The recent guidance provided by the U.S. Treasury Department on transaction reporting by crypto companies is shining some light on staking — one of the least understood but hottest corners of the digital-asset world.
Treasury indicated on Friday that “stakers” would be spared from forthcoming rules that are more targeted for brokers rather than investors using their tokens to help order transactions that create new blocks on various blockchain networks. That’s especially good news for crypto investors seeking a refuge amid the recent downturn in coin prices.
Staking has been booming in part because of the incentive-based aspect of crypto where various new coins and blockchains are competing for validators by promising stratospheric annual returns in the form of new coins. The rewards have been so lucrative that more than 70% of all tokens issued on many chains — Solana, Binance Smart Chain and Cardano, among them — were staked late last year, according to crypto researcher Messari and tracker Staking Rewards.
As staking options multiply and promised returns reach into the triple digits, the trend has only strengthened. In the fourth quarter, 7.7% of all the coins that make up the roughly $2 trillion crypto universe were staked, up from 1.8% in the year-ago period, according to staking provider Staked, a unit of the crypto exchange Kraken. And that’s even as Bitcoin, most of Ethereum, XRP and various stablecoins that make up more than 70% of the crypto market’s total estimated value, don’t allow for staking.
That’s likely changing fast, with all Ether expected to migrate to proof of stake this summer. The Ethereum network, the world’s most used blockchain, is running a smaller proof-of-stake network called Beacon in parallel with its main one to work out potential bugs.
“I think it goes from 8% [of Ether being staked] to 80% very quickly,” said Tim Ogilvie, chief executive of Staked. “It will happen over a year or two. Ethereum staking may be one of the biggest changes in crypto we’ve seen in a long time.”
Of the different ways to earn yield on crypto holdings, staking is generally seen as less risky than some other DeFi strategies such as yield farming. That said, new blockchains offering eye-popping rewards are often at risk of failing to attract enough transaction volume and making the coins rewarded worthless. Recent hacks of new protocols show the risks that come with investing in many of the upstart chains.
As the percentage of investors who stake increases, the pool of coins that are being frequently traded also shrinks. Staked coins typically take weeks to withdraw from the digital wallets they are locked into, and currently, staked Ether can’t be withdrawn at all. That can potentially contribute to increased market volatility.
Still, many sophisticated crypto investors who are holding their crypto for the long term are pouring their funds into staking to earn yields — and to beat crypto inflation. In proof-of-stake blockchains, stashes of coins help the networks order transactions, and these stashes earn new coins the network generates in return. Those who don’t stake are losing out on this new coin issuance, akin to inflation.
“If you are staking tokens that go up in value and are very promising, it’s a great way to get stable yield and have the upside of the underlying technology and products themselves,” said Paul Veradittakit, a partner at Pantera, a customer of Staked. “When we do invest in projects, we definitely try to stake as much of it as we can.”
Use of staking exploded as more proof-of-stake blockchains — Solana, Avalanche among them — debuted in late 2020 and 2021. Ethereum’s Beacon launched in December 2020, and its usage ballooned last year, to $29 billion staked currently — the biggest amount of any chain, according to data tracker beaconcha.in. As a further incentive, many new chains award more coins as rewards to early stakers.
“There’s massive, massive expansion every time there’s a new protocol, there’s a rush to these very juicy rewards in the beginning,” said Diogo Monica, co-founder of staking services provider Anchorage.
Some blockchains, like Avalanche, also let venture capitalists, who often hold tokens that they aren’t allowed to sell for a period of time, to stake. Ava Labs, which develops Avalanche, declined comment.
Until recently, one drawback of staking was that it can take days or weeks to withdraw staked funds. With Ethereum’s Beacon, withdrawals may only become available after a software upgrade in late 2022 or early 2023, said Tim Beiko, a computer scientist who coordinates Ethereum developers.
An increasing array of new services are effectively easing or getting rid of the lock-up that’s at the heart of staking altogether. Take Lido, a decentralized-finance app, which lets people use their staked assets as collateral to take out loans and to lend it out to earn extra yield via a slew of other DeFi apps. It already holds more than $9.7 billion in staked assets.
“You can play both games at once,” said Chase Devens, analyst at researcher Messari.
Large institutional customers have access to even better deals, resembling loans. Anchorage, for instance, lets certain staking customers to get all their staked coins back any time they want to for a fee. Anchorage gives them different digital coins, while keeping their staked tokens.
More small investors are getting involved. At the end of the third quarter, Coinbase Global Inc. said about 2.8 million customers were earning yield on their crypto assets, predominantly through staking.
“On a retail perspective, we’re seeing more and more people demanding it and actually asking for more coins to be staked so they can earn these rewards rather than sitting back and holding the token just for price appreciation,” said Steve Ehrlich, Voyager Digital Ltd.’s chief executive officer. Over the last six weeks, “We’ve seen our staking coins go up about 20% based upon the volume, not necessarily the price, but the number of tokens that people hold.”