By 2021, proof-of-stake (PoS) has cemented its position as the preferred consensus method for new and creative blockchains. Five of the top ten base layer blockchains operate on PoS: Ethereum 2.0, Cardano, Solana, Polkadot, and Terra Luna. It’s simple to understand why Proof-of-Stake (PoS) blockchains are so popular. The ability to put tokens to work, validating transactions and receiving a reward, lets investors receive a passive dividend while strengthening the security of the blockchain network they’ve invested in.
While blockchain technology advances at a breakneck pace, institutional investors’ financial products and services are falling behind. For example, 24 of the 70 crypto exchange-traded products (ETPs) on the market reflect ownership of staking tokens, but only three of them generate a return through staking. ETP investors not only miss out on the return, but they also pay management costs ranging from 1.8 to 2.3% on average.
Staking isn’t available in ETPs, which is sensible because the method needs tokens to be locked up for durations ranging from days to weeks, adding complexity to a product designed to be readily traded on exchanges.
If you miss out on the staking yield, you’re stuck with an inflating asset
It’s more than a squandered chance for PoS token investors to miss out on staking yield. As a consequence, you’ll be holding an asset with a high rate of inflation. The yield provided to stakers is mostly made up of fresh tokens. Hence, the supply of unstaked tokens is constantly diminishing. Staking rewards, as detailed in a Messari post, are a wealth transfer from passive holders to stakers. Rather than a value creation.
The irony is that many of these institutional investors who are passively holding PoS tokens started investing in the digital asset market. In order to protect themselves from inflation on real-world assets. And now their PoS tokens are suffering even higher rates of inflation.
The average rate of supply inflation for the top 25 PoS tokens, according to Staked, is over 8%, which is significantly higher than real-world figures. Meanwhile, because rewards include both freshly produced tokens and transaction fees, token stakers get yields that are higher than the rate of inflation. Stakers get an annual real return of 6.4% on average. The contrast is striking, passive investors face 8.2% inflation on their investment. With the possibility of paying further 1.8–2.3% in management costs. If they invest through an ETP, whereas stakeholders gain 6.4% in real rates.
Beside owning blockchains, investors must also engage in them
The capacity of a blockchain network to operate as a settlement layer, safely adding new transactions to the decentralised ledger, is what makes it valuable. This capacity is contingent on extensive and decentralised network involvement; as a result, a PoS blockchain is only as secure as the quantity of tokens staked. Which are effectively in use to validate transactions. Holding PoS tokens passively and not staking them reduces the network’s value, which is counter to investors’ objectives.
Unfortunately, this means that as assets under the supervision of PoS ETPs expand, a smaller percentage of the token supply will be staked. Resulting in less secure blockchains. As institutional money pours into passive PoS ETPs, the percentage of the total supply that staked decreases. Raising staking incentives and increasing inflationary consequences for passive holders. Institutional investment, in addition to owning PoS tokens, will need to engage in the networks.
It is difficult, but not impossible, to abstract away blockchain complexity
Staking isn’t an easy task. It entails maintaining a secure, always-on infrastructure with an extremely little margin for error. While adhering to the blockchain network’s regulations. Fortunately, there are many qualified validators with excellent track records. Who are willing to execute the staking job in exchange for a portion of the reward. Importantly, validators may stake tokens without assuming custody of them. Hence, the ideal approach for an institutional investor to stake their assets might be through a validator. From within a custodian’s account.