WTF Is... Staking (Part Two)

TLDR: Staking crypto is a way to earn passive income on the crypto inside your portfolio. In exchange for allowing your crypto to power blockchain network transactions and relinquishing your ability to sell for a period of time, you can earn rewards in the form of percentage yields of that same token. 

Welcome to the final article of our two-part "WTF Is... Staking" series. If you want to learn the basics of staking, check out Part One. Like many concept surrounding decentralized finance (DeFi), once you start exploring staking, new questions and terms emerge. So we created a Q&A to help the beginner DeFi baddie take her staking knowledge to the next level.

Here are some common questions (and answers) about crypto staking.

Is staking crypto like having a high-yield savings account? 

Sort of, but only to a point. The high-yield savings analogy is commonly cited to explain staking, but let’s unpack it.

In a high-yield savings account, you earn an annual percentage yield on your balance (e.g. 2.5% APY) and your bank uses your funds to make loans to borrowers. It’s true that when staking crypto, you earn a percentage yield (e.g. APY, which varies by the crypto) in rewards in exchange for allowing your crypto to validate transactions. The next similarity is that both high-yield savings accounts and staking have requirements: for example, minimum balances.

Beyond this, the analogy falls short. When staking, you are not loaning your crypto to individuals, but rather to that crypto’s specific blockchain network. Banks don't set the parameters, no do they decide where you stake, who sets the percentage yield and where rewards are paid out from. If we cling too closely to a high-yield savings account as an analogy, it is easy to start to think of an exchange like a traditional bank — and that is incorrect. Blockchain protocols are a technology; they are not banks. Likewise, exchanges and wallets are not banks, nor are they regulated as such. 

In short: Staking crypto is a means for passive crypto income, just as a high-yield savings account is a source of passive fiat income. But that’s where the comparison should stop.

Will my crypto staking get shut down the way crypto interest accounts have been suspended in the U.S.? 

Well, it’s crypto after all, so the real answer is: who knows? This question is a reflection of the gray area that is crypto, regulation and crypto platforms. 

In February, BlockFi, a crypto-lending and investment platform, suspended its interest accounts for new U.S. customers. The central question raised by the US government was whether BlockFI interest accounts are securities, and thus susceptible to securities compliance. The U.S. government deemed the interest accounts as securities (which BlockFI disagreed with), and BlockFi was found at fault for not registering the products as such. This is an oversimplification, but gets to the heart of the issue.

The accounts were not suspended just because they were interest accounts. And coming back to staking, staked crypto is not a crypto interest account, anyway. 

The question of whether cryptos are securities or commodities has loomed since Bitcoin went mainstream, and regulators’ views are evolving with more urgency as adoption increases.  Commodities are typically defined as “basic goods” that can be bought, traded or exchanged; for example: oil, grain, or gold. Securities, however, yield return from a common enterprise or company, like a share in a company that trades on the stock market. Commodities are considered “stores of value” because they hold value over time unlike a security; for example, shares of General Motors have fluctuated drastically over time. 

And while the U.S. is firm that bitcoin is a commodity and largely treats other cryptos as such (for now), debate persists about whether other cryptos are securities instead. When something is a security, there’s more regulation! 

In short: Staking crypto isn’t a crypto interest account. Do monitor how regulators views on cryptos as commodities or securities change because that will impact much more than just staking.

Wait, there’s two different types of staking? 

Technically, yes: on-chain staking vs. off-chain staking. 

On-chain staking is the staking you already know (tokens of proof-of-stake blockchains volunteered to power the blockchain in exchange for rewards). 

Off-chain staking, however, does not happen on a blockchain and is instead about earning rewards directly from your exchange. One implication is that non-proof-of-stake assets (e.g. $BTC) can be staked off-chain. The assets that can be staked off-chain are at the discretion of the exchange you’re using. Off-chain staking llows you to earn rewards on available and idle account balances maintained on the trading platform, thereby making off-chain staking somewhat closer to an interest account than on-chain staking. 

Major principles of staking still apply: percentage yields in rewards; parameters around unstaking and selling; minimum balance requirements. These are set by the exchange. Still, only select exchanges provide off-chain staking, and there are typically major geographic restrictions and minimum balances required to do so. For example, on the exchange Kraken, off-chain staking is not available to residents and citizens of the U.S., Canada, UK, select European countries and more.

Most of the time, when people refer to staking, it’s on-chain staking. On-chain staking is the default. So why even bother understanding the distinction? 

Well, many crypto transactions, like staking, can happen on- or off-chain. Off-chain activity does not happen on a blockchain and is not recorded on the public ledger. Off-chain activity is more analogous to traditional finance transactions, relying on agreements or guarantors to trust that the transaction will occur. Paying your friend back on Venmo or buying something with PayPal relies on the same principles. 

On-chain vs. off-chain transactions is a buzzy debate because off-chain transactions are faster, lower cost, and more energy efficient, since they do not happen on the blockchain. Still, the cons of operating off-chain involve higher risk, more experimental protocols, and a lack of transparency.

On- vs. off-chain also isn’t a zero-sum game. For example, art and community NFTs projects may store the smart contract identifying ownership on-chain but the actual image media is often stored off-chain. As builders, investors, and community members think about efficiency and governance in the Web3 economy, deciding which activity(s) should happen on- vs. off-chain is a critical component. The decision impacts the cost base and operations of a project.

In short: On-chain staking is the staking we all already know. Off-chain staking happens off of the blockchain and is not restricted to cryptos of proof-of-stake blockchains. 

To sum it up

Further resources:

Crunchbase News: Commodity Or Security?

Risk And Regulation In Crypto

Investopedia’s Guide To Off-Chain Transactions

On-Chain, Off-Chain And Decentralized NFT Storage

For More: WTF Is… Staking (Part One)

This is not financial advice. If you don't want to spend money investing in crypto or Web3 — you don’t have to. The intent of this article is to help others educate themselves and learn.

Nicole Kyle is a storyteller, podcaster and gender equity advocate exploring the intersection of money, equality, technology and creativity with a focus on crypto & Web3 education. Nicole was named a 2022 LinkedIn Top Voice in Gender Equity.

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