The Power of Crypto Compounding with Proof-of-Stake

Feb 14, 2019 5 min read
The Power of Crypto Compounding with Proof-of-Stake

If the Hodl strategy didn’t work for you, here is a little tutorial explaining how to compound your crypto portfolio thanks to staking…

If the Hodl strategy didn’t work for you, here is a little tutorial explaining how to compound your crypto portfolio thanks to staking! Let’s hope this will help, so you can hold cryptos and earn interest at the same time. 😚

What is Crypto Compounding?

The concept of crypto compounding is very easy to grasp. But before explaining what is crypto compounding, let’s have a look at what’s compounding in traditional finance.

Compounding is the process where you reinvest your asset’s earnings to generate additional earnings over time.

That is something usual to do in traditional financial markets as the volatility is low compared to assets such as cryptocurrencies. Suppose you invest $10,000 into The Super Startup (TSS). In the first year, the shares rise by 25%. Your investment is now worth $12,500. Happy with that good performance, you hold the stock. In the second year, the shares appreciate another 25%. Hence, your $12,500 grows to $15,625. Rather than your shares appreciating an additional $2,500 as they did in the first year, they appreciate an additional $3,125, because the $2,500 you gained in the first year grew by 25% too.

But with the bear market and falling prices, crypto enthusiasts and token holders tend to forget about this opportunity.

In fact, cryptocurrencies allow people to generate and compound additional revenues even if the price fall. There are several ways in crypto to generate additional revenues, for example, forks, lending, trading contest, mining, airdrop, bounty program… But in this article, we are focusing on how Proof-of-Stake (PoS) cryptocurrencies can help you generate an income even when the price falls or remains stable.

Thanks to Proof-of-Stake and other derivatives (among which Delegated PoS, Liquid PoS) you can now earn cryptocurrency rewards depending on the size of your holdings and the inflation rate of the protocol. To start compounding your crypto assets, you just have to reinvest these rewards, and thus your holdings will grow faster and faster as the years roll on.

For example, POS Bakerz provides delegation services for Tezos staking. This blockchain has c. 8.7% yearly inflation rate as of now. Every cycle that you do not delegate or do not stake yourself, you lose on this inflation. However, if you solo-stake your ꜩ for 1 year, you will earn 8.7% yearly inflation. If you solo-stake your holdings for 5 consecutive years, you would earn a 52% compounded return over the period. If you had ꜩ1,000, your total holdings would now be ꜩ1,520!

What is Proof-of-Stake and How Does it Work?

Most of the cryptocurrencies including Bitcoin use a mechanism call Proof-of-Work (PoW). Under PoW, the miners use a special software tool to solve some mathematical problems. And in exchange for that, they are issued a certain number of bitcoins. The main idea is to create a new block that gets added to the existing blockchain.

Over the years, PoW showed itself to be extremely robust to security threats, but also extremely energy-inefficient. The Bitcoin network alone is estimated to use more energy than some developed nations.

An alternative to PoW is called Proof-of-Stake (PoS). In PoS, proposers are not chosen according to their computational power, but according to the stake they hold in the cryptocurrency.

For example, if John has 10% of the tokens, he is selected as the next proposer with probability 0.10.

The good point is that PoS is both a natural and energy-efficient and overall less costly consensus mechanism, although it has been widely criticized for its ‘rich get richer’ formula.

And most important, it allows participants to earn rewards on their cryptocurrencies stake.

How Big is Proof-of-Stake?

There are many cryptocurrencies that pay rewards on a regular basis. Not all of them are exactly Proof-of-Stake, and some have yet to reach mainnet.

We can quote for example Tezos, Neo, Ontology, Waves, Cosmos, Livepeer, Polkadot, Decred, Lisk… And soon we will even be able to add Ethereum, after its Casper update, or Cardano to this list.

On the latest count, conducted by Bitcoin.com it turned out the Proof-of-Stake market cap of coins stood at 12.6$ billion, of which around $8 billion is locked up in staking wallets.

That’s still less than a third of bitcoin’s total $64 billion valuations. Nonetheless, this universe of future and current POS chains can’t be ignored, as it is set to grow and have a significant impact on the evolution of a crypto-based financial system.

Is Proof-of-Stake Leading to Crypto Banking?

2019 has seen a very positive start for staking. We can in particular quote the recent investment in Staked, a staking service provider, which has raised $4.5 million from Pantera Capital, Tyler Winklevoss & Cameron Winklevoss, Fabric Ventures among other actors such as Coinbase Ventures, Digital Currency Group or Blocktree Capital…

Staking-as-a-Service is clearly growing. With the recent moves from leading protocols such as Ethereum, which is scheduled to transition from PoW to PoS in Q4–19, it might even one day replace PoW, which could lead to a new layer of intermediation of crypto holdings.

This new growth in PoS and deposit intermediation could lead to some drawbacks among which counterparty risk, and incentive towards leverage. Crypto custodians, managing private keys on behalf of customers, could become a new banking player in this ecosystem, which was itself created to increase disintermediation and decentralization.

Staking is very similar to what we can find in the traditional financial markets. Stakers, would they be custodians or not, must maintain a staking ratio on some protocols — which can be compared to capital requirements for banks. Then, they pay their clients a reward based on their deposits and the inflation rate, which is not dissimilar to a savings account paying an interest rate.

When token holders understand that they ought to receive some interest from their cryptocurrency accounts at custodians or exchanges, we will see a large new ecosystem of staking providers emerging.

If Coinbase offers 2,5% while Binance or HitBTC offers 6% of staking rewards (or vice versa), the consumer choice becomes more clear.

This is exactly what banks compete on in terms of attracting deposits. On some platforms, users can already choose to stake their tokens and earn and interest based on inflation, or get an interest rate on their crypto for margin lending, up to ~7–15% or so depending on the token.

In 2020 we see big networks such as Tezos and Cosmos, but also smaller ones like Polkadot, investing in interchain communication and offline adaptation. These investments and the positive response from both the blockchain as the offline world, illustrate that Crypto banking could indeed become something that people will accept and start doing.

Below is an illustration of the yearly returns that some protocols currently offer or will offer in the future:

Note: Some of these protocols are still in Testnet and return estimates may vary in the future.

Looking for a trusted operator to stake your Tezos or other PoS tokens?

Try out Stakin and find us on the following address:

tz1Vyuu4EJ5Nym4JcrfRLnp3hpaq1DSEp1Ke

DISCLAIMER: This is not investment advice. This article is for information purposes only. Cryptocurrencies are highly volatile investment assets. We suggest that you conduct your research before deciding to purchase cryptocurrencies, and we will not be responsible for any loss of capital related to the reading of this article.

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