Staking promises rewards and other features (e.g., governance, transparency) that mirror incentive mechanisms in traditional finance. Like conventional financial products, staking relates to concepts such as currency risk, liquidity parameters, and interest rates.
In this report, staking is explained and defined. Afterward, some of the most compelling projects and mechanisms in the ecosystem are introduced. Furthermore, the importance of staking from the perspective of coin-holders and market participants is analyzed, before discussing in-depth other considerations and risks related to staking. Finally, market players are defined, along with the evolution of staking providers. Has staking's ecosystem matured enough for widespread adoption?
Binance Academy defines staking as:
“Staking is the process of holding funds in a cryptocurrency wallet to support the operations of a blockchain network. Essentially, it consists of locking cryptocurrencies to receive rewards.”
In its article, Binance Academy points out that in most cases, the process relies on users participating in blockchain activities through a personal crypto wallet (such as Trust Wallet or Coinbase Wallet).
Theoretically, projects utilize staking rewards as an incentive mechanism to encourage users to participate in the consensus finding of the chain actively. In practice, rational users are expected to be profit-seeking and therefore, must assess the potential rewards of participating in the ecosystem of each coin. However, staking rewards are typically denominated in a non-fiat pegged cryptocurrency, carrying potential volatility risks (which some of them will be discussed in the next subsections).
Historically, staking was first introduced as a concept in Peercoin (PPC), developed by Sunny King and Scott Nadal, who are now developing V Systems. Despite Peercoin beginning as a hybrid Proof-of-Work/Proof of Stake chain, it slowly transitioned to phase out any PoW rewards, thus solely relying on its PoS power.
There are several implementations for Proof of Stake algorithms, including several alternatives such as DPoS. At its core, the Proof of Stake algorithm is defined by Binance Academy as follows:
“The Proof Of Stake algorithm uses a pseudo-random election process to select a node to be the validator of the next block, based on a combination of factors that could include the staking age, randomization, and the node’s wealth.”
Fundamentally, “minting” a block in a Proof of Stake algorithm can be compared to “mining” a block in Proof of Work systems. To become eligible for minting blocks and consequently reaping block rewards, validators must stake cryptoassets on-chain. Depending on the chain details, these staked cryptoassets can be cut (in jargon “slashed”) to penalize malicious or unwanted behavior. Moreover, having locked (illiquid) coins in the network creates vested interests, as attackers are potentially dissuaded from performing any actions that could harm the value of the coin while they still hold this locked deposit denominated in the same cryptoasset.
Another variant of Proof of Stake is Delegated Proof of Stake (DPoS), the first version of which was displayed in BitShares, the first project created by Dan Larimer (who is also the creator of Steem and EOS). In addition to BitShares, other early projects supporting DPoS include Steem, Lisk, and Ark.
Binance Academy defines DPoS such as:
“A DPoS-based blockchain counts with a voting system where stakeholders outsource their work to a third-party. In other words, they are able to vote for a few delegates that will secure the network on their behalf.”
These delegates - also referred to as “witnesses” - are responsible for achieving consensus during both the generation and the validation of new blocks. In DPoS algorithms, voting power is (usually) proportional to the number of coins each user holds.
From an analytical perspective, stake-able coins can be segmented into five core families:
In this subsection, examples for each of these five subgroups are described to illustrate the variety of stake-able cryptoassets.
Algorand employs a pure proof-of-stake (PPoS) consensus protocol whereby the users’ influence on the production of a new block is proportional to their stake (denominated in ALGO). Featuring one-block-finality, the chain prioritizes randomization in the sets of consensus participants and allows users to directly earn staking rewards without the need of any intermediaries. The project provides an initial 1.75B in tokens for a staking rewards pool, after which transaction fees will be utilized to replenish the staking rewards pool.
EOS is a cryptocurrency that was created to support large scale applications, without any transaction fee. EOS relies on its unique resource-sharing model (i.e., CPU, RAM, and NET/network resources1) with a lending/borrowing peer-to-peer lending platform named EOSREX. EOS features a 5% annual network inflation, with 1% allocated to block producers who stake and receive the delegation, and another 4% allocated for future utilization for the growth of the overall ecosystem.
Since its network inception, Stellar (XLM) has offered what it terms inflation, a steady 1% inflation rate to the supply on the whole network, which allows its network to maintain low transaction fees, as stakers collect the inflation rewards weekly at 12 AM GMT every Tuesday.
