Welcome to Money 2.0 Stuff - The Block’s semi-weekly take on crypto markets, companies, and other stuff. The series will feature as part of our pro product offering set to release in late February. This issue is written by Arjun Balaji (@arjunblj).
It’s Just The Risk-Free Rate, Bruh
In today’s edition of Cryptocurrency Nerds Learn about Capital Markets, we take on “staking as a service” businesses. At the face of it, the business model is quite straight-forward: I have coins that I can stake (helping secure a Proof of Stake-based network) and can earn a certain yield in return for it. This staking process is rather complex to a non-technical user and certain optimizations that can be made, i.e., economies of scale in certain PoS designs, so the service is outsourced to a trusted third party.
These businesses pool up funds of many different people: long-term holders, active traders, etc. and maximize the yield that they can earn. While the marginal return generated by the staking pool is minimal, they make the process extremely convenient. The Block’s Francisco D. Chaparro explains:
Still, staking provides a number of technical headaches for investors, including having to run multiple servers and 24/7 monitoring to maintain those servers, Ogilvie said. “For every cryptocurrency, you need 2 to 3 servers and someone to keep it up 100% of the time,” Ogilvie said. “It is not a 9 to 5 job. It’s a nights and weekend job. And that’s for every chain you want to support.”
Like every other cryptocurrency land grab, a number of companies—largely venture-backed—have propped up in this category including Cryptium Labs, Rocketpool, Staked, Vest, Battlestar, and others that haven’t yet launched.
There are a few problems with these businesses:
Many of these staking companies are marketing their products as a high-yield credit product often pointing to “risk-free” rates while conveniently ignoring the fact that they’re really volatile cryptocurrencies. If you’re already long, that’s one thing, but earning a 20% yield doesn’t mean anything if your token drops 70% in price.
Advertised yields, currently as high as 15-100%+ in some networks, are totally unsustainable. They’re currently possible due to such low staker turnout. As the ease of staking drops considerably, expect these yields to drop as well. In many cases, the borrow cost of these cryptocurrencies is significantly lower than the yields advertised, which is also unsustainable.
The majority of the projects that offer high-yields are—to put it generously—not the highest quality projects. This is a story we’ve seen before, with the first wave of “master-node” coins that offered extremely high yields (subsidized by inflation). Due to the lack of liquidity in these markets, recognizing returns from the long-tail of PoS projects in good ol’ Federal Reserve certificates is next to impossible. For someone who’s already long, this is not problematic, but marketing this as a cool new credit product to someone who doesn’t already have long exposure is silly.
Fees are extremely high for these businesses, around 15-20% (of yields) at the high-end. Margin compression is inevitable. In addition to serious competition (with a dozen or more companies focused on the initial land-grab), expect to see new entrants. This sort of business model intuitively makes sense for custodians—who already have the assets aggregated—to layer on top of existing offerings.
In the rapid financialization currently taking place, people have seemed to lose sight of the fact that staking is fundamentally oriented around not losing your proportional share of the network: if you own 1% of ether, you stake to ensure that’s not diminished by inflation. Since the full network will never stake, you make a marginal return on the basis of your participation.
Always Wrap it Up
Wrapped Bitcoin is a ethereum-based token that is backed one-to-one by a regular bitcoin… Wrapped Bitcoin aims to function as a token that represents the value of bitcoin and offers the functionality of an ethereum token.
The utility of the WBTC token remains unclear. If you were interested in transacting on the Ethereum network or interfacing with the “Open Finance” stack, why wouldn’t you use ether? It seems a little strange to be using an Ethereum dApp but expressing preference in exposure to bitcoin rather than ether’s price volatility. Wouldn’t using a dApp mean you’re bullish?
I can see this sort of instrument being particularly useful in DEXs. If an ecosystem evolves for retail traders around tax evasion, it could be the case that crypto traders who have no option but to stay on the “Ethereum rails” use synthetic instruments like DAI or WBTC to balance their portfolio. In fact, AirSwap is an early supporter of WBTC, with team member Robert Paone adding:
“People prefer the economics behind bitcoin, but there are, frankly, a lot of cool things you can do on ethereum,” Rob Paone, Growth Lead at AirSwap, one platform supporting trading of the new token, told The Block.
While WBTC can’t be used to pay for gas on the Ethereum network, it could be used to fund ICOs (who may prefer taking WBTC to ETH) or be used as an asset for DAI collateral when they multi-collateral DAI is rolled out. It’s unlikely to significantly affect ETH’s utility as a payment mechanism in the Ethereum ecosystem though there are niche use cases where users may prefer it.
To date, about $250k worth of $WBTC has been deployed. It’s important to note: WBTC isn’t trustless. It’s a bit different than other “stablecoin” products such as Circle’s USDC which require both (1) trust in the custodian of the assets and (2) trust in the issuer—with WBTC, only trust in the issuer is required as proof-of-reserves is fairly straight-forward.
If you know me, you’ll know one of my major gripes is around pricing-of-things-involving-a-peg. Many cryptocurrency enthusiasts mistakenly believe that any asset trading slightly off it’s peg is a catastrophe when there’s plenty of rational reasons for doing so.
In the case of WBTC, in most cases I’d expect it to trade at a material discount. While you’re maintaining price exposure to Bitcoin, there’s still credit risk of the issuer and a trade-off in security, given the adoption of Ethereum’s security model over Bitcoin’s. There is also the possibility that WBTC could occasionally trade at a premium: if there is significant demand (e.g. on DEXs) for WBTC and there isn’t enough in circulation given the need for centralized issuance, there are windows where it could trade at a premium until the issuance is increased.
Other Stuff Happened
The first vote-buying experiments are happening via prediction markets. This was an inevitability and as someone who loves prediction markets and seeing governance systems broken by clever hackers, this is very entertaining.
Binance allows credit card payments for a limited set of customers. To me, a normie, there is almost no good reason to ever buy cryptocurrencies via credit card but I suppose some people just really love points.
Some bankruptcies at the NEM Foundation—thank goodness, I was worried I would have to learn about it for a second.
Much to The Block founder Mike Dudas’ chagrin, James Dolan has run the Knicks into the ground, executing a move trading Kristaps Porzingis to the Dallas Mavericks.
A truly wonderful week in cyber-currencies. Stay warm and Go Pats.