Like any industry that grows by leaps and bounds, crypto’s early iterations were built on first generation technology. Despite being cryptographically sound, Bitcoin’s proof of work (PoW) consensus mechanism has proved difficult to scale, and expensive to fund. Where it once signaled financial independence for value pioneers, costly mining rigs consume massive amounts of energy and erect barriers to entry for many would-be participants. Although still a legacy asset, the broader crypto ecosystem is providing a new roadmap to alternative forms of yield generation.
Proof of stake (PoS) offers a more accessible alternative to consensus that incentivizes participation through the promise of rewards. However, there’s much more to staking than just accruing value. On some networks, staking can help offset the machinations of the token’s internal economy, while others provide greater asset mobility or support along one’s crypto journey. Read along as we dive into the headier concepts behind one of crypto’s pivotal features.
Stake ‘em if you got ‘em
It’s well known that market participants who opt to stake crypto, rather than just hold it, gain the opportunity to earn network rewards. In turn, advantages like governance that allow holders to participate in decision making and network evolution are often enjoyed to a similar degree. However, a core feature underpinning most tokenomic systems is rarely mentioned alongside these accepted staking benefits. Namely, that not staking can come with its own, tangible risks.
When a network issues staking rewards in the form of its native token, participating users see their holdings of that asset increase, while the overall supply becomes more diluted. Inversely, users who elect not to stake retain a static amount that will become steadily devalued overtime due to the increasing supply. This effect is known as an inflationary cost.
Staking rewards are insulation against this devaluation. By keeping pace with the increasing supply, rewards offset inflation through their accrual. This is especially true for assets with high yields, as such issuance directly incurs higher annual inflation rates. Thankfully, participating users not only enjoy a more robust portfolio and assorted network perks, but they’re better insulated against fluctuating supply conditions. This helps participants retain and grow their initial investment at pace with a shifting market landscape.
Go with the flow
In light of recent events sending shockwaves through the ecosystem, issues of liquidity are once again in the spotlight. While the parameters of liquid staking can vary greatly between assets, it’s worth revisiting how the practice was helping to alleviate some of these concerns prior to the latest shake up.
Broadly speaking, liquid staking’s main function is to make the process more intuitive and rewarding for network users. By doing away with lock-up staking, market participants are no longer forced to choose between trading and network support. Plus, with once-locked assets now in de facto circulation, holders can earn rewards while still contributing to available liquidy across trading platforms. This is one of the critical ways liquid staking helps encourage the ongoing exchange of assets.
Additionally, liquid staking can require little or no minimum to participate, with some platforms even offering automatic staking rewards that begin at the point of acquisition. Not only does this help make staking equally accessible for individuals and institutions alike, but it increases network security and further promotes decentralization through such participation. Remember: the more people involved with staking an asset, the safer the network.
Layers to consider
Where staking works to secure and prevent centralization, layer 2 (L2) solutions aim to improve the scalability of a network. Those familiar with the blockchain trilemma will recognize L2 as solving for the final piece. However, what’s not often discussed is the impact a more efficient network would have on the distribution of staking rewards.
Typically, fees collected for network transactions are later distributed to staking participants in the form of earnings. Like Ethereum’s gas fees, these sums are calculated based on network congestion, a feature that’s directly correlated to network efficiency: the more efficient the network, the lower the fees.
While this is poised to lower potential APYs for native tokens on better scaled networks, this should not be seen as just cause to abandon staking. Rather, this should be viewed as evidence of wider adoption, while providing evidence of what a mature PoS network could strive to resemble.
Non-linear storytelling
Progress doesn’t move in a straight line, and neither does crypto. Yet for all the pitfalls of the previous year, new technologies and developments are continuing to emerge that quickly elevate to become essential infrastructure. While it still remains to be seen how all these disparate parts will fuse together, there’s a blueprint in the works for a greater era of financial inclusion.
As we write the next chapter in crypto, be on the lookout for these key features to continue impacting the future ebb and flow of the space.