A holder dilemma: Staking vs. DeFi

As we approach the unlocking of nearly 10% of the total supply of KSM, the native token for Kusama, it is essential to review the main differences between traditional staking and other DeFi strategies in today’s current market conditions.

Defining DeFi

We will mainly centre around Yield Farming, Lending, and Liquid Staking for this article. These three strategies together amount to a Total Value Locked (TVL) of $58B as of May 2022, according to DeFiLama. At the time of writing, that is close to 40% of the TVL of the whole crypto industry.

Staking vs DeFi: The Pros and Cons

As we navigate through the entire blockchain space, we have identified the pros and cons of both Traditional Staking and DeFi that enter into these three categories:

• The financial incentive for the individual
• The health of the network
• The Blockchain use case

Based on those three premises, we will focus on explaining where each strategy has a clear advantage or disadvantage over the other ones.

The financial incentive for the individual

If we compare the returns a user can achieve using the DeFi tools described before with those available on Staking in a PoS network, we wouldn’t be making a fair comparison.

The average return for Staking for all PoS networks is around 5%, with some networks offering returns as high as 20%. However, as we have seen from the events of last week these can be risky. Meanwhile, the return varies for other Lending protocols on the coins being lent, with 3–8% for cryptocurrencies and 10–18% for stablecoins. When it comes to Liquid Staking, the return is pretty much the same as traditional Staking, but users can make extra money by using their liquid assets for lending purposes.

It is evident that the returns can be higher on DeFi, but, like any investment, returns are directly proportional to the risks involved. In traditional Staking on most Proof of Stake blockchains, assets are secured by the networks of validators. In other DeFi products, investors expose themselves to impermanent losses, rug pulls, and even defaults by the borrower in the case of lending protocols, or as we have seen last week, the liquidation of algorithmically backed stablecoins.

In the case of DeFi, investors are more susceptible to scams. In 2021 alone, $10B was stolen from DeFi alone.

The health of the network

There is another clear advantage in Staking over DeFi alternatives. By delegating or staking your tokens, you are helping secure and decentralise the network. In the short term, it may sound trivial, but in the long run, ensuring the network you are investing in is secure, decentralised, and runs smoothly will directly impact the performance of your investment. The more value is locked in a network, the harder it is to perform a financial attack on the network.

Additionally, in some PoS systems, as a staking participant, you are able to actively participate in the governance decisions, which is crucial to the development and sustainability of a decentralised entity.

Besides that, some validators go beyond just validating blocks in a blockchain — for example, we at ZKValidator support privacy-oriented products via investments, grant-giving over on Gitcoin and other privacy promoting activities like events.

The Blockchain use case

Even as decentralised entities, blockchains aim to fairly compensate all stakeholders. An increase in the value of an asset is the result of usage; therefore, there is no viable network without use.

DeFi protocols, because of the incentive offered, are great for boosting usage across the blockchain space. According to Chainalysis, the total transaction volume for the crypto space grew 527% in 2021, mainly driven by the 912% growth in DeFi alone. Considering this, we could say that Staking is more of a passive approach, which doesn’t directly drive value. However, it secures the platform upon which non-DeFi paradigms, such as NFTs, metaverse projects and all sorts of other experiments, are able to flourish. In this passive way, Staking your tokens allows these other use cases to emerge.

Conclusion

Overall, Staking can be perceived as a safer investment tool that positively impacts the networks they help run. Depending on the validator, this impact can go beyond the whole blockchain ecosystem with initiatives to support specific agendas, such as the ZKValidator promoting and supporting privacy across the entire space. On the other hand, DeFi investment vehicles can deliver a higher yield but carry with them a greater risk, not only on the asset’s depreciation but due to scams and malicious practices.