Liquid proof of stake (LPOS) and the emerging of staking/baking services are new to most tax and regulatory bodies throughout the world. At StakeNow we are dedicated to building a bridge for a new technology like Tezos to coexist with the established financial and legal system, explaining its mechanisms to authorities and finding analogies to existing regulations in order to fall into useful categories. Of course, we do not do this alone but with the best specialists in the respective field. This effort is aiming for the broad acceptance of cryptocurrencies without the need to move in the shadows. We believe that this is a necessary discussion to enable the mass adoption of cryptocurrencies while maintaining its crucial values like participation and self-empowerment as key aspects of decentralization. Regulation is always inflicting overhead and favoring larger companies able to afford associated requirements. This proposal aims to find a compromise regarding voting procedures letting smaller baking services stay in business.
In this article we explain the state of the current regulatory framework in Germany (or outside Germany, for German customers) for companies building their business model on the use of cryptocurrencies. A key takeaway is that the design of Tezos liquid proof of stake without the slashing of customer funds and the complete control over the tokens by the customer was a great choice regarding financial regulation! We have anticipated this, and it was a main motivation to concentrate on Tezos baking only as other technologies are in the scope of regulation with their slashing and depositing mechanisms.
“According to regulatory assessment, the delegation of voting rights results in the administration of those payment tokens in terms of the crypto custody business. This result cannot be changed by differentiating to what extent vDL [StakeNow] exercises the voting rights as a result of instructions [polls on Twitter or Telegram / GitHub as a signaling mechanism] from the client and thus acts without any scope for decision-making.”
There is the need to act immediately if we do not want this to be the reason for baking services to stop voting or excluding German customers, if this is even feasible in a legally safe way (exclusion by terms of service?). This could bring down the majority of validators in most PoS networks if the laws are enforced strictly in the long run and it should be treated equally with other network risks. There is also a chance that the ruling/opinion is adopted by other regulators which leads us to the conclusion that a proactive behavior is the best choice to overcome this hurdle.
In our opinion the community has multiple options:
Ignore the problem
Start an argument “that they just do not get the idea and it is all a big misunderstanding”
Propose a change in the voting procedure (and the governance mechanism respectively) that allows us to stay in discussion but have a safe way to operate in the current grey zone
We hope you appreciate the equivalence of choices we offered. But first let us conduct some analysis.
The problem why we are having this debate originates from the following chain of effects that the regulatory body has identified:
Tez are classified as financial instruments after KWG (German Banking Act)
The on-chain governance system is used to ratify changes in the core protocol of Tezos and its main network
The ratification right is reserved to the stakeholders respectively the owners of tez
The rationale is that the stakeholders care for the value of the token and therefore agree on “the best” common protocol to maintain the network effect
The value is (in theory) increasing with the adoption of new technologies and the resulting demand generated by the usage of the Tezos main network
A vote is therefore impacting the price of tez
Conclusion: A baking service can thus impact the value of the delegated tez from clients with the submission of a vote
In general, it is up to debate whether any rights at all are carried over as it is the interpretation of the BaFin (Federal Financial Supervisory Authority) since merely the balance of the stake is delegated. Apart from this essential question it is important to understand that tokens never have “rights”. Only people have “rights” and the argument is about the “administration of rights that have been DERIVED from the ownership of a token”. As Tezos has a “role system” you could argue that the token holder only has “1 voting right” with a full roll of 8000 tez. At the example of StakeNow this would only affect ~5% of our clients. One could argue that the voting rights are created at the baking service as they accumulate the delegated tez resulting in full rolls. We have been given the legal opinion that a “partial roll” is already considered a voting share and therefore the owner has partial voting rights that transfer with the delegation. But for the sake of the argument let us differentiate the following cases:
Clients without a full roll owning only a “partial roll”
Clients with >=1 roll plus a “partial roll”
The baking service’s own stake with >= 1 roll plus a “partial roll”
We have heard the argument that even through the ownership of a full roll you do not have a voting right as you would still need to do the “register operation on chain”. We would draw the analogy to a shareholder meeting where you own a vote with a company share. You have the right to vote on the shareholder meeting even if you “still have to drive with the car to the meeting and fill out some paperwork” before you attend and cast your vote.
