What you need to know about virtual asset staking services?

Hong Kong’s regulatory framework for virtual asset trading platforms has been in place for some time. In addition to virtual asset trading, licensed platforms can now apply to the Securities and Futures Commission (SFC) to offer virtual asset staking services to clients, allowing investors to earn potential yields by participating in blockchain validation.

To enhance investor protection and reduce staking-related risks, licensed platforms must comply with additional requirements for staking services, including internal controls, disclosure of information, selection of blockchain protocols and third-party service providers (e.g. blockchain validators), etc. Licensed platforms can only offer staking services to investors after obtaining written approval from the SFC.

The virtual asset staking service offered by licensed platforms allow investors to potentially earn rewards by locking- up certain virtual assets based on a proof-of-stake consensus mechanism to participate in the relevant blockchain protocol’s validation process.

When investors use a licensed platform’s staking service, they agree to deposit and lock-up their virtual assets for a period in order to earn potential returns. However, for most investors, staking service is a new offering. Therefore, it is crucial to fully understand how it works and the associated risks before participating.

First, not all virtual assets can be staked; only those using proof-of-stake consensus mechanisms (such as Ethereum) can be staked. Additionally, staking rewards are not guaranteed and staking services typically require a minimum lock-up period. Given the high volatility of virtual assets, if prices drop significantly during the staking period, the rewards earned may not offset the losses. Investors can find details of staking services on licensed trading platforms, including the specific virtual assets that can be staked, any third parties involved in providing such services, fees and charges, minimum lock-up periods, unstaking process and its length, arrangements during outages, business resumption arrangements and custodial arrangements, etc.

Investors should review the risks disclosed by licensed platforms, including slashing risk which refers to penalties imposed if validators do not comply with the blockchain protocol rules (such as validating fraudulent transactions), resulting in losses to the investors. Apart from the lock-up risk and slashing risk mentioned above, there are still other risks, e.g. blockchain technical error/bug risk, hacking risk and inactivity risk relating to the validators, and the legal uncertainty relating to staking which may affect the nature and enforceability of a client’s interest in the “staked” client virtual assets.

Investors may encounter virtual asset platforms on the internet or social media that are not regulated by the Hong Kong SFC. The staking services offered by these platforms, apart from the staking services explained above, may also represent a wide range of virtual asset arrangements such as "deposits," "lending," "savings," or "earning". Since these platforms are not regulated by the SFC, their operations may lack transparency, making it difficult for investors to assess their robustness and credibility. If such platforms collapses, ceases operations, commits fraud, defaults, suffer from theft or cyberattacks, investors may not be able to recover their funds. Additionally, if these platforms have no connection to Hong Kong, local regulators and law enforcement may have no jurisdiction over them. In case of disputes, investors may face difficulties in seeking recourse or legal compensation. Furthermore, the outlaws may exploit fake high-yield staking schemes to conduct scams.

Virtual assets and related services are considered as emerging products. Investors should not focus solely on potential returns while overlook the risks. Social media is flooded with investment advice, tutorials, and analyses on virtual assets, investors must not blindly follow others and should conduct their own research to understand the nature and risks of these products/services. For those considering virtual asset trading or staking services, it is crucial to choose SFC-licensed virtual asset trading platforms to safeguard their interests.