What is Staking?

From an investor’s standpoint, staking involves depositing or locking up coins for a period of time and receiving a yield on those coins as a reward...Staking is becoming a popular way to earn “passive” income, which is income you earn automatically over time without dedicating any of your time to it.

Author: Rocky | September 27, 2021

What Makes Staking So Valuable?

Most people sell their time to receive an income that finances their lifestyles. Fundamentally, we are taught to follow a set path in order to achieve a steady paycheck and live within the means society deems reasonable. But the savviest financial minds understand real wealth comes in the form of time. Earned income may be the backbone of this structure, but it’s a weak one because it’s time-consuming, linear, and capped at the amount you earn. Staking is becoming a popular way to earn “passive” income, which is income you earn automatically over time without dedicating any of your time to it. Not only does staking add value to a network and help elect block producers within an ecosystem, it provides a measurable reward that incentivizes long-term participation and increases adoption, which inherently adds value to portfolio income as well.

Staking, and What Makes it Such a Powerful Tool for Growing Wealth

From an investor’s standpoint, staking involves depositing or locking up coins for a period of time and receiving a yield on those coins as a reward. An example would be staking 1,000 $XYZ coins for one year, and earning 10% APY (annual percentage yield). At the end of this one year period, the investor would have 1,100 $XYZ coins. A 10% increase over the course of a year may not sound significant, but here is where the powerful concept of compound interest comes into play.

Albert Einstein famously referred to compound interest as the eighth wonder of the world. “He who understands it, earns it; he who doesn’t, pays it.”

Staking and Compound Interest

If the investor in the example above then re-staked this larger holding of 1,100 $XYZ coins for a second year, they would receive 110 $XYZ coins during the second year because they earned 10% on 1,100, instead of 10% 1,000 $XYZ coins. Their total $XYZ holdings would then be 1,210 after two years. This slightly larger increase in return from 100 in the first year, and 110 in the second year, may also seem insignificant, but compound interest starts to drive investment growth exponentially with higher APY across longer time frames.

Any investing expert can attest that exponential growth is the key to building wealth, as it allows your money to build increasingly larger yields over time on its own. If an investor earned 10% APY compounded annually on 1,000 $XYZ coins for 10 years, they would have 2,594 $XYZ by the end of that period; after 30 years, that number would be 17,450 $XYZ.

Again, this may not seem like a lot of payoff for 30 years’ wait, but consider that this was only an investment of 1,000 coins and required essentially no further effort from the investor. Still, while earning 10% annually in traditional markets and investments is considered an excellent return,10 years for a 2.5x return may seem like far too long of an investment horizon.

If that’s a reservation you have about staking, we have good news. You could easily earn higher yields over a shorter time. There are cryptocurrency related staking programs that offer 20% or higher APY, which drastically increases the exponential growth of an investment, especially if the price of the token increases in multiples on top of the 20%+ APY.

LGCY Network is an example that offers up to 28% APY in perpetuity. The chart below shows our hypothetical $XYZ coin with 10% APY, and growth for LGCY stakes based on a 28% APY compounded annually.*

* LGCY staking rewards are paid out in USDL, which then need to be converted to LGCY to compound gains. This means the price of LGCY can impact the actual level of USDL rewards and dollar value associated with APY. If USDL is instantly converted to LGCY and fully restaked, 28% APY is accurate in calculating the growth of the number of tokens of the investor.

Using a compound interest calculator can help you see the exact growth over time of an investment. Simply plugin different initial investment sizes, interest rates, and compounding periods.

Essential Staking Concepts

Now that the importance of compounding, APY, and time have been addressed, let’s take a closer look into how staking works and what investors need to be aware of. The term “staking” can be interchangeably used to describe multiple forms of locking up coins to earn a yield, the most common of which are discussed below.

Staking with a PoS/DPoS Network

The first two staking methods pertain to staking with a network that utilize Proof of Stake (POS) consensus protocols in order to reach transaction consensus and secure the blockchain. These protocols are replacing much less energy-efficient Proof of Work (PoW) protocols, such as Bitcoin’s, by moving on from the previous standard protocol of mining. By eliminating the need for specialized hardware with high energy costs required for mining in PoW, PoS networks are secure, more accessible and promote wider, readier use.

