The impending transition to Ethereum 2.0 has put staking in the spotlight, with both exchanges and standalone staking platforms offering institutional players and retail investors alike the opportunity to enjoy the rewards of staking, without actually having to run a node.
In total, over $10 billion of the total $19 billion proof-of-stake coin market cap now locked in staking contracts. Much of this popularity stems from the appeal of staking as a way to earn additional passive income—akin to earning interest on fiat in a bank account by depositing funds and then receiving a small percentage back each year.
But the investment case for staking extends beyond just regular returns, and those willing to dive deeper into this new crypto economic model will discover a multitude of different reasons for investing.
Maximizing risk-adjusted returns
The biggest staking platform—Coinbase Custody—sells staking to institutional investors as a way to receive consistent returns regardless of the rollercoaster of volatility typically associated with the crypto market.
Lucrative returns make this particularly attractive in an era of negative interest rates, with Ethereum 2.0 expected to offer staking rewards up to 12%, and others like Cosmos already offering 8%.
Some staking supporters argue this steady income acts as a life support mechanism in crypto bear markets, giving investors the incentive to HODL, rather than panic sell when the going gets tough.
However, whether this actually enhances the stability of staking tokens remains to be seen.
As most investors will stake through a service provider, counterparty risk should also be taken into account: Coins being staked must often be kept online, where they are at greater risk of theft than coins kept in cold storage. On the other hand, validators using their own infrastructure arguably run a greater risk of incurring network penalties—known as slashing. These punishments typically involve stakers losing a portion of their delegated tokens, and are levied by proof-of-stake networks to deter sloppy and insecure node setups, or the deliberate breaking of rules.
The other factor affecting the return of staked coins is inflation, or more accurately speaking token dilution. Some staking models incentivise holders to stake—and thereby secure the network—by issuing new tokens, similar to how a corporation might issue new stock to a class of existing shareholders.
Some staking protocols like Augur have a fixed supply, but others like Ethereum have a variable inflation rate that can be impacted by changes to the network. This risk of dilution should be factored into any calculation of risk and return.
On Stakingrewards.com you will find the “Adjusted Reward” Metric, which provides an understanding if you are at risk of dilution or can effectively increase your share on the overall network token supply.
The fixed income of staken tokens has led many to draw comparisons with traditional assets like treasury bonds and bills, or municipal bonds which pay interest income on top of the original capital.
In the world of legacy finance, bonds are used to balance portfolios as a risk-off asset, and some think staked tokens could play a similar role in portfolio diversification — just like bitcoin is starting to be accepted by portfolio managers like Paul Tudor Jones as a non-correlated asset with a different flavour of risk.
Diversifying in this way might mean using staked tokens to offset the risk of holding equities or commodities, or using staking within a cryptocurrency portfolio to guard against the fluctuation of single coins by gaining exposure to a diverse portfolio of revenue-generating nodes.
The on-chain governance of staked coins represents a unique value proposition for investors.
While major decision-making on Bitcoin and other big cryptocurrencies is restricted to those running full nodes, holders of staked coins can take a more active role in guiding the direction of their investments.
This might be particularly appealing for those who witnessed the bitcoin community tear itself in two as tensions brewed over scaling solutions in 2017, leading to an eventual split of the blockchain between Bitcoin and Bitcoin Cash.
Some suggest the on-chain governance of staking means disagreements are less likely to bubble over into contentious blockchain forks, as consensus can be reached more easily because users are more intimately connected to the results of their decision-making.
Exactly how well these blockchain-based governance mechanisms can resolve disputes is not year clear, but so far high-profile staking coins Tezos and EOS have managed to work their way through issues accompanying token development, though not without harsh criticism from the crypto community.
A new breed of investment
While staking makes a strong investment case, token holders should remember that the primary purpose of staking is not to create an income or generate ‘yield’, but to put ‘skin in the game’ — increasing network participation and ensuring the blockchain remains resistant to censorship. This makes for a unique investment proposition that is unparalleled in the world of legacy finance.
About the Author
Kieran Smith provides content strategy and copywriting services for cryptocurrency companies at Bitcopy.