Recently speaking with someone who loves everything crypto, she and I got into the guts of staking. Unbeknownst to me, I didn’t have as full of a grasp of the dynamics of this growing marketplace. It is exciting, to be honest.
The act of staking provides another way for owners of particular digital assets to earn capital. Think of it as lending the US Dollar out to different banks, offering you interest (yet your return is far better than any bank). Yet you’re not staking US Dollars; you’re staking Polkadot, Ethereum, Tezos, Algorand, Solana, Avalanche, etc. Those cryptocurrencies m0stly all have one thing in common: they are Proof-of-Stake (PoS). PoS is when you stake an asset – the native token of the network.
Holders of these native tokens participate in this activity by becoming a validator or delegators. As a validator, you run your node using advanced technical skills (see the Eth example below) and manage your system (i.e., online hardware). Validators command higher rewards and receive voting rights on some blockchains, but you have to invest higher sums to qualify. For instance, to become a validator on Ethereum 2.0, you must commit 32 Eth. The second way is delegating, a popular option for retail crypto investors who perhaps want (i) more accessible on-off ramps to participate in the activity or (ii) have lower amounts the native tokens. For example, to participate in the Avalanche network, you need 2,000 AVAXs ($186k today). Lastly, some validators have established companies that run pools that accept cryptos from other investors. You don’t have to worry about maintaining the node – but you do pay a small commission through what your staking rewards may have been.
To make this post as helpful as possible, I’d like to showcase how difficult and easy it is to stake (coin dependent). I’ll cover Ethereum (running a node), Solana (in a wallet), and Bitcoin (through a third party, although this example is considered lending). Staking or lending can be done in many ways and on multiple venues. The easiest way is to log into Kraken or Coinbase and deposit the number of ETH you’d like to be staked. They then do all the back-end work (pooling, custody, interest management). But as mentioned above, there are many ways and multiple venues.
A costly and time-consuming way is to become a validator (Beacon Chain Explorer). As a validator, the individual is responsible for securing the network and receiving continuous payouts for proposing, verifying, and vouching for the validity of blocks (i.e., actions that help the network reach consensus). Importantly, as a validator, ETH is posted as collateral (32 per). The only way to become a validator is to make a deposit contract on the current Ethereum chain (running an Eth1 and an Eth2 node). Once you deposit your ETH, it cannot be accessed until the mainnet merges with the Beacon Chain. Tactically, it gets a little complicated as you need to do some in-terminal commands and also have the supporting hardware (400GB for the Eth1 mainnet chain data alone, SSD storage to consistently handle necessary read and write speeds, ~700-800 MB/hour on upload bandwidth):
- Choose your Eth1 (Nethermind to Besu) and Eth2 client (Lighthouse to Prysm)
- Decide on how many validators you want to run. Remember 32 is for one, and you can consider it locked up for the next two years. If you need ETH liquidity, it’s best not to store it all.
- Generate your keys and download the CLI
- Upload your deposit json
- Connect your wallet
- Review the summary and begin on the transaction front
All of this work will get you a declining yield over time. As of this writing, it is just below 6% (i.e., 5.6%), as there are almost 10M ETH staked.
Compared to the validator method on Eth, Solana is quick and straightforward, and Solana is another Layer 1. There are many ways to stake the native token. Two popular ways are through the most popular non-custodial wallet (Solflare) or an exchange (Kraken). If you download a Solflare wallet, you can stake the coin in-app.
The product is intuitive and easy to use. For example, using Kraken as your exchange of choice, you purchase 10 SOL. You as a user then have three options: (1) keep it in your custodial wallet on Kraken, (2) stake your SOL through Kraken (by clicking the Earn widget), or (3) transfer your SOL to Solflare. Once in Solflare, you have an option on the main view to ‘stake,’ where each user earns roughly 6.5% today.
Lastly, a fringe example, Bitcoin. Bitcoin is Proof-of-work. But there are ways to still get yield in a similar method for any retail user. BlockFi is one company offering such services whose APR is currently 4.5%. BlockFi does this by lending BTC at a higher interest rate than they pay depositors to institutions collateralized that do market-making and arbitrage. The spreads across these markets provide a significant opportunity for relatively low-risk profits. The institutions (or counterparties) that partner with BlockFi likely do not want to take the market risk of buying BTC, which could lose value, so they borrow them and pay back the loan plus interest in-kind while keeping the remainder as profit.
Those counterparties are as follows (link here):
- “Traders and investment funds who see a fragmented marketplace and discover arbitrage trading opportunities. Arbitrageurs need to borrow crypto in order to close mispricing between exchanges or dispersed markets. Similarly, margin traders need to borrow in order to execute their trading strategies.
- Over the counter (OTC) market makers make money by connecting buyers and sellers who do not want to transact over public exchanges. OTC desks need to keep inventory on-hand to meet their client demand. Owning crypto outright is capital intensive and comes with the attendant risks of price fluctuations. Instead, they may prefer to borrow inventory in order to facilitate transactions. Liquidity is another essential component to healthy markets.
- Businesses that require an inventory of crypto to provide liquidity to clients. This bucket includes companies like crypto ATMs. These businesses also need to be able to support withdrawals while keeping the vast majority of their crypto assets in cold storage. The liquidity we provide them helps with these basic and important functions.”