Coinbase’s recent foray into ‘Staking as a Service’ via their Coinbase Custody arm grabbed headlines across the cryptocurrency landscape last month. Representative of an ongoing departure from standalone, traditional custodial services, the move is part of a broader branch of developing narratives around Proof-of-Stake (PoS) blockchains that are launching.
Considering Ethereum’s pending transition to PoS and the emergence of networks like Cosmos, staking may ultimately prove to be a prevailing trend among custodial services as the industry progresses. However, even if staking does become a widespread service down the line, its long-term effects on the developmental role of governance in PoS networks is uncertain.
The move towards staking services is not strictly limited to Coinbase either; several firms are gearing up for a potential rush of institutional clients into the promising returns touted by staking crypto assets.
Expanding Custodial Services and Hopeful Returns
Staking as a service has fueled positive speculation about the appealing returns from idle crypto assets that suffered heavily during the extended bear market. Institutions have been hesitant to jump into the crypto markets for a variety of reasons, and the uncertainty of altcoins and their poor performance following the meteoric highs of late 2017 likely contributed significantly to their uncertainty.
At a high level, staking as a service is basically when a firm (i.e., a crypto asset custodian) posts the ‘stake’ or ‘bond’ required to validate transactions and receive the requisite return via a PoS-based protocol network. Staking requires that network tokens are locked in a ‘hot’ wallet which functions as the collateral for validating transactions, and also allows staking participants to participate in the governance of a network.
For example, Coinbase’s announcement of staking services initially will center on Tezos. Coinbase will post the bond required for ‘baking’ on Tezos, the colloquial term for staking in their community, on behalf of their institutional clients. Importantly, Coinbase will store all institutional funds that clients want to deposit for staking offline in cold storage and will provide their own funds to the hot wallet, effectively mitigating risk on behalf of the client in the case of the funds being slashed or stolen. Institutional funds will remain fully insured in cold storage.
Staking bonds often correlate to a percentage of the total being staked. For instance, if a Coinbase client wants to stake $10 million XTZ (the native Tezos coin), then Coinbase would need to post the bond into the hot wallet of $1 million — since the bakers must post a 10 percent bond of the total stake in Tezos.
The percentages of staking bonds will likely differ between PoS chains, and both returns and risk will need to be accounted for by the firms offering staking as a service.
Custodial firms are banking on staking as a service as a revenue-generating solution to the woes of the market that attracts more institutional money. For example, Coinbase’s staking services that they announced with Tezos can lead to 6.6 percent annual returns — after Coinbase takes its cut. Such returns are vast improvements over interest earned on a financial instrument such as government bonds, offering an appetizing draw for institutional clients to deposit funds with custodial services that offer staking services.
A flood of institutional money into custodial services to take advantage of staking will likely not happen overnight, but having a third-party service conduct the often convoluted process of staking is an important development in the eyes of many observers. According to Coinbase’s announcement:
“Prior to today, the risk necessary to actively participate in staking has mostly outweighed the return. As a result, many institutional investors have elected to sit on the sidelines.”
Segregated vs Non-Segregated Services
Coinbase is not the only custodian providing staking services either. Firms such as Figment, Cryptium, Battlestar Capital, Anchorage, and Copper are also positioning themselves for the rise of PoS protocols.
Battlestar Capital even partnered with crypto-lending pool provider, Celsius Network, to offer ‘non-segregated’ staking services that can yield up to 30 percent returns on idle assets — a projection that should clearly be taken with a grain of salt.
High-yield projections aside, it is important to understand the difference between Battlestar Capital’s non-segregated and Coinbase’s segregated staking model. In Coinbase, client accounts are separated on-chain into independent accounts to make the transparency and regulatory process more similar to banking — something that is comforting to institutions and regulators.
Conversely, Battlestar Capital and Celsius Network are operating a staking pool where ‘self-bonding’ strategies are possible to yield higher returns. Self-bonding in Tezos was described by Battlestar Capital Founder, Jason Stone, to Coindesk as:
“If you deposit your Tezos with a group running a self-bonding strategy, you earn the amalgamated yield of bonding plus delegating, as opposed to allowing the service provider you chose to receive the greater yield from posting bond themselves, leaving you with only the rewards (less a fee) from traditional baking, i.e., choosing a provider to delegate to.”
Coinbase cited Battlestar Capital as not being a competitor sinceCoinbase is not a public staking service offering open to everyone. Coinbase’s move into staking services is also intriguing for another reason; several prominent executives have left their institutional arm recently, leaving the overall strategy of their institutional business in question. However, staking services seem to be a significant focus for the major cryptocurrency exchange, whose estimated $520 million in revenue in 2018 fell short roughly 60 percent of their original projections.
Coinbase will also be rolling out governance support for MakerDAO, and its Maker token that governs the Dai stablecoin parameters within the platform’s CDPs. Notably, MakerDAO has been struggling with scaling to demand, recently proposing a stability fee of 14.5 percent.
Concerns Moving Forward
Healthy skepticism is a critical aspect of meaningful progress, and there are some legitimate concerns about the long-term effects of staking services offered by custodians. For instance, low staking participation among PoS networks is likely their greatest challenge moving forward, and although third-parties performing the staking eases the burden on clients, many institutional clients will likely prefer to delegate their staking governance power — particularly if they are eventually staking on numerous chains.
Even if institutions choose to participate in the governance of chains they are staking on, they would have enormous impacts on the future direction of such platforms. Considering their outsized deposited assets that correspond directly to influence in decision-making in staking protocols, institutions would dwarf smaller governance participants, concentrating major governance or on-chain amendments (i.e., with Tezos) in the hands of a few rich institutions — a notion that runs contrary to the larger narrative of decentralized control in crypto.
Fears of concentrating governance power and other complexities involved with PoS are criticisms that have already been articulated extensively and are beyond the scope of this article.
However, where the problem of aggregated governance power can really be compounded is when custodial services offer staking to institutional clients early in a bootstrapped PoS network’s existence. For example, should Coinbase offer staking services for pending PoS network like Polkadot once it launches based on client demand, institutional clients would command significant influence over the early stages of the network.
Their initial deposits would grant them increasingly stronger control over the network as they would generate larger returns in the native network’s token in proportion to their vast holdings — precluding retail investors from having a meaningful impact and disincentivizing them to participate in governance further.
It is too early to lucidly understand the consequences of staking services for PoS networks, however, largely because PoS networks are a relatively new phenomenon and the flagship PoS transition, Ethereum, has still yet to unfold. In addition, governance is a notoriously convoluted concept, especially when you mix in novel cryptocurrency networks and interest-bearing services based on services for validating their transactions.
Staking services may prove a fruitful business model for both custodians and institutional clients, but understanding the potentially adverse consequences of its development along the way is also vital to take into consideration.
Staking as a service seems poised to become a dominant trend in the cryptocurrency space as institutions look for revenue-generating returns on their idle assets and PoS networks continue their growth. Staking represents an intriguing concept in both investment and governance, and it will likely have significant consequences on the looming entrance of institutions into the broader sphere of digital assets.