In our humble opinion we would state that the owner of a roll owns the right if he or she is by itself, without discrimination or overburdening technical challenges able to cast a vote.
In our opinion the requirement would be to let customers with >= 1 roll vote for themselves as proposed in this PR for “vote overrides”. Voting on behalf of them or by instruction is not allowed in some jurisdictions. We will emphasize that a “vote override” in the current implementation is not mandatory. This would eventually lead to the baking service making the decision for the client with its vote for all rolls considering effects like “voter laziness”. Therefore, the current implementation is not enough!
The baking service and the company operating it have the right to cast a vote for their own rolls as they are the legal owner of the tokens from which the voting right is derived. There is very little up to zero doubt about this.
A baking service would need to be able to cast a vote for the rolls they own.
Every baking service would have to decide for itself if they consider the accumulated partial votes as rightfully their own or a shared and distributed vote.
This would require voting for the remaining accumulated votes as optionally.
With the extension of the current mechanism, we must take care to not break backward compatibility. Considering the implementations of current tools or the fact that someone just does not care about the described problem and would like to behave as always.
In order to cast a ballot you have to perform the following operation described in the Tezos developer documentation:
tezos-client submit ballot for <delegate> <proposal> <yay|nay|pass>
In order to fulfill the regulatory requirement and satisfy the distinction between the above-described cases in addition to keeping the maximum flexibility for differing future rulings we propose the implementation of the following additional function:
tezos-client submit ballot for <delegate> <proposal> <yay|nay|pass> <number_of_rolls>
The parameter can be encoded the same way as the current roll value. The number of rolls associated with a delegate can already be retrieved with
GET ../<block_id>/context/delegates/<pkh>/voting_power .
We propose to introduce another RPC and internal function that returns the number of “unspent votes” like
GET ../<block_id>/context/delegates/<pkh>/unspent_voting_power .
The previous implementation would have the maximum rolls of the delegate with voting_power as default value for number_of_rolls. The new function needs a sanity check on the parameter if it resides between 1 and unspent_voting_power which is voting_power at the beginning of every period. The current vote override feature could be shipped as intended. The question that needs to be discussed is whether a delegate could vote multiple times until the number of maximum rolls is reached or if just one execution of the function per voting period is allowed. The implementation needs to take care that the vote override from clients is always dominant and the overridden votes reduce the number of available rolls of unspent_voting_power for the baker when casting their vote. It would in our eyes be more convenient if there is no mandatory order of execution in voting from clients or bakers.
Some final thoughts:
The roll system has often been perceived as a technical need that is best to be removed in the future. But if we look at the above interpretation of a different treatment regarding the potential transfer of voting rights, we conclude that with the roll definition we split the stakeholders into multiple groups with different rights and obligations as well. A minor stakeholder would have the obligation to search for a baking service that represents his interest the best way. It would encourage baking services to canvass customers by “giving them a voice”. On the downside, clients with more power in terms of owning complete rolls would in addition have the obligation to vote by themselves and make educated decisions. Furthermore, splitting voting from baking might be also a good idea. The voting key could be passed over to non-profit organizations as seen with voting on behalf of small shareholders (i.e. Schutzgemeinschaft der Kapitalanleger e.V., Deutsche Schutzvereinigung für Wertpapierbesitz e.V.) which can carry out the vote. Of course, this is already a very wide view into the future.
We are looking forward to your remarks and the discussion on the implementation details of this proposal. As we do not believe that technology should adopt to regulation, we have focused on proposing a feature that is desirable by itself and we take it as a positive impulse from the BaFin to improve the Tezos governance procedure.