Kraken blocks German customers from Lightning Network

The Kraken digital asset exchange continues to fight America’s securities regulator while blocking its German users from accessing the Lightning Network for as yet unclear reasons.

On September 12, Kraken’s attorneys filed their latest response to the civil suit brought against its parent companies Payward Inc. and Payward Ventures Inc. last year by the Securities and Exchange Commission (SEC). The suit accuses Kraken of operating an unregistered securities exchange, broker, dealer and clearing agency, while putting customer assets at risk via shoddy “business practices, deficient internal controls, and poor recordkeeping practices.”

Kraken previously paid a $30 million penalty to the SEC related to its asset-staking services but tried to have this latest suit dismissed on the grounds that none of the tokens it offered to the public qualified as securities and thus it was immune from the SEC’s oversight.

That bid was rejected late last month by Judge William Orrick of the U.S. District Court for the Northern District of California. Orrick ruled that the SEC had “plausibly alleged that at least some of the cryptocurrency transactions that Kraken facilitates on its network constitute investment contracts, and therefore securities, and are accordingly subject to securities laws.”

Some other ‘crypto’ firms targeted by the SEC in this manner have offered similar arguments to Kraken’s but these arguments have been shot down by other federal judges in other districts. While the SEC’s historic use of the phrase ‘crypto asset securities’ has come under criticism, judges have largely supported the regulator’s belief that some of the transactions represent ‘investment contracts,’ thereby triggering planks of the Howey test.

Kraken’s latest 76-page response largely sticks to its guns, continuing to insist that the SEC has no jurisdiction over digital assets and that Congress is the only entity that can resolve this dilemma by crafting bespoke rules of the road for ‘crypto.’

This is a popular and self-serving dodge by ‘crypto’ firms, who understand all too well that Congress is incapable of reaching consensus on how to boil water. The apparent hope is that the current environment will persist long enough for everyone in ‘crypto’ C-suites to make a large enough packet to retire to their nuclear bunkers on their private islands where no one cares if they’re lying.

Don’t mention the Lightning Network

Across the pond, Kraken has offered conflicting explanations for why it abruptly blocked its German customers from accessing the Lightning Network, the ‘scaling solution’ to the many drawbacks of the BTC blockchain. Said drawbacks include a glacial capacity of seven transactions per second (TPS) and the high transaction fees that result from such a throttled throughput.

Incidentally, the developers who run the most popular iteration of Lightning were among those who imposed the restrictions on Bitcoin that resulted in the artificially constrained BTC network. Pretty cool when both supply and demand reside under the same roof, huh?

In a notice recently published on its support page, Kraken announced that as of September 10, changes were coming for its customers in Germany. Verified clients “will face BaFin [Germany’s Federal Financial Supervisory Authority] regulated counterparties (DLT Securities GmbH and DLT Custody GmbH) for crypto services.”

Along with this announcement came an unpublicized revision to Kraken’s list of “supported address formats for cryptocurrency withdrawal for German clients.” A German customer who’d previously enjoyed Kraken’s no-fee BTC withdrawals to Lightning Network noted that this option was now gone.

Speaking to Kraken’s support team, the customer was originally told it was a site maintenance issue, but the team member later admitted that “we are now not currently supporting BTC Lightning transactions. This change has take [sic] place from September 10th due to new regulatory regulations.”

Pressed for more details, the team member said only that “Lightning addresses are no longer supported” and “[c]urrently it is down to regulatory issues but as soon as we are able to bring back the service we will.”

Once this change was more widely reported, Kraken changed its tune, claiming that the support staffer “incorrectly cited regulatory changes” in their conversation with that German customer. Instead, Lightning’s absence was “the result of technical changes,” the nature of which went unexplained.  As one Reddit user put it: “Technical changes that .. only apply within certain national borders.. right.”

Tellingly, no date for the return of Lightning withdrawals has been provided. The Kraken spokesperson said only that the exchange “unfortunately sometimes have to make tough decisions to ensure we can offer a reliable and secure platform for as many clients in Germany as possible.”

Working as intended (when working at all)

Lightning was intended partly as a way of using BTC without waiting a week for your transaction to be approved and without paying a fee worth more than the product or service you wanted to purchase. (That is, when the notoriously fragile Lightning actually works.)

But Lightning transactions aren’t settled on the main BTC network, and as the reality of blockchain traceability began to dawn on the ‘crypto’ masses, some individuals saw Lightning as a way to avoid scrutiny of their transactions.

Some of these individuals may have done so for reasons of principle, but many others were likely aware that the product or service they desired wasn’t the kind of information they wanted to share with the authorities. Or they simply wanted to obfuscate their digital getaway trail following a scam, rug pull or other crime, and needed to launder the proceeds of same.

If you’re looking for potential reasons why Germany’s BaFin told Kraken to put Lightning back in its bottle, recall that a few months ago, Layer 2’s like Lightning were declared “an obstacle for criminal investigations, especially in relation to evidence admissibility” by the European Union Innovation Hub for Internal Security (a group that includes EU law enforcement agency Europol).

Stateside, the question of whether the individuals operating Lightning nodes are effectively serving as unlicensed money transmitters remains largely untested. But since Lightning nodes generate fees from the transactions they process, it likely wouldn’t be too hard to find a U.S. judge who agrees that where there are profits, there should be permits.

It bears stating that some blockchains that don’t artificially constrain their bandwidth have no need for layer 2 scaling solutions. BSV, the only protocol that honors Satoshi Nakamoto’s original Bitcoin design, can handle three million transactions per second, all on a strong and secure base layer, for fees measured in fractions of a cent.

BSV further distinguishes itself from the herd by requiring its nodes to observe strict Network Access Rules, including those that enable Digital Asset Recovery. The latter doesn’t treat victims of fraud, theft or misdirected transfers as if they’re technological illiterates who deserve their fate, instead offering the opportunity to pursue legal recourse to help reclaim their digital assets.

Robust, capable, fast, regulatory compliant, consumer-friendly… It’s enough to make one believe that Satoshi Nakamoto fella knew what he was doing.

But maybe these guys don’t

Kraken was founded by arch-libertarians who historically haven’t raised much fuss about their platform being used by whomever for whatever. Kraken co-founder/former CEO Jesse Powell has decried U.S. authorities’ takedown of controversial coin mixers such as Tornado Cash, which proved popular with North Korean hackers looking to launder their stolen tokens.

Despite Powell’s laissez-faire outlook, he wasn’t above engaging in a little anti-competitive tactics when it came to dealing with technologies that offered an alternative to the prevailing ‘crypto casino’ exchange model. Kraken was one of four exchanges—the others being Binance, Bittylicious and Shapeshift—that participated in the delisting of the BSV token in April 2019.

This led to the £9.9 billion collective proceeding in the U.K. against the four exchanges. This legal action, which aims to compensate BSV token holders who saw the fiat value of their digital assets decline following the delisting, is currently proceeding to trial after a Competition Appeal Tribunal (CAT) ruled that the threshold for approving the claim had been met.

Powell’s personal life has occasionally proven as controversial as his company. He previously alluded to potentially committing bank fraud to keep the cash flowing during Kraken’s early days, while his home was searched by the Federal Bureau of Investigation (FBI) last year amid claims he hacked and cyber-stalked a California arts group that dared oust him from its board of directors.