Some Crypto Investors Find a Way of Playing it Safe

(Bloomberg) -- After the volatile cryptocurrency price swings of the last few years, some investors are becoming content with essentially earning interest on their holdings.

They’re embracing a practice known as staking, where their tokens are placed in so-called digital wallets and used to help validate transactions that create new blocks in blockchain networks. In exchange they receive rewards in the form of coins. The proof-of-stake process can generate returns ranging from 5 percent to 150 percent, depending on the coins and amount held.

That’s a big change from how transactions are verified for Bitcoin, which follows a proof-of-work system where so-called miners compete to solve complex mathematical riddles and win new coins. With token prices showing few signs of recovering after plunging as much as 90 percent in 2018, the staking has made it somewhat easier for investors in coins such as Tezos, Decred, Cosmos, EOS and Livepeer to endure the bear market.

"Regardless of market conditions, staking provides returns denominated in the asset being staked," said Kyle Samani, managing partner at Multicoin Capital Management in Austin, Texas. "If you’re going to be long, you might as well stake."

Some Crypto Investors Find a Way of Playing it Safe

The practice, also known as forging, has given rise to a cottage industry of specialized startups, with names like Staked, EON Staking Inc. and Figment. Many new crypto custody services, such as Anchorage, are also starting to offer staking as well. EON, which is launching a staking-as-a-service offering in February, will charge a 5 percent fee on the interest its clients earn.

Staked announce Thursday that it raised $4.5 million from Pantera Capital Management, Coinbase Inc., Digital Currency Group and other investors. Anchorage, which launched on Jan. 23 and says its clients include venture capitalist Andreessen Horowitz, which is also an investor, and crypto asset investment firm Paradigm, offers coin custody and staking for institutional customers.

"As we see more proof-of-stake protocols emerge, the ability to stake your tokens and earn interest from staking is a great way to make money," said Paul Veradittakit, a partner at Menlo Park, California-based Pantera. "An ability to make strong consistent returns."

Staking does carry risks. When coins are staked, it can take hours or days for the networks to free them up for trading. That means that investors may miss a market rally or get caught up in a plunge. There’s also some regulatory uncertainty over whether the coins issued as rewards can ever be viewed as securities. Some staking companies, such as Figment, have created special repurchase agreements for clients to minimize potential tax implications. The investors have to trust the startups doing the staking for them, too.

"Staking requires a certain amount of trust, unlike proof-of-work," said Aaron Brown, an investor who writes for Bloomberg Opinion. "My observation to date is when crypto requires trust, disaster follows. It’s usually reported as hacking, but it is usually insider malfeasance or gross negligence. So while I don’t specifically predict problems, no one should be surprised if they crop up.”

Investors may be able to test that out soon with Ethereum. The third-largest cryptocurrency is expected to shift to a proof-of-stake system as part of a network software upgrade later this year. There are more than 100 coins using such systems, according to Poslist.org.

“There may be a big part for staking in proof-of-stake systems in a mature crypto economy, but today it’s something investors should do at their own risk only,” Brown said.

©2019 Bloomberg L.P.