7/4/2022. "Staking" Crypto Investment Products are Poised to Explode
Bitcoin is often compared to gold. If you've read my article "How To Invest In Blockchain (In 2022)", you'll remember my 'how to buy gold' analogy for investing in blockchain.
- Gold - you can buy physical gold (either direct or via an ETF - exchange traded fund), or, you can buy stocks of gold-mining companies (again, directly or via an ETF).
- Blockchain - you can buy and hold cryptocurrencies directly; or, you can buy into publicly-listed companies that benefit from the blockchain economy.
Like gold, mainstream cryptocurrencies generally don't produce an income, and in fact have a cost to own. Whereas gold's costs are predominately physical such as secure storage, in the case of cryptocurrencies they relate to 'inflationary' costs. As more of a cryptocurrency gets produced over time, each coin is devalued, such that the price of goods (or gold, or fiat currencies) measured in the crypto will rise. (I set aside the effects of demand for a coin, which naturally drives up the value.)
But what if this paradigm could be broken? What if suddenly your 'gold ETF' started paying you a dividend or passive income? How much demand would there be for an ETF or investment fund that's backed by gold but also pays you a passive income? A fantasy question that answers itself.
Famous investor Warren Buffet is renowned for his negative view on gold and total belief on stocks - because unproductive assets lose out to productive assets over time. And although gold is commonly touted as a hedge against inflation, one of the very best forms of inflation protection is holding shares in quality companies with well managed borrowing and a business model that allows input cost increases to be smoothly passed to the customer.
Gold is also promoted as a 'store of value', which might be more legitimate than the inflation-hedge story. But suppose you're an investor today, facing huge inflation (40-year high in US, 30-year high in UK), does simply 'storing value' make sense? Why not put your value to work for you?
Goldman Sachs says that bitcoin competes with gold as a store of value. The firm estimates that the cryptocurrency has around a 20% share of the 'store of value' market. That's just Bitcoin alone. As I write this, BTC (Bitcoin) is about 41% of total crypto market capitalisation, and second place ETH (Ethereum) has 19%. Apart from it's utility as a base layer crypto for such things as smart contracts, the 'new and improved' ETH2.0 (coming very soon) is loud and proud about a key difference with BTC.
The new generation ETH uses 'Proof-of-Stake' (other examples are Cardano, Polkadot, and Cosmos), and not 'Proof-of-Work' like BTC (other examples being Litecoin, Monero and Dogecoin).
Dummies Guide - Simple Overview of Proof-of-Stake versus Proof-of-Work
Very briefly, Proof-of-Work (PoW) and Proof-of-Stake (PoS) are two different types of consensus protocols. Consensus is a key concept for a decentralised and immutable ledger.
In PoW - network participants, called miners, perform complex computations to solve a puzzle - calculating an alphanumeric code ('hash') required to validate a transaction and add a block to the blockchain. The first miner to derive the right code is rewarded for the effort.
- With PoW, the more hardware you have whirring away, the more likely you are to be the winning miner for a transaction.
In PoS - network participants, called validator nodes, commit or 'stake' quantities of the coin or token, for the chance to be randomly selected to validate a transaction and add a block to the blockchain. A selected validator node receives rewards in the form of the native token of the network.
- With PoS, the more cryptocurrency a node stakes, the more chance it has of being selected for the reward (like buying lottery tickets).
From the above, you can immediately see why PoS is considered so much more environmentally-friendly than PoW. It doesn't need acres of computer servers to support the blockchain. PoS is also more scaleable and with a higher transaction throughput.
Get Paid to Store Value?
By staking native cryptocurrency or token, not only are participants supporting the network, they are earning the rewards. Now, long term holders ('HODLers') of crypto can earn passive income by staking.
Setting aside the volatility of cryptocurrencies (which should never be ignored, and can be extreme), if I am a long-term investor, would I prefer to hold unproductive and inflationary digital assets, or would I prefer to stake productive digital assets and earn up to 20% returns (or more)?
How to Stake Crypto in the Real World
To recycle my lottery ticket simile, in countless departments of countless companies around the world, employees and staff pool their resources to buy national lottery tickets. If a purchased ticket turns out be a winner, then the proceeds are divided amongst members of the syndicate.
This is precisely the concept of a crypto 'staking pool'. Such pools are often private organisations with an operator, high entry barriers, and fees. They may also require participants digital assets to be locked in a specific wallet (blockchain address). Participants also need to be crypto-savvy and understand the risks.
A particular risk with PoS consensus is 'slashing'. This occurs when a validator 'misbehaves' - such as being offline as part of a group (which could indicate an attack), running harmful code, or other malicious activity. If such an event happens, a percentage of the validator's stake is lost. Participants who have delegated their tokens to that validator, will also find their stake slashed. Hence, selecting which validator nodes to delegate stake to is important and requires due diligence.
Staking platforms lower the technical know-how barrier for crypto investors. The two main categories of platform are:
- Providers specifically focused on the staking model, such as StakingLab and Stake.Fish which is currently offering up to 20% on Ethereum, Polkadot, Cosmos, Cardano, and Solana, amongst others; and,
- Larger and more well-known crypto exchanges that offer staking-as-a-service (SaaS) to their customers, with big names including Coinbase and Binance. There are a variety of staking products offered, including flexible savings and locked stakes, with rates of return varying accordingly (for instance a flexible savings return will be quite low compared to a 90-day lock).
Cryptocurrency ETPs (Exchange Traded Products) that hold - and stake - cryptocurrencies, could become like the mythical gold ETF that pays dividends. (Or, if you prefer, silver, palladium, etc.).
Products are beginning to emerge, such as:
- 21Shares has already launched a Solana Staking ETP, current AUM $140m.
- Coinshares has a Physical Staked ETP for Cardano, as well as Polkadot, Solana and Tezos.
Being exchange-traded, it's straightforward for investors to access ETPs. Furthermore, the regulatory environment of a major stock exchange gives comfort to investors who may be wary of the crypto domain.
Furthermore, such ETPs will give corporations, banks and other institutional investors, such as pension funds, the chance to easily allocate to staked crypto as an asset class. The big beasts of the investment universe have been piling into cryptocurrencies; the opportunity to invest in staked crypto will amplify their enthusiasm.
The Winning Mainstream Cryptos Will Be Productive, Not Just Speculative
According to CoinMarketCap, total cryptocurrency market capitalisation two years ago was about $0.2 trillion. Today, it is $2.1 trillion.
Total crypto market cap and share of bitcoin and ethereum, 2020 vs 2022.
In just two years, the dominance of bitcoin has fallen from 65% to 41% of total market capitalisation. Meanwhile, Ethereum has more than doubled. During this period, overall market cap has rocketed tenfold.
Ethereum (ETH) is the currency of choice for purchasing NFTs (Non Fungible Tokens), a market that has seen explosive growth over the last year. The utility and use cases for ETH underpin it's rise against BTC, which is more gold-like in it's unproductivity.
Once the Ethereum network upgrade is complete, and staking is fully live on ETH, the opportunity for passive income will drive its popularity still further. And as staking becomes more understood, and retail products more mainstream, the same will apply generally to the universe of Proof-of-Stake cryptocurrencies.
Important Note. This article is for information and education only and is not a recommendation to take or not to take any kind of investment action.