Cryptogram-02SEP2022

Stake, don’t lend

September 02, 2022

2 September 2022

In this issue

Hello,If you look some of the most embarrassing scandals of the ongoing crypto-winter, like Celsius, Vauld or BendDAO, there is a common theme: they all had something to do with lending.When a bunch of finance bros entered the crypto sector and seduced us with their complex financial products built over crypto tech and  promising great results, a lot of us suckers fell for it. The thing about these products is that they are great when there is a bull run – there is too much money around, pretty much anything would work. But when the bear rummages through, you got nowhere to hide, while the bros have vanished with their pot of gold.

Crypto markets are now hyper-financialised, and yet there are too many “business models” with no real business underneath. Coins are just being moved around from one wallet to another, creating a façade of commerce. Yet, there are productive ways to employ your crypto capital lying around pointlessly in your wallets, and one of the ways is staking, instead of say, lending. 2022 has already given crypto investors some hard lessons on risk management, with the quick fall of some well-known platforms.Today, we tell you how you can earn additional returns with your crypto assets, but with prudence and patience. 

The newsletter is put together by Giottus Crypto Platform and The News Minute’s Brand Studio. You can read all the previous issues of Cryptogram here.

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THE BIG STORY

How to earn with staking, and why not lending

We’ll start with the “why” first, and the short answer is: risk.Crypto is a volatile asset class that usually promises a lot and under delivers in the short-term. Many investors fall for gimmicks that are practically impossible to sustain. One such gimmick was a 20% ‘risk-free’ annual interest on UST (a Terra stablecoin pegged to the US Dollar). This was promoted through Anchor Protocol and made Terra’s LUNA a fan favourite for the first quarter of this year. Many investors used this ‘risk-free’ approach to preserve and grow their capital while the bear market played out. Essentially, in most of these cases, investors lent their crypto assets to others to make more money.This collapsed in May and ensured a strong decline in the overall crypto ecosystem. Associated platforms and exchanges which had overleveraged on Terra’s growth and other risky plays also were impacted. Celsius, 3AC, Vauld, Hodlnaut, Zipmex… the list goes on.

There is only one way you can make money for your investors with lending – you have to make more money than the interest you have promised. If someone promises a 20% annual interest to their users, they should be able to gain more by taking ‘risker’ positions in the market – in terms of trade or other lending options. Compared to bank interest rates of 2-6%, this represents a 3-4x higher returns for just parking capital. In a crypto bull market, this was achievable as retail monies were flowing into the ecosystem quickly. But when a market downturn hits, this becomes unsustainable and hence inherently becomes loss-making for the platform.The main reason is that many of these platforms are essentially middlemen. So, the collapse of one central platform led to money being locked in and thus impacted cash flows across the ecosystem.Lending continues to be available in the market in various platforms, but the manageable annual interest rates have been slashed to around 10-12%. The current annualised percentage yield (APY) provided for top crypto assets in various lending platforms can be found here, and as you can see, the rates are down to what can be considered rational levels given the market realities.That’s why, stakingStaking is a viable alternative to lending.With Ethereum’s Merge coming up this month, it is about time we think you consider staking some ETH to keep the blockchain in its new avatar going. (Here’s a quick explainer on Proof-of-Stake vs. Proof-of-Work consensus mechanism.)To validate transactions in a PoS blockchain, which Ethereum will be once the Merge happens, validators only need to ‘stake’ a certain number of coins of that blockchain (the more, the merrier). By verifying transactions this way, validators earn a share of the transaction fees.Compared to mining, which requires high end computing power, validators need minimum investment to get onto staking. A lot of validators in turn create staking pools to outsource their staking power – retail investors provide support to such pools and can get rewarded based on performance of their staking pool. Typically, staking can provide a 5-9% annual interest on the crypto asset – lower than lending but a safer passive income option.Risk wise, staking returns are only dependent on the blockchain’s usual operations. Centralized platforms and exchanges that aggregate such demand pools are able to provide a hassle-free approach to staking. Wary investors can also use hardware wallets to maintain full control of the coins while they are being staked. Staking often requires a lockup period though, where your crypto can’t be transferred for a certain period of time. This can be a drawback, as you won’t be able to trade staked tokens during this period even if prices shift. Also, staking is not available for all assets – if you only own BTC, for example, and want to earn rewards on it, lending is a better option. While investors wait for a successful merge to stake their ETH, popular blockchain tokens such as ADA, DOT, MATIC, AVAX and TRX are available to stake today. Below is a chart with current rewards (interest rates change with time) you can earn by staking these coins on StakingRewards. Note: While some coins do give higher returns, they may be an inherently riskier asset – the top 10 crypto assets give rewards below 6%.

But you still need to watch your back Staking, in our opinion, is better than lending but that still doesn’t mean you do not DYOR. You still have to be prudent. It is a good practice to have a checklist of questions that give you clarity before making any investment via staking (works for lending too!).Here are a few: 

  • How will the platform give you the promised returns?

  • Are the returns reasonable, or too high compared to general market? 

  • Are you able to withdraw funds when you can? 

  • Does the platform have a responsive customer support that can clarify your queries quickly?

  • How much of your capital is exposed to one particular platform?

  • Can you absorb the loss if your biggest platform goes under?

When you diligently answer the questions above, you can map your risks better.

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  THE TOP FIVE 

Stories from this week you cannot miss

  EXPLAIN, PLEASE 

Demystifying the world of cryptocurrency

Since Ethereum’s Merge is expected in a few days, this week we explain the MERGE.If you understand Proof-of-Stake vs. Proof-of-Work, the Merge is pretty easy to understand.

As of today, Ethereum operates on a PoW consensus mechanism, in which miners need to use huge amounts of computational power and energy to process transactions on the Ethereum blockchain. Since this was untenable, the Ethereum network decided to move towards a PoS mechanism, where “miners” turn “validators”, and all validators need to do to participate in the processing of transactions and earn rewards is to “stake” their ETH – put them to work on the blockchain. Now, this change was not going to be possible overnight. So, the PoS mechanism was built and made operational over another layer of the blockchain, called the Beacon Chain, and this chain will now be merged with the Ethereum Mainnet, which is the primary layer operating on PoW today. This combining of the two layers is the Merge, and with that Ethereum will become a less energy-guzzling and more efficient blockchain. Let’s get all set for it!

If you have any questions or feedback for us, write to us at [email protected]. You can check out the previous issues here.

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