Contingent Staking and Schelling Fences

There’s been a lot of talk in recent days about a proposal for Contingent Staking (CS) which could be implemented on Cardano to enable SPO’s to set conditions that delegators must meet, such as their nationality. This could technically implemented by using DIDs, necessary metadata and a multi-sig transaction for delegation.

This proposal has caused a lot debate on Twitter, with many SPO’s forming an opinion that this is definitely a **bad thing**. The arguments generally create an equivalence between CS and Know Your Customer (KYC) requirements.

So why was it proposed and does it matter? To answer we need to take a step back and take a look at the wider regulatory environment especially in the US.

In recent weeks and months it has become clearer that the Security Exchange Commission (SEC) US regulatory agency intends to take action against known bad actors in the crypto space (SBF, Do Kwon), as well as those who are reputable but have overstepped lines on rules for investment products (Kraken and staking on CEX’s). The trajectory suggests that they will tighten enforcement against stable coins and staking which may bring layer 1 blockchains into scope at a later date. Mainstream financial products all have clear KYC requirements which support Anti Money Laundering (AML) and other restrictions which are generally accepted by most law abiding people to be a **good thing**.

There are clear reasons for thinking that Cardano staking would not be impacted as it is non custodial given the SPO does not control the funds on behalf of the delegator, unlike Ethereum where staking is custodial and entities such as LIDO would almost certainly fail the test. However there are also a number of use cases for SPOs where contingent staking may be beneficial. For example:

  • Non Government Organisations or Not for Profits (Charity pools) who wish to ensure delegators are from a specific region or accept specific terms and conditions.
  • Projects with Initial Stakepool Offerings who wish to collect a wallet address and confirmation from delegators on eligibility to receive tokens that will be issued later.
  • Political candidates who may want to enrol delegators and collect email addresses.

So far so good. So why the concern from SPOs? The argument is essentially based on “slippery slopes” which LessWrong gives a great account of… It runs like this:

  1. Contingent staking is introduced and some SPOs adopt to meet regulation that requires KYC because they are based in that jurisdiction.
  2. Because there are also in-scope delegators to SPOs in unaffected jurisdictions those SPOs now face a choice whether to move to CS to keep the in-scope delegators and remove risks, or stay permission-less and face potential regulatory censure if the regulator in the delegators jurisdiction intervenes (the Schelling Fence).
  3. Now CS is in part of the ecosystem it rapidly becomes the norm and an expectation for all SPOs even though it was only necessary for a few SPOs initially. Regulators in other jurisdictions start to ask for KYC as they know it can be supported.

There are a few issues with the argument stated, firstly false equivalence between CS and KYC. While CS can support implementation of KYC it is not equal to KYC. Secondly that the Schelling Fence will not hold and there will be an increasingly number of SPOs moving to CS. This ignores the counter pressure or demand for permission-less pools in parts of the world that are not subject to the new regulatory requirements. It also ignores that Cardano staking makes it unlikely to be targeted by rules that require KYC.

Finally we would note that this capability brings some significant benefits to an ecosystem that wishes to position itself as a global financial operating system; the ability to support contingent staking decisions as a protocol primitive which will in turn allow many new use cases and regulatory requirements to be supported in a simple manner on Layer 1.

Wherever you sit in this debate, you will be able to vote when it’s encoded using the CIP process. One of the governance benefits to come as we move into the Voltaire era.