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Staking as a service

Staking as a service

Staking as a service is a blockchain service provided by businesses comprising investment risk mitigation and maximization of return on investment by attending to the participation requirements of proof-of-stake (PoS) cryptocurrency networks.

Overview

Proof-of-stake networks incentivize users to improve their security by rewarding validators with block rewards composed of network inflation and transaction fees. These inflationary rewards are meant to encourage users to put their assets to work on the blockchain. In networks with a regular inflationary supply of cryptocurrency, the holdings of users that do not stake them are subject to continuous dilution.

In the event that 100 percent of the network is staked, no relative change in network ownership would occur, since all of the inflationary rewards would be distributed to all existing holders. However, this is very unlikely to happen, considering that the network would have to be completely inactive. Therefore, every PoS network exhibits different active staking rates depending on the activity and incentives at play within each respective network.

Chains that have no minimum stake requirement still demand capital in other forms, such as high-end computers, voting fees, and sufficient capital staked for the validator to be elected. If a participant has enough capital to meet the minimum stake threshold, they are tasked with the ongoing responsibility of keeping their validator online and performing accordingly with the network's rules. If any of these validators go offline or misbehave, they may be penalized with "slashing"—a system of punishing validators implemented in most PoS networks.

Staking comes with an opportunity cost, since assets are locked up for a period of time and can’t be used for other purposes, such as borrowing and lending. This problem applies to most PoS networks that use a bonded staking mechanism but are avoided in networks such as Cardano, which support native liquid staking. Altogether, these problems are exactly what the staking as a service industry aims to solve for its users.

*Note: Due to SaaS (software as a service) already being an established acronym in the industry, staking as a service will be referred to as STaaS throughout this topic.

Past proof-of-stake market predictions

In 2021, two senior analysts working for J.P. Morgan proposed with the rise in popularity of blockchains running more energy-efficient networks than Bitcoin and Ethereum, a new way to earn tokens, called staking, would become a major source of revenue for both institutional and retail investors. In the report, the then-current market capitalization of proof-of-stake tokens had been estimated at over $150 billion. Its authors made the prediction that the option of utilizing crypto assets to earn yield via staking would elevate digital assets into a more popular asset class and potentially help to induce mainstream adoption of cryptocurrencies.

Earning a positive yield by staking cryptocurrencies corresponds directly to market volatility. For instance, Ethereum's competitor Solana allows investors to take the native SOL cryptocurrency and earn SOL rewards, but if the value of the SOL token were to decline, its owners would see no real gains. This applies to all PoS cryptocurrencies. However, as the cryptocurrency market matures and volatility decreases, staking may become a more reliable source of revenue.

Utility of staking as a service

The surge in popularity of PoS systems can be partly attributed to being more environmentally friendly, more inclusive, and more conducive to long-term decentralization. Most experienced blockchain users avoid approaching staking as a passive process, due to its inherent risks. Staking can be somewhat inaccessible to novice users, as it requires active engagement in complex processes, such as monitoring staking performance, electing the correct validator on the network to support, and facing the risk of having their held assets diminished by slashing.

To mitigate these challenges, STaaS has gained popularity as a way of staking funds with consistency and reliability in mind. Staking as a service involves enabling holders of a PoS cryptocurrency to participate in consensus through a dedicated staking provider, such as an exchange or financial institution. These entities provide STaaS to maximize returns for their customers in return for fees, allowing holders of PoS crypto assets to participate in staking without the requirement of specialized knowledge.

Consumers and institutions have been relying on intermediaries such as exchanges to acquire digital assets since the beginning of decentralized finance. Staking as a service represents a value-adding service offered by intermediaries of this type to clients both large and small. As a large number of institutions have evolved beyond the simple business of buying and selling assets, STaaS was introduced as another step in adding value to clients’ holdings. Through staking, participants have an active role to play in keeping networks decentralized and secure.

Potential for high return on investment

Staking as a service offerings enable PoS cryptocurrency holders to take advantage of the financial opportunities that staking platforms may bring. Staking is lucrative because holders of the native token are stakeholders in the network, who can be rewarded for participating in consensus. Unlike traditional cryptocurrency mining, those with actively staked assets gain the right to participate in block production, or they can pass their right to participate in block production to a validator on the blockchain. This allows the validators to produce the next block in the chain, for which they are rewarded and thus incentivized to continue to participate in the network. This mechanism differs from traditional proof-of-work (POW) consensus systems, in which only the miners are rewarded.

