Reflections from the Inaugural Staking Summit
Building the Foundations of a Billion Dollar Industry
2019 is shaping up to be the year of staking. There are many firms working on products, services, projects, investment products, and initiatives that seek to develop, commercialize, and advance the state of staking. As I was reflecting on all of the firms and projects who have entered the fray in the last six months, I was impressed by rapid growth of the staking ecosystem.
Given the rapid evolution of “staking,” we brought together a small-ish group of stakeholders (no pun intended) on Monday, March 18 to have an open conversation about how we can collaborate on best practices, data sharing, and education & advocacy efforts.
The purpose of this post is to share some of the topics we discussed as a group, the next steps we’re working on, and to provide a forum for all participants in this new market to collaborate, communicate, and share data.
We hope this is one of the many catalysts that drives more events, research, and collaboration, and spurs more digital and physical communities to develop as the topic of staking grows and evolves.
The Current State of Staking
At the time of writing (March 26, 2019), there are 11 Proof of Stake protocols with a network value of over $100M that deploy a staking function of some sort — including masternodes. These protocols have a collective network value of nearly $9 billion, and an average staking rewards of roughly 5% per year. This means the staking market currently represents at least $450M in annual staking rewards.
There are also several multi-billion dollar networks, including Binance’s BNB token and Cardano, that are about to shift to Proof of Stake, and numerous networks in the process of launching that will deploy Proof of Stake. Tentatively, these networks have a value of at least $8 billion, using conservative estimates of value on launch. If we apply the same 5% network reward rate, we can expect this market to be roughly $400M per annum. Conservative estimates indicate staking could be a billion dollar market as early as mid-2019. As one might imagine, the competitive landscape for products, services, and investment vehicles capitalizing on the relatively low-risk strategy of staking is heating up!
Who Cares About This Stuff Anyways?
As I often to like to ask, but why. Why is staking becoming a topic? Well, investors are fiduciaries, and if they are long an asset (ie plan to hold it for a while), they should be earning inflation to preserve their pro-rata share of the network. Most funds do not yet have the capacity and likely won’t have the desire to do everything themselves. Individual investors also do not have the capacity to learn, track, and participate in all of the elaborate ritual associated with staking across numerous protocols.
My own research has taken longer than expected because of the challenges in gathering reliable data and doing basic research. Even understanding just how each protocol works is a serious time commitment! From a service provider perspective, there is not yet an entity that provides services to every network, and there may not be over the long term either. Not all networks are built the same, and they require expertise — no one entity can be a master in all protocols.
There are a large number of stakeholders who are impacted by the evolution of the staking ecosystem, and will have a vested interest in shaping outcomes. Some of these participants are more passive, and some are more active. However, all will play a critical role in the future of staking, and should be a part of the conversation. The below diagram attempts to detail some of the key participants in the staking ecosystem today.
The Summit represented stakeholders from these diverse groups, and we believe that the future of building a functional staking ecosystem will depend on continued collaboration and communication between these parties.
Key Topics of Discussion
Initial conversations were organized around a few key themes, including:
- Language, syntax, and ways to describe staking that distinguishes work from governance and creates a new and specific lexicon
- Advocacy efforts and opportunities create templates, tools, and standards, including regulation, tax, control matters, and disclosures
- Education around staking, governance, and resources to inform token holders (what does good governance even look like?!)
- How end token holders interact with staking and governance in different protocols, and what tools, products, and services can help increase participation
- The politics of staking, and the new opportunities and potential attack vectors this creates
Ultimately, the group prioritized four key topics, which are detailed below with points from the conversation, and ideas on how to take these conversations forward in a more focused manner.
Investment Products & Yield Generating Assets
We discussed the various design parameters of investment products and strategies including legacy finance analogs such as reverse repos, derivatives, and debt products. A big theme was how to manage volatility and staking rewards, track liquidity and volatility of the underlying staked assets, whether fixed or floating reward rates should be used, and how prediction markets, synthetic derivatives, and other hedging strategies could be combined with staking strategies to provide investors with more desirable products.
One of the key areas for continued exploration was emulating master limited partnerships or other tax advantaged vehicles where expenses and amortization could be passed through to investors in a tax advantaged way, especially to finance hardware and other capital investments, as well as how to effectively calculate, manage, and treat the rewards accrued — whether there should be physical delivery of coins or synthetic delivery via a second instrument, if rewards should be compounding or cashed out periodically, whether rewards should be paid in like kind or in fiat, and determining cost basis for tax purposes.
There were a number of issues noted around how scalable staking strategies might be, given the relatively small size of the market and the lack of market depth in some of these assets when liquidating for cash or bitcoin. We also discussed the governance implications of staking as an investment strategy, how one might determine who owns the underlying rights associated with the network, and how a secondary market for voting / governance rights might be needed, or some sort of STRIP like instrument that separates the act of securing the network in return for inflation rewards and participating in governance.
Next Steps — The group agreed that an investment products sub-group would be helpful, and that this group could focus on research, legal and tax approaches, and coordination in provisioning and management of liquidity to minimize the impact of staking products on the integrity of the market for these underlying assets (if such a thing exists). More importantly, the group agreed that people who don’t yet own crypto may find staking vehicles more familiar for investment, as the reward resembles a stock dividend or a yield-bearing asset, and displays a unique risk — reward profile.
