Should Cryptocurrency Exchanges Stake Coins?

Top Staking
Nov 20, 2018 · 5 min read

The debate on whether exchanges should stake users’ funds eventually comes down to ownership. If exchanges are purely custodians, they should do nothing with the user’s funds. But if exchanges are active stakeholders in cryptocurrency ecosystems, they would do well to participate.

Do Exchanges Stake Coins?

Presently the correct answer with some exceptions is NO. But, while not many exchanges stake proof of stake cryptocurrencies currently, it might not always be that way in the future. The staking rewards left sitting on the table will likely soon become too tempting for exchanges to not start staking and earning staking rewards. This has struck up a debate in the cryptocurrency industry as their are conflicting positions.

  1. Position 1 — “Exchanges should not stake coins”: Exchanges are only custodians of deposited funds and should not do anything with them besides hold them until users withdrawal.

❖ Reasoning for not staking coins: Exchanges are Custodians only

➜ Locking of funds

In the process of staking cryptocurrency a portion of funds at stake become locked for a period of time as the node participates in reaching consensus . If exchanges stake cryptocurrency, there will be times when withdrawals could potentially be delayed due to the locking of funds.

➜ Ownership

Many people do not see exchanges as owners of the cryptocurrency deposits they hold only as custodians. So an exchange moving, voting, or staking those coins are acts of ownership and break their inferred agreement as custodians of their depositor’s funds and the depositors are the true owners and should have a say.

➜ Staking Rewards

Staking rewards are transaction fees or inflation of cryptocurrency supply awarded to the participants that secure the network and help it reach consensus. These rewards act as an incentive for participants to secure the network. In theory exchanges could keep these rewards as profit, or disperse them to their users taking out a fee. Without a predetermined contract or agreement between the user and the exchange this could get messy. Also many exchanges don’t have the infrastructure to accurately distribute rewards to users accounts.

➜ Loss of Stake

Part of the proof of stake consensus mechanism is also the disincentive of losing ones stake if they try and attack the network. If a rogue employee or exchange unsuccessfully tries to attack the network, they could lose coins at stake. Once lost these coins are gone, and so the exchange incurs a risk of losing depositor funds.

❖ Reasons for Staking Coins: Not your private keys not your cryptocurrency

➜ Ownership

In cryptocurrency ownership is very simple. Own the private keys own the cryptocurrency. So exchanges because they own the private keys — own the cryptocurrency. This is not always a popular opinion but fundamentally it is true. Unknown to many is that fiat bank accounts act the same way. You don’t own the money you deposit in your bank, you simply own an account with them and they own your money and can do with it what they please.

The same is true with cryptocurrency exchanges. As soon as you deposit your cryptocurrency into an exchange you no longer own the cryptocurrency you only own an account with that exchange. They are free to do with the cryptocurrency what they please.

➜ Locking of funds is a minor issue

Most exchanges today use a hot and cold wallet security system. A hot wallet with a smaller amount of funds is connected to the internet and used for daily deposits and withdrawals. A cold wallet is not connected to the internet and is only used for offline transactions to refill the hot wallet. This leads to times where a large user withdrawal is delayed due to the need to refill a hot wallet.

In staking cryptocurrency not all funds are locked in staking for long. So if some funds are requested for withdrawal and the funds are staking. It would be the same minor delay as refilling the hotwallet. Not a big deal.

➜ Participating as a Stakeholder in Cryptocurrency Ecosystems

Exchanges in many cases are the largest holders of cryptocurrencies and the most active wallets in an ecosystem. As such they are also the biggest stakeholders of them coins and the most interested in securing that network. When exchanges participate in honest staking they act to protect the network. This, not only protects their interest but the interest of their depositors protecting the network.

➜ Distributed or kept rewards are a win-win

The idea of an exchange profiting off of your deposit with them can seem wrong at first. But, if you look at it like a bank account it is no different. In many cases your bank profits off of your fiat deposit, and shares none of that profit with you. This doesn’t adversely affect you and the bank profiting usually leads to better services to you as a depositor and lower fees elsewhere.

For a cryptocurrency exchange it can be looked at the same. If exchanges profit off of staking rewards. It doesn’t adversely affect depositors and could lead to lower fees in other areas such as withdrawals. If exchanges do decide to share profits with depositors it’s an even bigger win-win as depositors get to have their funds grow where there was no work on their part.

Time will tell the winner of this debate and the free market will eventually decide. Exchanges that provide the best service to customers will win. Some exchanges will share staking rewards, some will not. They will have to compete with each other for the same proof of stake customers.

Customers when depositing will have to to decide how they feel about the issue. If they don’t want exchanges using their funds in any way. Or if they think exchanges staking their coins is a win-win and they could benefit from it.