Staking-as-a-Service 101

Today’s leading blockchains are undergoing a massive shift from Proof of Work (PoW) to Proof of Stake (PoS) consensus mechanisms. The original PoW model pioneered by Satoshi Nakamoto has fallen out of favor as critics point out the negative externalities created by its security model and its trend towards centralized mining pools. In its place, PoS designs are witnessing tremendous growth for their promises of energy efficiency and greater decentralization.

What is Staking?

In the cryptocurrency world, staking refers to “locking up” a digital asset by “staking” it to secure a blockchain network. In term of securing the network, participants who stake their coins receive a share in the block reward in form of newly minted coins.

Staking is an integral part of a Proof-of-Stake (PoS) consensus mechanism. Proof-of-Stake requires network participants to stake the network’s native asset to achieve distributed consensus. Block rewards are attributed to stakers using a combination of random selection and the size of the stake (measured by the number of tokens) that have been provided.

Proof of Stake (PoS) represents the newest wave of innovation embraced by many popular blockchain projects on the market today. Many so-called third generation cryptocurrencies, such as Algorand, Cardano and Polkadot all rely on some form of PoS to help achieve consensus in their networks. Even Ethereum, the world’s second largest cryptocurrency by market capitalization with millions of users and thousands of decentralized applications (dApps) has chosen the path towards PoS as the future of their protocol with the launch of ETH2

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What Are Staking-as-a-Service (STaaS) Platforms?

Staking-as-a-Service (STaaS) platforms enable crypto investors to stake their stakable PoS digital assets via a third-party service that takes care of the technical aspect of the staking process. For this service, platforms charge a fee – usually a percentage of the staking rewards.

The idea behind Staking-as-a-Service platforms is to enable anyone – even those without technical knowledge – to take part in the staking economy.

They lower the (technical) barriers to entry so that anyone can earn tokens by providing them as a stake in a PoS network. The use of third-party staking services is often referred to as “soft staking.”

The Rise of STaaS

Lowering Technical Barries

If staking is the native revenue channel for participants in a PoS network, why doesn’t everyone run a validator? There are several factors at play here. First, there is generally a minimum capital requirement to become a validator which ends up pricing out the majority of retail users.

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Even chains like Solana that have no minimum stake requirement still demand capital in other forms such as high-end computers, voting fees, and sufficient capital staked for the validator to be elected. Most PoS networks will punish offline or misbehaving validators using slashing penalties. Finally, staking comes with an opportunity cost - assets are locked up for a period of time and can’t be used for other purposes such as borrowing and lending in DeFi. This problem applies to most PoS networks that use a bonded staking mechanism. Altogether, these problems are exactly what the STaaS industry aims to solve for its users.

The STaaS industry was originally created to offer the economic benefits of staking to the masses while solving the challenge of ongoing validator maintenance for non-technical users. STaaS is a relatively straightforward business model - users transfer or delegate their assets to a STaaS provider that manages a set of validators. This allows even the smallest of users to enjoy the benefits of staking. By using a STaaS provider, a user can easily stake almost any PoS asset in a few clicks.

Potentially Lucrative Return on Investment

STaaS services allow holders of PoS coins to tap into the lucrative financial opportunities that staking platforms may bring. The reason why it is lucrative to participate in staking is because holders of the native token are stakeholders in the network, who can be rewarded for participating in consensus. Unlike traditional mining, those with “skin in the game” have the right to participate in block production or delegate their right to participate in block production to a validator on the blockchain. These validators are given the right to produce the next block in the chain, and they are rewarded for doing so. Therefore, each PoS network exhibits different active staking rates depending on the activity and incentives at play within each respective network.

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The ever-changing staking rate results in a dynamic reward rate for network’s stakers. As more stakers enter the network, the active rewards rate decreases as staking rewards must be distributed to a larger group and vice versa.

STaaS Categorization

Custodial STaaS - “Exchange Staking”

Custodial STaaS providers are characterized by taking control of and maintaining customers’ assets throughout the entire staking process. The most common examples of centralized staking providers are centralized exchanges such as Coinbase, Kraken, Binance, ....

Custodial STaaS is generally targeted towards retail users that want a simple way to earn a return on their holdings without worrying about the backend processes. Since customers already trusted these third parties to custody their assets, staking with these providers doesn’t require any additional trust assumptions other than the STaaS provider’s ability to competently manage a validator or outsource this responsibility to yet another third party. However, the same risk of custodial wallets and exchanges applies for custodial STaaS providers - not your keys, not your crypto.