Stellar’s inflation rewards were initially designed to be easy to obtain, but not too high of an interest rate to dilute the total value of supply of the network. The initial intention was to simultaneously attract new platform users, as well as encouraging an active usage of the coin by introducing opportunity costs for merely hoarding coins.
However, Stellar has recently proposed an upgrade that, if ratified, may eliminate its inflation, citing a failure of fostering development and rewarding of positive actors within the Stellar ecosystem. Instead, Stellar has rolled out some unique airdrops, such as the one to Keybase users and Github users, targeting developers and decentralized technology users.
NEO’s rise to fame after its rebrand from Antshares largely stemmed from its introduction of the two-coin model, a model in which a gas coin, creatively named GAS, was issued to NEO holders as a reward.
The issuance of GAS, while dilutive at the start, is capped with a fixed maximum supply of 100 million coins. As a result, the issuance of the second coin slowly decays overtime for the supply to converge to a finite number.
This token economic model was unique for two reasons - firstly, it created a new system in which block rewards would not dilute the coin that provides the ability to earn the block rewards. Secondly, the model allowed for a separation between a pure utility token and a token whose value is derived from the ability to produce or earn the utility token.
Dash, a privacy coin that was formerly known as Darkcoin, initially started as Bitcoin code-fork, but became probably most notable for popularizing the concept of a “masternode”.
Every masternode requires “bundles” of 1,000 DASH to operate and participate in the consensus mechanism. This model set the standard for tokens to be created as an “access token” to partake in the consensus, and commensurately earn “fruits for labor” provided to the network.
Currently, there are nearly 4,000 masternodes (MN) on the Dash network. Relying upon its masternode network, Dash has also unveiled an “Instant Send” function to safely accept transactions right away upon receipt, thus no longer requiring a multi-block time to consider transactions final. The project also implemented ChainLocks based on “Long Living Masternode Quorums” to mitigate the risks of 51% and double-spending attacks.
Generally, this masternode set-up allows for a fundamentally rule-based, yet open system network. Owing to its significant entrance barrier of having to own 1000 Dash, large token holders are aligned with all network participants. Hence, bad behavior from MNs supposedly would lead to a reduction in the asset value, i.e., the price of Dash.
Perhaps the largest elephant in the staking room is Ethereum, with its pending switch to Proof of Stake being long-coming. With Ethereum Classic (ETC) firmly rooted in Proof-of-Work, Ethereum has many research camps developing various staking-powered mechanisms. To date, the Ethereum Foundation and related Ethereum stakeholders have funded almost $10 million worth of grants for Ethereum 2.0 solutions. Most of these solutions have been designed to make Ethereum more scalable while packing in more features such as privacy. With Ethereum being the second-largest market cap coin and one of the longest-running blockchain products, it could drive many projects to follow and switch to Proof-of-Stake.
In the next section, an overview of the most significant projects is mapped and put in perspective with the overall total industry market capitalization. Furthermore, some of the essential requirements for each chain are introduced.
As of October 24th 2019, the largest 10 cryptoassets supporting (or planning on supporting) staking represent a cumulative market capitalization of $25.8 billion.
|Name||Ticker||Design||Expected Yield (APR)||Marketcap ($)||Staking/Masternode requirements|
|Ethereum||ETH||PoS (pending)||Est. 4.00%||17.6B||32 ETH|
|Stellar||XLM||Stellar Consensus Protocol||1%||1.2B||1 XLM (0.05% of supply for inflation destination)|
|Tron||TRX||DPoS (switching to PoS)||4.13%||1.0B||1 TRX|
|Cardano||ADA||PoS (pending)||Est. 3.70%||977M||1 ADA|
|Dash||DASH||PoS-like system with Masternodes||6.33%||576M||Masternode: 1000|
|Tezos||XTZ||Liquid PoS||6.94%||507M||1 XTZ (Baker Roll: 8000)|
|Neo||NEO||dBFT||1.52% (denominated in GAS)||497M||1|
|Ontology||ONT||dBFT||2.91% (denominated in ONG)||297M||1|
Sources: Binance Research, StakingRewards, CoinMarketCap
According to StakingRewards, the highest yields include projects like Synthetix (61.9%) and Livepeer (102.7%), as of October 28th 2019.
Sources: Binance Research, StakingRewards. Data as of October 28th 2019.
Synthetix Network displayed the highest yield amongst the fifteen largest cryptoassets which support staking. However, higher staking yields may not necessarily provide benefits from the perspective of users, as discussed in the next subsections.
Sources: Binance Research, DApp Total, StakingRewards. Data as of October 25th 2019.
