Doesn't creating a masterkey password on Kraken void the protection of 2FA? Kraken allows users to create a masterkey that is just a password. Wouldn't creating a password to bypass 2FA completely negate 2FA?
Yes. Your right.

A lot of 2FA/U2F enabled websites/webservices have such "recovery" methods.
2FA/U2F only works in the right way when you can't recover your login credentials if your second factor has been lost/not-available.