Inflation is on the rise and investors are facing increasing pressure to find more ways to hedge their investments. Aside from the traditional methods of hedging inflation such as investing in the stock market, gold and real estate, some people are turning to alternative investments, such as staking cryptocurrencies to earn steady passive incomes.
Staking refers to locking one’s cryptocurrencies in a proof-of-stake (PoS) blockchain for a certain period of time. These locked assets are used to achieve consensus, which is required to secure the network and ensure the validity of every new transaction to be written to the blockchain. In return, those who stake their cryptocurrencies receive returns in the form of “block rewards”, or new coins from the network.
In other words — staking allows investors to lend their coins to a developer to support the operations of a blockchain network. New coins are provided to them as a reward, says RockX CEO Zhuling Chen.
“Let’s think of blockchain like a payment system. In traditional finance, the settlement of the payments are done by the companies themselves, be it Stripe, Visa or PayPal. But the nature of Web 3.0 is permissionless, which means that people can participate in the settlement or processing, and RockX is one of the validators that generate blocks and confirm transactions on a blockchain,” he explains.
In RockX’s case, investors not only enjoy the block rewards — the transaction fees, which are required to use the networks, can be passed on to stakers, benefitting those who participate in the staking pool. Chen goes as far as to compare staking to sovereign bonds. “The block reward is [similar to] the central bank providing the bond yield, while the transaction fees are [like] the GDP generated in the society. This makes staking a very different type of yield compared to trading or lending,” he says.
While the yield differs for every token, Chen says investors should be able to achieve substantial returns by diversifying their crypto staking portfolio. Staking the second largest cryptocurrency by market cap Ether, for example, would provide investors with around 5% annual percentage yield (APY), which Chen describes as “decent”.
For other coins like Polkadot — which is still within the top 10 ranking in terms of market cap — investors stand to earn up about 13% APY while other caps with smaller market cap and lower trading volume such as Osmosis may provide about 47% APY.
RockX CEO Zhuling Chen. Photo: RockX
Risks of staking
Although staking provides investors with a good opportunity to earn on their cryptocurrency holdings, there are several risks that they should be aware of. For one, the yield is denominated in the token itself, which means that investors face currency risk.
Additionally, cryptocurrency prices can be extremely volatile. Large price drops of the staked assets could offset or outweigh any interest that investors earn. One recent event was Terra’s reserve currency, Luna, that was trading at above US$80 ($109) apiece in early May, before collapsing to below a penny after Terra’s stablecoin lost its peg to the US dollar. This means that investors barely earned from the 8% APY.
Despite this, Chen maintains that staking as a whole is still a viable alternative for yield generation and will not be suddenly disregarded because of the collapse of a major token. He points out that there are still many cryptocurrencies other than Luna and Terra that could potentially give attractive returns.
“While conditions are bearish now, the value of these tokens will also rise when the market recovers, and this is what we’re seeing in crypto markets generally. As an example, if the value of your coin has fallen by 5% to 10% so far, your options are either to sell it now and cut your losses or continue to stake it and receive rewards, which will increase in value if and when your coin goes up again,” he adds.
Another factor that investors should consider is the importance of choosing the right validator, says Chen. While investors do not have to worry about counterparty risk and custody risk (as the coins do not leave their own wallets), choosing the wrong validator could cost investors lower returns.
Chen explains: “If a validator processes the transactions on the blockchain wrongly or exhibits any other harmful behaviour, the blockchain will punish the token holders that chose the said validator. This situation is called ‘slashing’, in which a percentage of the staked tokens will get slashed as a penalty.
Sink your teeth into in-depth insights from our contributors, and dive into financial and economic trends
“The blockchain may take 1%, or in extreme cases, 10% of the total tokens temporarily as a form of punishment. So far, we have not experienced any slashing, but we have seen other validators get slashed from 0.1% to 1%. To clarify, this is a very rare occasion.”
Staking also carries liquidity risk — in a normal staking model, investors are not able to move the staked tokens out of their wallets. While this does not apply to all tokens, some do require lockdown periods which may last a few days to a month.
Recognising that some may want to still trade their tokens within the lock-up period as the market is highly volatile, validators such as RockX have introduced “liquidity staking” to mitigate the liquidity risk. Chen explains that when investors put their tokens in a smart contract to stake, they get another token which represents the staked tokens’ ownership. This new token can be sold anytime without moving the staked tokens.
“This makes things very easy for customers as they do not have to worry about the locked-up period and still claim the yield should they still own the token that represents their ownership,” he adds.
Chen acknowledges that despite the opportunities that staking presents, not many cryptocurrency investors within the region are staking their coins. He attributes this to a lack of awareness regarding the yield and risks associated with it, as well as the barrier to access.
“Most people access crypto through exchanges because to start trading, they need to open an exchange account. However, most exchanges do not offer staking yet. Also, we’ve observed that staking is more common in the West, whereas Asian investors are more interested in trading. We hope that with the option of liquidity staking and more exchanges offering staking services, there will be more participants in this region.”
The next bull run
Since its inception in 2019, RockX claims to have more than US$900 million assets staked, providing US$90 million in annual yield. The firm has recently extended its validator network to Bifrost and Celer Network and in the process of expanding its validator network to Interlay and Avalanche.
RockX raised US$6 million in Series A funding earlier in April, valuing its crypto staking platform at approximately US$30 million. The funding round was led by digital asset platform Amber Group and other crypto industry leaders and businesses such as Matrixport, Primitive Ventures, FBG Capital, Draper Dragon, IMO Ventures, Alpha CW and Megastake.
Moving forward, Chen notes major anticipation in the crypto space towards Ethereum’s shift from proof-of-work (PoW) to PoS mechanism. “This is a very strong testament that major blockchains are moving towards PoS,” he says.
Since its inception, Ethereum has been using the PoW system. It is now moving to PoS to make it a more environmentally sustainable network and to manage the high transaction fees, among others. The move is slated to take place within the second half of the year.
With this expected change, Chen says the staking yield for Ethereum stands to increase from the current 5% to over 10% — an extremely attractive rate for interested investors. “It can be more attractive because [the move] would eliminate the PoW mining yield and pass it to the PoS. This is also why the general trading market is highly anticipating Ethereum price to be solid.”
Instead of looking at the performance of specific tokens, Chen says that he is more interested in looking at viable trends that are highly needed in the cryptocurrency industry. “Layer-1s are definitely exciting because all of them are doing a very fantastic job, in terms of technology, and also in terms of getting money into the space,” says Chen, adding that Layer-2 is also crucial for scalability and greater output.
Layer-1 refers to projects that provide solutions which improve the base protocol to make the overall system a lot more scalable. Examples of Layer-1 coins include Bitcoin, Ethereum and Avalanche. Layer-2 refers to networks built on top of Layer-1 to improve its functionality. Layer-2 coins include Immutable X (IMX) and Synthetix (SNX).
As the crypto winter continues, Chen believes that the next bull run may take place when a new wave of innovative decentralised applications — including decentralised autonomous organisations, social finance, decentralised finance and non-fungible tokens — are able to attract more investor interest again.
Cover photo: Bloomberg