Tax, Legal, and Regulatory
There is clearly a whole new legal and regulatory landscape that needs to be explored in this new world. One key message was that all participants firmly felt coordinated engagement with regulators would be in the best interests of the staking community. This includes advocacy efforts and the creation of templates, tools, and standards, including regulation, tax, control matters, and disclosures standards.
There was a long discussion on the tax implications of staking, and whether this is dividend income, passive income, savings income, or 1099-MISC income — or something else altogether! On the tax side, the determination of fair market value is a thorny matter given the challenge of tracking price with a reliable market oracle, as most times the market price on CoinMarketCap does not reflect the price at which positions in size can be bought or sold, and perhaps using rules from the Pink Sheets / OTC markets on pricing could be helpful here.
One additional idea was the creation of something like LIBOR, where a rate-setting mechanism is created by some of the industry participants including exchanges and OTC desks. All attendees felt there was a lot to collaborate on in the tax space, as when tax regulators from around the world begin to oversee this space more closely, they will likely use existing guidance from firms in the space. Therefore, setting a well-researched, supported precedent is important.
Next Steps — A few firms have already begun writing memos and working towards more clarity on staking in the US market in particular. These firms agreed to share these templates, and the participants are actively working on a public repository for these documents. Furthermore, a few firms agreed to take the lead on engaging leading professional services firms to explore publishing some primers and initial opinion pieces to help grow the domain.
Economic Structures, Network Participation, and “Decentralization”
The next dialogue around economic structures and network incentives was an interesting one. The core of this conversation was the principal / agent problem, as described by Coase in the theory of the firm and expounded on throughout the last 100 years of behavioral economics — what happens in instances where agents (service providers or protocol teams) have an interest that conflicts with that of principals (investors)? Examples include rate fixing and cartel behavior, a phenomenon I personally have been fascinated by and written about at length, the creation of a secondary market for selling voting rights and thereby creating a separate market for governance, and the issue of free riders and using token economics to reward people who submit protocol upgrades.
One core theme was the topic of larger players, especially custodial players, dominating the market. We discussed strategies to incentivize smaller validators and staking services to stay in the market, and ways to encourage less “centralization” — perhaps through a progressive tax of sorts where larger players would earn lower yields or subsidize smaller players. There is also a clear need for better data and research around the efficacy, cost, and risk of using staking as a network maintenance mechanism.
We also talked about the design of staking systems, and how reward maximization and services that engage in dynamic staking reward optimization could adversely impact security on networks. It was agreed that to maintain competitive dynamics, switching between service providers should be as easy as possible, and that exchanges could be the largest threat to staking by serving as centralized aggregation points for tokens. There was discussion about unnamed exchanges taking clients’ staking rewards and selling them for their own gain, and the need for greater transparency.
Next Steps — There were some existential questions about the future of staking, and agreement that exchanges and other aggregation points where coins are held need to be more transparent staking relationships and providing options to their users. Some participants started working on a “buyer beware” post to help educate users, and there was discussion of creating a staking “code of ethics” to drive some agreement around transparency and disclosure standards. Protocol teams expressed an interest in more collaborative research, data sharing, and dialogue between themselves and the staking community to help drive better design principles for protocols, networks, and governance mechanisms.
Language and Syntax
Lastly, the theme of language and terminology was a consistent challenge throughout the conversation. It is difficult to distinguish the different types of staking, and explain the unique nuances of each protocol. We need more specific language to describe the various methods for staking and distinguish work / staking to secure the network from governance, and the relationship between technical consensus, social consensus, and financial reward via network inflation rates or token depreciation in the form of slashing. Not everything should be made equal across protocols but common understanding would be helpful.
The group had concerns about using terms like yield, interest, or other financial terminology that could conflate the act of staking with regulated activities, or create confusion around the risks associated with staking. There was also a brief discussion around sharia compliant activities and how to explain staking in the context of islamic finance.
Next Steps — The group agreed to share Staking 101 documents and identify ways to standardize common terminology and definitions. The goal of these efforts is not to commoditize language, but to create more consistency in how staking is explained.
Where to From Here
We realize much of the discussion was exploratory in nature, and one of the reasons we focused on the discussion in priority order is because many of the topics are interesting but not yet at a point where they are actionable.
As a starting point, we want to create an initial directory and “staking ecosystem map” of protocols, service providers, projects, funds, and efforts in the staking space that we can share publicly and encourage folks to add to as the space grows.
If you’re involved in staking in any way, shape, or form, please add your firm here!
We’ll post this list publicly, along with other resources, in the coming weeks, and hope to continue publishing data and research around staking in one (somewhat) consolidated place.
This was a smaller group discussion, as the upper limit on attendees was the space available in the CoinShares office. We will repeat a summit of some sort every quarter, and organize for a larger day-long conference later this year.
Lastly, this group is working on a more comprehensive industry effort around advocacy, education, and standards, which will be launched in the coming weeks. If you are interested in being involved, supporting, or learning more, please contact me, Jason Stone from Battlestar Capital, or Santiago Roel Santos from EON Capital.
We are excited to see the staking ecosystem grow and evolve!
A sincere thanks to everyone who was able to participate, whether directly or by submitting their comments in advance.