Departure from traditional investing

The way PoS networks allow users to earn a return on an asset is radically different from traditional investments. Instead of operating on the basis of interest or dividends, PoS networks usually offer a sizable reward for staking: generally 5 percent or more per year. Within this, STaaS is relevant in that the institutions providing such a service can ensure a level of performance and consistency required to maximize return on investment in a way that the average user may not be able to.

Slashing protection

The dynamic and decentralized nature of PoS networks means that a single operator going offline or ceasing operations would harm a stakeholder’s ability to earn tokens. Staking as a service provides assurance that rewards will be generated reliably by professional operators, bolstered by the fact that many STaaS providers have insurance against slashing, a common factor in many PoS blockchains for poor performance, meaning returns are never cut for any unforeseen circumstance.

Accessibility

Staking as a service takes the complexity out of staking for users by managing the staking process on their behalf. Customers can enjoy a familiar user experience with a platform they are already familiar with and leave the staking process in the hands of the provider. The rewards generated also go directly to a user’s wallet hosted by the staking provider, adding to their original holdings.

Concerns over staking as a service

Concerns have been raised over the ethos of STaaS in the blockchain industry, particularly regarding the potential compromise of decentralization due to eventual institutional governance.

Decentralization

Concerns have been raised over whether STaaS is true to the core character of decentralization, since centralized staking providers controlled by single entities may eventually pose a risk to decentralization if they come to control the majority of the stake in the system. The extent of outsized influence, such service providers, have on the governance of the network has also been put into question.

PoS has gained popularity partly because any owner of tokens within a PoS blockchain can play a part in block production in a minor way. In its early days, Bitcoin worked similarly, as anyone who owned even an inexpensive computer could freely participate in mining. This changed over time, as block production within Bitcoin has become increasingly centralized by industrial-sized businesses, decreasing the amount of available large mining pools and diminishing the effectiveness of individual operations. In the case of STaaS, the presence of large entities that control a major portion of users’ stake would give central actors significant influence in block production, shifting control away from the masses and towards the few.

Institutional governance

Institutional governance in STaaS networks may pose difficulties, as the custodians of users’ tokens may grant institutions the right to vote on proposals, resulting in their disproportionate influence on the system. Staking as a service providers who vote on governance proposals may do so with self-favoring incentives, which could potentially cause conflicting interests between participants who hold tokens on behalf of others for the purposes of staking, and those with full ownership of their own tokens.

Use cases of staking as a service platforms

Staking service platforms run a validator infrastructure (mostly cloud solutions) with around-the-clock uptime of the nodes and staking infrastructure and active avoidance of slashing. Operating a staking platform can be costly, and the service for delegators (persons or companies who delegate their tokens to a validator address) is not free. Staking services charge a fee for their validator solutions, typically a percentage of the staking rewards.

Staking service fees can vary from 1 percent to 20 percent or more, depending on the staking network. Normally, users can change their selected staking service following an unbonding period (ranging from 1-30 days) at any time. The biggest staking networks include Ethereum, Terra Luna, Cosmos, Polkadot, Solana, Avalanche, and Binance. General advice for STaaS customers highlights the importance of the following:

  • Service uptime
  • Slashing history
  • Founding date of the company providing the service
  • Credentials of the validators and founders
  • Financial background of the company
  • Governance model of the staking service
  • Community presence and stability

Staking-as-a-service platforms and organizations

Ethereum 2.0 (ETH2)

Ethereum (ETH1) was designed as the first blockchain that allows programmable smart contracts, achieving this through a POW consensus mechanism. Because ETH1 has been cumulatively successful as a result of widespread adoption since its launch in 2015, the fees and energy requirements needed to sustain the blockchain rose proportionally with the network's growth, introducing various operational challenges. The Ethereum 2.0 (ETH2) concept was developed to overcome them with upgrades supporting the thousands of smart contracts and millions of users hosted by the blockchain, making it easier and more valuable for them to do business.

One of the most significant changes in ETH2 is the transition of the blockchain from its original PoW consensus mechanism to a PoS model. While PoW relies on an external resource for mining (electricity), PoS uses an internal resource (users’ stake). In its original form, as the utility and adoption of ETH1 expands, its environmental impact is magnified. In general, PoW operations use a lot of electricity, contributing to many natural resources being consumed as a result, whereas ETH2’s new PoS-based consensus mechanism makes for a more sustainable, eco-friendly cryptocurrency system.

Timeline

Further Resources

Title
Author
Link
Type
Date

Staking as a Service

Conor Keville

Web

June 17, 2021

Staking-as-a-Service Platforms List

Web

April 23, 2022

References

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