  • Staking on a Proof of Stake (PoS) Network: In a PoS protocol, individual users are incentivized to promote blockchain network security through having a “stake” in the network. Consensus must be reached in order for the blockchain to advance and continue processing transactions. To do this, validators are selected via algorithm based on their staked number of tokens to verify data blocks. Safeguards against malicious or fraudulent validators are in place, prioritizing validators who would have a greater amount of staked tokens than they would earn in transaction fees. This ensures they have a vested interest and in the success of the ecosystem as a whole. Of course, this also tends to lead to an imbalance of power in the community, as validators with the highest staking get priority.
  • When Ethereum began transitioning to Ethereum 2.0, for example, the intent was to move from a PoW to a PoS consensus model. Under this model, users can deposit 32 $ETH to activate validator software for storing data, processing transactions, and adding new blocks to the blockchain, and then earn $ETH yields. Users can also transfer less than 32 $ETH to staking pools and then earn proportionate yields based on their contributions and rates offered by the third-party validator.
  • Staking on a Delegated Proof of Stake (DPoS) Network: The DPoS protocol was developed in response to the inherent inequities of PoS. The core philosophies are essentially similar, but the main difference is that in DPoS networks, network users democratically nominate block validators. Stakers are able to pool their tokens and assign them to candidates via a staking service provider, ultimately arriving at (typically) up to 100 validators per block. The transaction fees those validators receive from validating their blocks are then shared across their nominating pools according to the percentage of the total pool each individual staked, meaning every player in the process maintains an equally vested interest in its success, regardless of their level of capital.
  • The LGCY Network is an example of a DPoS protocol, for example, the top 27 governing bodies act as validators. Network users can delegate their stake to any of the 27 governing bodies, and each user will then be paid a yield on their delegated stake.

Staking within a Project’s Native Staking Program (Not PoS)

Some projects implement their own internal staking programs to earn that project's native token even though the act of staking is not involved in supporting blockchain functionality. These staking programs are often accessible directly through the project's website. The purpose of these staking programs can be to temporarily decrease sell pressure by locking up a portion of the circulating supply, given that token price increase can lead to faster adoption, or to attract new investors seeking projects that have a staking program as a part of their value proposition.

Staking with a Third-Party Platform

A myriad of options through third-party platforms, protocols, and exchanges allow users to stake different cryptocurrencies in order to earn a yield. Some of these may not directly support a PoS or DPoS blockchain, but instead enable a user to earn yields by allowing or using the third-party platform to lend or provide liquidity with users’ staked coins.Stakingrewards.com provides a list of many coins and their staking options, but this should only serve as a starting point for researching staking programs and should not be relied solely upon. We recommend thorough research and due diligence prior to trusting any third-party with your cryptocurrency.

  • Example Centralized Staking Platforms: Celsius and BlockFi are two popular centralized platforms used for staking, and they offer staking rewards on a large number of tokens. Exchanges like Coinbase and Binance also offer staking rewards. The APY paid by these centralized platforms can vary over time.
  • Staking on Decentralized Apps: Some consider lending on DeFi apps like AAVE, MKR, and YFI to be a form of staking. DeFi lending can have many nuances, and it requires the most research not only to understand, but also to identify risk. There can be significant risk involved with depositing your cryptocurrency into DeFi apps, as hacks unfortunately do happen, which can lead to a total loss of deposited crypto. The largest and most established DeFi apps are likely (but not guaranteed) to be the safest. An in-depth exploration of DeFi lending and yield generation is outside of the scope of this article but will be discussed at length in a future article.

Other Prestaking Considerations

There are several other brief topics that are important to take into consideration before staking.

Dilution Through Inflationary Staking Models

PoS networks and projects that implement a native staking program will often reward users in their own native token (Ethereum 2.0 will reward stakers with $ETH). Unless a token burn mechanism is in place, like the $ETH token burn introduced in Ethereum Improvement Proposal (EIP-1559), these staking programs are likely inflationary.

To illustrate this, let’s use the hypothetical $XYZ coin as an example again. If the circulating supply is 100,000 tokens, and every single $XYZ holder stakes the entirety of their coins and earns 10% APY over the first year, the supply of $XYZ would then be110,000 at year end. In theory, if demand was kept constant, the 10% increase in supply would have a dilutive effect on the price of each coin. While every holder now has 10% more $XYZ, the $XYZ may be worth 10% less. In practice, supply and demand curves are rarely linear, and buyers may not factor the supply increase in their willingness to buy at a certain price.

Another key consideration here is that some holders will not stake their coins, which leads to staking rewards that are proportionately higher than inflation levels. If 40% of the 100,000 circulating supply of $XYZ is staked, each staker will individually earn 10% on whatever amount of coins they deposited into the staking contract. Since only 40% (40,000) coins were staked, the 10% APY leads to a circulating supply of 104,000 after one year. In this scenario, the supply only increased by 4%, while those who partook in staking had a 10% increase in the number of tokens they hold.

Those who did not stake but held their coins over the course of the year saw supply increase by 4% while they held the same amount, leading to dilution of their holdings. If an investor has no intention to stake a given coin, they should be wary of native staking programs that reward users with very high APY, as this may have negative impacts on their position via inflation. Staking rewards can also lead to increased sell pressure once the rewards are collected, as investors take profits on their rewards which can decrease price or slow the rate at which price increases. This is another consequence of inflationary staking models.