Excluding Ethereum, the cumulative staking market capitalization, as of October 24th 2019, is worth around $11.2 billion with around $6.4 billion being staked.
Sources: Binance Research, StakingRewards. Data as of October 25th 2019.
Furthermore, in comparison with the total industry market capitalization, it represents a staking dominance of around 5%.
Finally, there are large differences amongst staking ratios between blockchains. Staking ratio is defined as the ratio of the amount staked at a single point in time divided by the total circulating supply of the cryptoasset.
Sources: Binance Research, StakingRewards. Data as of October 28th 2019.
As illustrated by chart 4, Synthetix Network showed the highest staking ratio across the largest fifteen blockchains by market capitalization. Regarding assets listed on Binance, Algorand, Tezos, and Cosmos displayed the high staking ratios (>70%) among all the largest blockchains supporting staking features. On the other hand, coins like TRON or Qtum exhibited a staking ratio of under 25%.
The next section discusses the “staking dynamics”, i.e., the key parameters to consider from the perspective of all stakeholders.
In this section, we introduce the individual user’s staking dynamics: when deciding whether or not to stake a coin, users should be considering not only the rewards but also all the risks & restrictions and obligations associated with active participation in staking.
Instead of block rewards being awarded to miners proportional to their hashpower in traditional Proof-of-Work blockchains, rewards are distributed to PoS participants, often proportionately to users (or probabilistically proportionately) who stake tokens on the network.
These rewards come in all shapes and sizes, with some systems having maximum rewards caps, requiring periodic claiming, lock-up periods (similar to Bitcoin coinbase reward time), as well as the frequency of compounding rewards. For example, Komodo caps rewards for wallets that have not made a “claiming transaction” within the last month, thus suggesting that the user is inactive and not participating in the ecosystem. Therefore, it is imperative to claim at least once a month. For projects like Stellar, which issue their inflation rewards every Tuesday at 12 AM GMT, rewards are automatically sent without requiring a new claim transaction, but the rewards compound only weekly.
Along with staking rewards, participants in staking may also receive other rights or access, depending on the structure and governance of a given cryptocurrency. While they may often be displayed or advertised as APY (annual percentage yield), beyond these rewards, a whole range of additional issues is bundled together, as not all blockchain rewards are created equally. Rewards do not come without any restrictions or concerns. Precisely, these costs of participating in staking (discussed in subsection 2.3) are impacted by obligations and requirements (paragraph 2.2).
In this subsection, both the obligations and requirements for staking participants are discussed.
Staking participants are reliant on the many parameters of staking, which are unique to each blockchain. Thus, they are positively incentivized to speak up in governance and vote for decisions regarding the chain and its ecosystem.
The process for being eligible to become a node runner can vary drastically and may include considerable costs. Depending on the chain, there may be an application form, a registration fee, as well as a potential bond (or staked deposit) that validators must post prior to being considered for a validation spot. The effort required to pass these hurdles is another cost that must be considered when reviewing staking projects. For example, it costs 9,999 TRX to apply to become a Tron Super Representative, and 2,000 ICX to apply to become an ICON P-Rep.
For most of the PoS systems, there are physical hardware costs (such as a Ledger, HSM, or another signing). Additionally, there are costs to run masternodes which relate to general resources such as RAM, CPU, or other “resource commodities”. These resources may be provided directly via physical machines and servers, or via cloud providers. For example, the ICON foundation recommends an AWS C5.9xlarge instance, which currently costs $1.53/hour. This prorates to $13,400 per year of operating a node. As resource exchanges like EOSREX and file storage and decentralized computing protocols like Sia, Storj, and Golem gain popularity and capacity, it may make it easier for users to acquire these resources in a decentralized manner.
Obligations of staking participants are not exclusively economical but may extend to having a certain technical expertise.
When analyzing prospective staking options, users must check if the chain requires an un-bonding period or other loss of liquidity to count a balance as staked. Specifically, questions such as “Can users move funds while they are staked?” or “how easily can they stop staking at any given time?” must be considered.
In fiat terms3, users must consider how the chain’s staking reward rate compares relative to rewards for holding other coins.
For example, DAI, a stablecoin built on ETH, should theoretically mimic the expected opportunity cost of not holding ETH (and its corresponding expected appreciation). If ETH is projected to grow by 15% by the end of the year, the equilibrium rate to borrow DAI should be the amount that people should expect to earn from using DAI to purchase a cryptocurrency.
