Crypto Dividends: Staking Coins for Gains Potentially a Good Strategy in a Bear Market but Is Not Without Risk
According to Bloomberg, investors turn to staking for gains in the crypto bear market, but there are risks.
Volatility coupled with one of the longest bear markets ever experienced by the cryptocurrency industry have compelled many investors to consider staking as a method of “playing it safe,” according to a Bloomberg article.
Staking, which is similar to earning dividends or interest on your investment, is not a new concept. However, in a long bear market, it does become more prevalent among cryptocurrency investors, as possible gains from regular trading are not as fruitful. As Kyle Samani, managing partner at Multicoin Capital Management, stated to Bloomberg:
“Regardless of market conditions, staking provides returns denominated in the asset being staked. If you’re going to be long, you might as well stake."
Staking rewards are a byproduct of the proof-of-stake (PoS) consensus algorithm, first introduced by Sunny King and Scott Nadal in a white paper in 2012 for peer-to-peer cryptocurrency Peercoin (PPC).
Since then, hundreds of cryptocurrencies have adopted a PoS consensus algorithm as a method to verify transactions.
The majority of cryptocurrencies use either proof-of-work (PoW) or PoS — or some iteration of it.
PoW relies on the proof that a certain amount of work has been done to verify transactions. Both Bitcoin and Ethereum use PoW to validate transactions, although Ethereum has been making it clear that they will be moving to a PoS system, called Casper, as part of the Serenity network update expected for later in 2019.
At an August 2018 Blockchain at Berkeley event, hosted by the student-run organization Origin, Vitalik Buterin, co-founder of Ethereum, stated he can’t wait for all crypto networks to move away from PoW:
“I am seriously looking forward to when the cryptocurrency community basically passes away with proof-of-work.”
With PoW, nodes (or miners) compete to verify blocks of transactions by running highly specialized and expensive processing equipment (such as Application Specific Integrated Circuits, or ASICs) to solve complex mathematical equations. The first node to solve the equation can add the next block of transactions and collect the reward, which could either be a set amount or percentage of the transaction fee. The process, also called mining, has a number of drawbacks:
- It is highly energy intensive (the Bitcoin network consumes almost the same amount of energy as the entire country of Singapore).
- The high energy dependence is not only expensive but also bad for the environment in countries where nonrenewable fossil fuels (such as coal) is burned to generate electricity.
- Specialized mining equipment requires a significant upfront investment, which can be risky, considering that rewards are not guaranteed.
- With the advent of large centralized mining pools, the risk of a 51 percent attack on PoW networks is a very real threat.
PoS, on the other hand, only requires network participants to hold a certain amount of the native cryptocurrency in a specific wallet for a certain period of time. This is called staking and doesn’t call for any expensive computer equipment or massive amounts of processing power to solve complex mathematical equations.
Key differences from POW are:
- Nodes are often called “validators” rather than “miners.”
- There’s no specialized computer hardware requirement to become a node, which means the burden on power resources is drastically reduced. This is not only cheaper but also more eco-friendly.
- With PoS, there’s no threat of centralized mining pools.
- A 51 percent attack would be much more expensive to carry out. In order to take control of a PoS network, an individual or entity would have to purchase 51 percent of the available tokens. Not only that but, if you owned 51 percent of the tokens, you would want to do everything in your power