Function X: March Hash Out- Part I
The journey of Decentralized Finance and Staking
This series will be divided into two parts for better understanding of the decentralized staking. The first part is to understand the staking through decentralized protocols, the terminologies, type of staking and overview of the staking process that Function X provides.
Mechanism & rationale of DeFi
Decentralized finance is currently an experimental form of finance to offer traditional financial instruments that does not rely on central financial intermediaries such as brokerages, exchanges, or banks, and instead utilizes smart contracts on blockchains, the most common being Ethereum (Wikipedia). From the perspective of finance, funds need to travel and be utilized to create value. Centralized organizations are able to do this through the shared clearing system that was built decades ago by central banks.
However, in decentralized finance, the basic flow of funds remains the same except the connecting point shifts from a centralized server to a blockchain. The obvious reasons are fund transparency, fund safety and others. However, the “secret sauce” is to enable the fund to be ‘communicable’ and ‘interactable’ with other smart contracts.
For example, Alice stakes Token A in smart contract B (a yield aggregate platform), and the smart contract B will further stake the fund in Protocol C (a insurance platform), in which smart contract B will get an LP (Liquidity Pool) token D as receipt. All these processes can only be done when tokens and smart contracts are interacting and connecting on the same ‘highway’ (blockchain). Hence, it has to be an on-chain transaction in order to kick off the cycle.
High return or high APY (Annual Percentage Yield) is an inevitable topic when people discuss DeFi.
Where does all this return come from?
It does not come from thin air. Normally, it comes from interest by lending money (providing a loan) , capital gains and transaction fees by providing capital (providing liquidity), a premium by providing insurance and so forth. Using the example mentioned above, Alice stakes Token A in smart contract B (a yield aggregate platform), and the smart contract B will further stake the fund in Protocol C (a insurance platform), in which smart contract B will get a LP token D as receipt. Then smart contract B will further stake LP token D to smart contract E (a borrowing platform) to earn interest. In return, Alice will get a reward from smart contract B, protocol C and smart contract E and Alice could get a higher reward by multiplying the above mentioned staking process.
Risk and reward
High risk should come with high return. The greater the risk, the higher the reward. In the worst case scenario, participants might lose everything. The frequently mentioned risks are:
1. Impermanent loss that happens when you provide liquidity to a liquidity pool, and the price of your deposited assets changes compared to when you deposited them;
2. Security loophole or code error, such as unlimited minting of new token or an error of the price oracle;
3. Rug pull where the owner of the smart contract takes away all the tokens deposited in the smart contract; and
4. Business logic attacks, such as flash loans that drain all deposits in the vault.
Due to the complexity, rapid changes and sophisticated processes of smart contracts, nothing is guaranteed, not even a security audit firm can ensure with absolute certainty the security of each protocol and smart contract. It is a high risk activity, so if you want to participate in DEFI Do your own research (DYOR) and only put in what you can afford to lose.
Simple notes before you participate:
- Do a research on the project to check if this is legit
- Make sure only visiting the official website / app
- Use blockchain explorer to check if the operating smart contracts are legit (open source, verified, etc)
- Do not reveal your private key and seed phrases to anyone
- There is no free lunch in the market
A journey through staking on a decentralized protocol
With new business models and new technical innovations having been introduced recently, more staking and post-staking events and activities will be implemented in the near future. For those who have not joined the crowd, we would like to take this opportunity to guide our community to embrace this trend alongside with the mainnet launch of Function X. New things to be learned and new habits to be cultivated.
The Team will divide this guided journey into 3 phases with significant incentives at each phase:
1. Entry stage: This is mainly to familiarize users with a DeFi environment and to develop good cyber hygiene practices, including setup, staking (lock up), transferring tokens, harvesting and collateralizing assets. Entry stage is sometimes known as pre-governance stake because it has all the benefits of participating in governance but minus the governance responsibility (and penalty if you break governance rules). Hence, some see this stage as a “getting free tokens without responsibility” stage.
2. Governance stage: Encouraging users to participate in the governing process of the network.
3. Participation stage: Encouraging users to participate in market activities, such as trading, borrowing (taking a loan), synthesizing assets, providing liquidity and so on.
Please stay tuned for more updates.
Staking & post staking
As a first step, this article will introduce “staking” on a decentralized platform. Staking refers to users actively ‘locking up’ their tokens on a specific platform for a certain period or time and with the consensus that the owner of that specific platform will use the tokens for specific purposes. Normally, we can simplify the staking into dual-token staking and single token staking (single-sided staking).
1. “Dual-token staking”(dual side)refers to putting two different pairings of tokens into one pool, normally as token liquidity, such as NPXS/ETH, FX/DAI. This might incur impermanent loss or impermanent gain of the principal when the market fluctuates. Hence, with the higher risk, the reward and return of this type of staking would be higher. The majority of the staking and farming that you see nowadays is dual-token staking.
2. “Single-token staking” refers to putting one pairing of tokens in one pool, normally for loans, insurance or token holding rewards. The risk is much smaller compared to the dual-token staking, thus, the reward and return would be determined based on the pool participants.
Why do we have post-staking?
Rather than doing nothing after the staking, there are several protocols that provide post-staking activities. For example, in a lending platform, users can choose to re-stake their LP tokens to another smart contract to earn interest; in a synthetic platform, users can further trade the asset available on the platform, such as BTC, ETH, for the synthetic asset that’s synthesized by the previously staked asset.
We believe practice is the best way to learn and become familiar with new things. We would like to draw your attention to [Hash Out March (part 2) A guide to participate in Function X staking]. In the second part of the March Hash Out, we will share more information about the mechanism to stake PUNDIX and FX token through a decentralized way.
Last but not least, as with all things crypto, Do Your Own Research (DYOR) and remember, nothing is guaranteed. And please, only risk what you can afford to lose!