Besides, some market participants may expect to receive better risk-return profiles through active investment and trading than through passive staking, mirroring the dilemma in traditional markets between active and passive investment strategies. For instance, someone planning on holding Komodo long-term may think he can increase his number of KMDs by actively trading KMD over the course of a year by more than the staking reward yield provided on the chain (currently 5.1%).
Furthermore, some macroeconomic models could potentially be considered in assessing whether staking does provide benefits from the perspective of users. The choice of a macroeconomic model can be justified by the fact that operations are similarly financed; instead of relying on external value added activities, currencies and staking coins are financed by inflating the total circulating supply. This unique trait renders a comparison with most established financial assets an odd choice. Hence, the comparison with currencies appear the most comprehensive to understand why high staking yields (funded by inflation increases) may dilute the value, through price reduction dynamics that are in analogy with macroeconomic theories.
Sources: Binance Research, CFA Institute, Kaplan Financials
According to the Interest Rate Parity Theory, if staking returns are paid in the native cryptocurrency through an increase in its supply, then the interest rate parity states that the expected future spot price of the cryptoassets must be equal to the interest rate differential multiplied by the spot price between two assets.
Let’s consider a model with two assets: the US dollar and a cryptoasset (e.g., Tezos/XTZ) whose staking rewards are paid through consecutive supply increases.
However, based on the International Fisher Effect, it is possible to calculate the expected spot price change such as:
Hence, if a cryptoasset has a staking yield higher than the risk-free interest rate (denominated in USD), this cryptoasset should theoretically experience a future price decrease (in USD) ceteris paribus. However, as illustrated by the high volatility of the cryptoasset class4, the expectations theory often does not hold.
As a result, someone expecting the price of a coin to increase by more than the expected spot price change defined above should start staking this specific cryptoasset.
As a result, it is worth considering that an extremely high staking yield which appears appealing at first may not necessarily be so interesting from the perspective of users, owing to the high inflation rate across the network. Another interpretation could be the fact that high staking yields might be indicative of hidden risks.
Models similar to NEO’s two-coin model are even harder to analyze from a macroeconomic perspective, as one coin is never diluted at all from the staking mechanism, and instead serves as the base currency from which the staking rewards are calculated. All in all, staking yields cannot be considered in a pure black-box fashion as reward payouts affect price dynamics and other endogenous factors that make a coin more or less attractive as an asset to hold.
Environmental and exogenous factors also exist and remain critical aspects that must be considered. They include elements such as:
In the preceding sections, several tradeoffs were discussed with various degrees of complexity. Fortunately, users do not have to face alone all these tradeoffs as there are many staking providers that provide options and tradeoffs for users, depending on their individual needs. In this section, market players are described and categorized based on the various types of service(s) provided to existing and prospective users.
Staking pools are typically (on-chain) addresses or individual delegated candidates that accept votes or on-chain pledge support, without requiring relinquishing custody of one’s coins. Often, staking pools are coin-specific, much like mining pools, and are designed specifically for helping reduce the barriers to entry to participating in earning some piece of the consensus rewards. Hence, it allows small players to take advantage of any economies of scale that may exist on any chain. One of the best examples is Lumenaut Pool for Stellar, a free pool that allows users to set them as an “inflation address”, which then subsequently passes the rewards back to the delegator.
For many Ethereum-based or EVM-compatible staking mechanisms, smart contracts may be deployed to pool together funds and earn optimal rewards. Examples include Tomochain’s Tomo Pool or ThunderCore’ staking pool service.
For some chains, further work is necessary beyond just pledging funds on-chain. In these cases, service providers may operate a node and handle most (if not all) of the obligations that may exist for a given chain. Delegation services, such as Staked.us, Infinity Stones, Certus One, and Chorus One, participate in many chains. These services are particularly useful for delegated Proof-of-Stake systems, for which validators must attain a critical mass of coins to participate in the staking mechanism.
These delegation service providers also roll out other utilities and tools for blockchain users to better understand the networks they are interacting with. For example, Staked rolled out its Robo-Advisor for Yield (RAY), Infinity Stones offers reports on the coins it supports, Figment.networks offers block explorers for Cosmos & other Tendermint-based chains through its Hubble domain, and Chorus One offers biweekly roundups on all things staking-related.
In exchange for this access, education, and to cover the real fiat costs of operating nodes, many “Staking-as-a-Service” providers charge a fixed rate fee on the staking rewards generated from any amounts pledged by users. Thus, staking providers operate as a “revenue-sharing” business, taking a cut of the total staking rewards claimed by their users.
