regulations.
That will be written as a SIP, and then people vote. We can have an argument about the pros and cons of these types of things, and then a decision will be made. Here’s what people do on Twitter: they play the victim. They say, "Oh, I’m being silenced. Oh, Charles has decided this. Oh, this has happened." Again, it’s dishonest; it’s a negotiation technique. They get all their friends to dogpile on, but they’re not being honest. There’s no honesty here.
This has nothing to do with debate because the process of debate is right now in hypothetical mode. A SIP hasn’t even been written for this; a process is not even being followed to ratify this type of thing. Ultimately, at the end of the day, doesn’t this pass common sense? As an SPO, you have to look at yourself in the mirror and ask, "Wouldn’t you like to have this power?"
You don’t have to use it because there’s not a notion of replacing the stake pool certificate with a contingent stake. It’s just an additional field, and you could decide to run with one or the other. People are going to make those decisions, and they have to decide the operating model that they want.
If we are to be a good community and get ahead, we have to start thinking this way. Get rid of the drama; stop being drama queens. You have to be fact-based, and you have to think a lot about what we’re trying to accomplish here. This ecosystem is something that, if we are successful, will service the needs of billions of people. It will probably be the financial operating system of a continent or two, which means there’s going to be regulated and unregulated activity on the system.
Combinations have to be made; hooks have to be made for both business flows to work. Or we can just decide as an ecosystem that we don’t care about that, and we’re just going to leave it as it was originally designed. That’s your choice, and you vote on these types of things about where the roadmap goes. If that’s what you want to do, okay.
But do be aware that by limiting the utility of the system, ultimately, you limit its resilience, survival, and value. The point of Cardano was to be able to accommodate all of these types of things in a structured way, in a fact-based, transparent way. That’s what we’re trying to accomplish here.
We just have to be better at debates, and people have to grow up a little bit and stop being drama queens about these things. Every single time something is brought up, they just freak out. I know it’s drama because I talked about this in 2021, and nobody cared. I released the video; there was some fanfare, and people thought it was a good idea, but nothing came of it.
Then, certainly because of Kraken and other things, people have been drawn into sensational headlines. By the way, Kraken looking at the SEC ruling actually had nothing to do with staking as a service. It had to deal with the fact that they were doing yield enhancement and exposing customers to risk with that yield enhancement. That’s what it had to do with. There was no complaint about the act of merely staking on people’s behalf if you actually read the SEC ruling.
Now, am I friends with the SEC? I think they’re the best people in the world? No, I think they’ve done a lot of damage in the industry with the ambiguity, lack of clarity, and their desire to be in control of everything and call everything a security. But that’s a completely separate need. We have to talk about facts and be fact-based as an ecosystem.
Being fact-based right now, no one in the U.S. government is directly saying that staking is illegal or a regulated activity. Some laws have been passed that put a compliance requirement from a tax perspective, but the Treasury Department has said that you, as a stake pool operator, at the moment do not have a reporting requirement.
Now, that can change; they can decide to start enforcing things, and of course, when and if they do that, then people have to get involved. But as it stands right now, their issue is yield enhancement because there’s trust, there are disclosures, there are information asymmetries, and there’s certainly risk being introduced into that process. It’s right there in the settlement agreement.
The fact that that occurred triggered some people and made them think it’s okay to go beyond the facts and start getting very dramatic about stuff. At the end of the day, we’re just trying to move along as an ecosystem, and we’re trying to make some hard decisions. There are a lot of roadmap items here that are above my pay grade, and they have to be decided by the community.
No one debates better, faster, cheaper, especially when it comes with limited or no trade-offs. But then when you start talking about protocol-level capabilities versus optional infrastructure versus other things, then suddenly there is a philosophical consideration. Part of the SIP ratification is going to talk about the overhead of this. I’m going to talk about the security concerns, absolutely. I’ll talk about the philosophy: should a stake pool operator be allowed to fire its customers? A whole bunch of these things.
It’s a multi-dimensional analysis that has to be done, and I have every confidence that the community as a whole has the capacity, in a structured way, to look at these things. Wise minds will prevail. We will not get anywhere if our politics in Cardano start reflecting American politics, and we start playing the politics of division, hysteria, and demagoguery.
Self-confidence doesn’t work when you go down that way. We’re all ultimately on the same side. I’d like to believe we want this to become a multi-billion person ecosystem. We want Cardano to have great use and utility. I’d like to see Cardano run economies. If it’s running economies, there’s going to be a space for regulated activity, and so you need to have hooks to provide that.
This doesn’t mean you’re turning over the protocol to one government or the other; it just means you can now use the protocol to capture your multi-trillion dollar marketplaces and innovate and improve them and allow those actors to play within that space. It means more liquidity, more adoption, more
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