Non-inflationary Native Staking Programs

Networks that provide native staking rewards without invoking inflation are less common. As mentioned, with EIP‒1559, a portion of each transaction fee is burnt which will continue to occur with its transition to Proof of Stake. These token burns have the potential to offset the $ETH that is rewarded to stakers reducing the degree of inflation or even leading to deflationary tokenomics.

LGCY Network has another promising approach to providing staking rewards without an increase in $LGCY supply. Instead of being rewarded $LGCY tokens, stakers will receive $USDL, which is LGCY Network’s native stablecoin. This creates zero inflation and ensures no staking-driven sell pressure of $LGCY since there are no $LGCY rewarded.

One of the greatest benefits to this model is that investors who receive their $USDL rewards will have incentive to buy more $LGCY with these rewards to compound gains at 28% APY. This has the potential to increase buy pressure significantly, leading to $LGCY price increase and providing sustainable, inflation-free, passive income in perpetuity.

Decreasing Dollar Value of Tokens While Staked

We have established the concept that if an investor stakes 10 $ETH in an Ethereum 2.0 staking pool and is earning 5% APY, after one year they would have 10.5 $ETH. Notice how this return is paid in $ETH, and based on the number of $ETH staked, not the dollar value. While the investor would earn 0.5 $ETH regardless of price fluctuation, if $ETH price dropped significantly (from $3,000 to $1,000), the dollar value of the 10.5 $ETH at $1,000 would be far lower than the dollar value of 10 $ETH valued at $3,000 per $ETH.

This leads to a few important factors that should be understood prior to staking

1. Is there a lock-up period involved, or can an investor withdraw their coins from as staking program at any point?

For Ethereum 2.0 staking, running a node and most staking pools require locking up funds until Ethereum 2.0 is launched, which does not have a confirmed date. Many staking programs allow users to withdraw their stake at any point in time, but the user may forfeit a significant percentage of their APY for withdrawing early. This at least allows flexibility, which can be very valuable given the volatile nature of cryptocurrency prices.

2. What is your investment horizon?

If an investor plans to hold or stake $ETH for many years and is not concerned with market volatility or price between now and then, they may not care that their $ETH is locked until the Ethereum 2.0 launch.

Other staking programs allow investors to select a staking period. Common periods include 1-month, 3-month, 6-month, and 1-year. Typically, longer staking periods offer higher APY. For example, 1 month may offer 15% APY, 3 months 18% APY, 6 months 24% APY, and 1 year could offer 32% APY. Again, it is important to know if early withdrawal is allowed, and what the early withdrawal penalties may be. Early withdrawal penalties often significantly reduce the amount of APY received upon withdrawal.

If an investor believes the crypto bull market will continue for 7-8 months and that a bear market may begin after, staking a majority of their coins for 6 months might provide better return than a 12-month option in which early withdrawals are penalized.

On the other hand, if this investor maintains conviction that a token will see success and price will increase over a 5-10 year period, staking for successive 1-year periods will allow for excellent growth in their number of tokens, and could lead to a much heralded passive income stream.

Remember that APY denotes the yield that would be earned on an annual basis and is calculated incrementally, even if you are staking for less than a year. That means 15%APY for a 1-month staking period would give a 1.25% yield (15% / 12 months). Similarly, 6 months at 24% APY would net a 12% yield.

Passive Income and the Value of Staking

As Web 3.0 applications and tokens gain adoption, an ever-growing array of staking models are being released. These include staking with a PoS consensus based network, staking with a centralized, or decentralized third-party platform, and staking with a project’s native staking program that is not associated with PoS consensus.

Staking tokens that are associated with fundamentally advanced projects can provide passive income opportunities that dwarf those found in traditional investments. When high staking yields are paired with token price appreciation, exponential wealth generation develops.

The impressively high yields found within blockchain network ecosystems can be attributed, in part, to the early stage of many DLT and Web 3.0 applications, and the potential risk associated with young technologies. However, high yields and the opportunity for asymmetric risk adjusted return are also possible within Web 3.0 investment and staking due to a lack of widespread understanding of the role these technological advancements will play in the digital future of society.

No investments come without risk, but neither do massive yields. The key to investing isn’t avoiding risk altogether, but minimizing it while also maximizing potential profit. In the relatively young frontier of staking, safeguards put in place by PoS and DPoS protocols are helping to mitigate many of the volatilities of more traditional investments while offering more predictable results and sustainable yields through the power of compound interest. However, it is still vital to identify the best opportunities that suit your risk tolerance and financial goals.

LGCY Network represents a significant opportunity for investors looking to harness the earning potential of compound interest by including staking options in their portfolios. Their innovative staking model positions their stakers for sustained compound growth over time. To learn more about $LGCY staking and explore the potential, see LGCY Network’s staking on Mainnet.

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