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Non-Custodial STaaS

STaaS wouldn't be a true Web 3.0 service without the ability to participate while maintaining custody of one’s assets. The process of transferring stake to a non-custodial STaaS provider is known as delegation. Most PoS networks support native delegation, which means that the process of delegation is built into the network itself. However, the reward distribution method is slightly different. Since the network recognizes and supports delegations, it can distribute a delegator’s share of rewards directly to the delegator rather than leaving it up to the validator to pass the rewards on. This helps to reduce some of the counterparty risk associated with the custodial STaaS business model.

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Liquid Staking Solutions

Since staking is a commitment to the security of the network, assets need to be locked up in order to prevent a “bank run” scenario where all the stake is quickly withdrawn, and the network’s security collapses. The lockup period is unique to each network.

Liquid staking provides depositors with a derivative asset that represents their staked position, accrues staking rewards, and can be traded and potentially used as collateral for DeFi activities. While liquid staking is a feature that both custodial and non-custodial STaaS providers may offer customers, it’s most commonly used in decentralized staking pools.

These protocols don’t run validators themselves. Instead, they accumulate staking deposits and distribute them to validators already operating in a given network. For this reason, rewards and penalties are generally shared by all depositors in a staking pool.

The Downside of STaaS

Risks

While STaaS democratizes the staking process for crypto users, it doesn’t come without risks. As we discussed previously, staking itself isn’t risk-free. Any validator is subject to penalties for slashing events such as downtime or double signing that prevent the network from reaching consensus.

The creation of liquid staking derivatives leads to a set of intertwined risks of its own. First, since these derivatives are synthetic assets, they need to maintain the peg to their underlying staked asset. This is no easy task.

The second risk of dealing with staking derivatives is a matter of liquidity. If the staking derivative can’t be exchanged for any other assets in the market, it doesn’t really serve any purpose other than being a deposit receipt. This is directly related to the peg risk as well - the more a staking derivative deviates from its peg, the more illiquid it becomes.

A final risk regarding the STaaS industry applies only to decentralized staking pools designed to aggregate and distribute stake across various validators. These pools may dampen any counterparty risk associated with choosing a specific validator, but they add smart contract risk since the protocol must route stake across its network of approved validators.

Threatening Decentralization

A common criticism of the PoW mining industry is that it encourages the centralization of resources and therefore security providers. Any point of centralization in a network’s security system makes it easier to compromise the network. While PoS networks don’t benefit from the same economies of scale as PoW networks, the STaaS industry is a critical variable that will influence the decentralization of PoS networks.

It will be necessary for the crypto industry to keep large STaaS providers in check to prevent this kind of centralization. Delegating to smaller validators and encouraging STaaS providers to maximize the number of validators under their management are two ways the community can help these PoS networks to remain as decentralized as possible.

Dominating Governance

PoS networks often have a form of governance in which token holders vote on proposals and improvements to the network. Without a central entity to improve the blockchain, it is down to a community of token holders to participate in making the blockchain better. The theory is that those with the most at stake have the biggest incentive to see the network succeed, and they will vote on what improves the prospects of the blockchain they are invested in.

Governance in relation to STaaS poses a question as the custodians of users’ tokens may indeed grant the institution the right to vote on proposals as a result of holding such coins. This would give such SaaS providers outsized influence on the system beyond simply collecting tokens from participating in consensus. STaaS service providers who vote on governance proposals may have different incentives or ideas for what is good for the blockchain. This could potentially create a dilemma between those who hold tokens on behalf of others for the purposes of staking and those who own their own tokens entirely.

Conclusion

Ever since the inception of Bitcoin, the environmental impact of mining has been widely recognized within the blockchain space. Today, PoS represents an alternative to mining that has a negligible impact on the environment around us. Despite the advantages and lucrative returns, staking remains opaque and confusing for many everyday users. STaaS provides a secure on-ramp, typically in an easy-to-use interface, for anyone to begin their staking journey. This ensures a level of quality and hands-off management that many users desire.

Despite the advantages, there are many who question if SaaS is true to the core spirit of decentralization. Centralized staking providers controlled by single entities may pose a risk to decentralization by controlling too much of the stake in the system. Another question is the level of outsized influence such service providers have on the governance of the network. Overall, STaaS provides an accessible way to engage with new, innovative Proof of Stake blockchains which are sure to shape the industry over the years that follow.

Disclaimer: This article is meant for informational purposes only. It is not meant to serve as investment advice. The article is aggregated from Messari , Blockdemon and BlockSocial to give investor the lastest and most accurate knowledge.