These delegation services also offer significant overlaps with custody solutions, as the fund holder can help staking on behalf of the user and also take a cut, similar to delegation services.
For example, with Coinbase Custody, users will be able to collect rewards for select custody coins in a revenue-split model, with Coinbase taking a share of the rewards. From the perspective of coin holders, the revenue-split model allows them to delegate custody while still benefiting from margin-positive returns (vs. not staking).
Holding one’s own funds may be both a blessing and a curse - for some users, retaining custody is of utmost concern (“not your keys, not your coins”). However, for others, maintaining private keys, wallets, and other necessary infrastructure may be a burden. In this case, an attractive alternative could include relying upon a custodian or other staking providers who provide some Service Level Agreements (SLAs). For instance, Staked.us offers an SLA on uptime for its nodes, ensuring that users can be reassured of any technical difficulties that may come up during staking operations that prevent the user from receiving proportionate rewards. Uniquely, staking providers are held to a level of accountability through the transparency of the blockchain, as staking providers competing for users’ delegations are forced to display their rates publicly on-chain for users to select right alongside their uptimes and past performances, thus providing clear transparency into their business model and reliability.
Platforms that are already actively engaged in the ecosystem and offer trust-based services are ideally positioned to further monetize their existing user bases by funneling users to their staking validator. Because these trusted network participants must have already established a reputation for providing something of use to the community, they are naturally well-positioned to steer users to delegate assets to a trusted validator further.
The ability to cross-sell existing customers is facilitated by the fact that users may already have accounts/balances with these platforms and can thus avoid going through burdensome onboarding processes. For example, TrustWallet has rolled out its staking platform, providing its existing token holders an opportunity to participate in network staking rewards directly through their interface.
However, in the case of Huobi, OKEX, and Coinbase, the products are separate from their exchange wallets themselves, and thus, users cannot both trade and stake at the same time in the same product.
Staking rewards on exchanges for user balances held directly on trading accounts is unique because it provides a dynamic similar to maker-taker fee spreads. While users set limit orders, the coin they are providing to the trade still remains in their wallet and accrues staking rewards. As a result, limit sell orders of staking-supported coins are incentivized, rather than market sell orders6. Uniquely, users who want to partake in staking rewards may also be incentivized to set market buy orders, rather than limit buy orders, to guarantee the order completion and the beginning of staking rewards accrual.
Project teams have new opportunities as exchanges partake in the process of staking, as these exchanges can help act as a last-mile conveyor of education regarding their technology and chain to the crypto-audience masses. Particularly on exchanges, the front lines of price war battles between bulls and bears, incentivizing longer-term holdings through staking rewards mechanisms, may prevent some “pile-on” investing mentality in which the momentum of trading may drive prices significantly down during a short period.
Though the term “soft staking” has been thrown around, the effect of exchanges adopting staking may give rise to a more robust staking ecosystem for all projects. Uniquely, exchange providers can offer more access and liquidity to token holders while simultaneously increasing the network staking participation rate. From the perspective of exchange platforms, the support for staking is a very compelling decision, as it allows exchanges to align interests with the longevity of the products they offer on their marketplaces.
Concluding, Binance Research proposes a working taxonomy of staking projects. This taxonomy is derived from Section 2 above and can be expanded on in the future. It gives a simple overview of the core differentiating elements of staking projects, including:
Besides this general overview, staking can be assessed from several different perspectives.
For users, staking provides a new assortment of investment opportunities and strategies to generate passive income along with their underlying bets on a blockchain. To serve these users, many staking providers will create business lines bridging the needs of users to participate in blockchain rewards. As the evident growth of the staking ecosystem continues, network effects are likely to draw in more and more players into the staking game.
For projects, considering the staking dynamics during mechanism design and governance may allow them to provide a more compelling offering to compete for staking-seeking users. Staking can also be described as a lending system where the chain is the lender of last resort, substituting technical risk (of contract failure or exploit) for counterparty risk. As such, projects setting staking rewards will also have to consider the interplay between their rates and the rates that the open market may command in lending markets.
The concept of being able to set a “native interest rate” on-chain promises the ability to provide significant rewards for users without significant physical or technical capital to participate in consensus. As the infrastructure matures for receiving staking-related rewards and participating in DeFi, blockchain users will have more options at their fingertips to choose the products that best fit their needs.
With Ethereum slated to switch to Proof-of-Stake in the not-too-distant future, the blockchain space may be forced to reckon with staking sooner, rather than later.