The PoS and DPoS consensus algorithms are already used by such cryptocurrencies as Cardano, Dash, Qtum, EOS, Lisk, and Tron, and four of them are in the top 15 by market capitalization. With Ethereum that is preparing for a major upgrade and Tezos that is running atop Liquid Proof-of-Stake, the total market capitalization of such projects would have stood at $18.6 billion on January 24. Michael J. Casey, the chairman of CoinDesk’s advisory board and a senior advisor for blockchain research at MIT’s Digital Currency Initiative, believes that PoS will bring in new cryptocurrency businesses and financial models—in particular, staking-as-a-service that in its essence would be similar to interest income in the traditional banking.
Holders of PoS-based currencies will be able to delegate their coins for staking through an intermediary, which will provide a lower entry threshold and allow users not to worry about technical burdens. Such a service can be delivered by cryptocurrency exchanges or any other provider who will take on the technical side of the job and for that, charge a fee deducted from the income of the stake. In particular, staking for Tezos is already possible through the Cryptium operator, which also promises future support for Cosmos, Iris Network, and Polkadot. Rocket Pool, a service for staking Ether, will start operating once the Ethereum network has transitioned to PoS. The minimum stake for a node operator when implementing Casper will be 32 Ethers, while the Rocket Pool gives you a percentage when delegating (depositing) only 1 Ether and also allows users to be a node operator with 16 Ethers. The service has already completed a two-month open beta test of its v1 testnet.
Casey notes that he started thinking about the development of such services and related issues after reading blockchain entrepreneur Maya Zehavi on Twitter, where she commented on a new crypto assets regulation report by the European Securities and Markets Authority (ESMA). Zehavi says that at the moment, ESMA recommends cryptocurrency exchanges to introduce segregated accounts (a system in which client funds are kept separately from the company’s funds), and in the future, it will also be necessary to “explicitly inform clients whether their funds are used for staking purposes” and “get specific consent.” “It got me thinking of how unavoidably appealing staking-as-a-service is for all the exchanges managing people’s trading in POS coins. There are no clear signs that any are actually doing this with crypto tokens in their custody—and if that is happening without users’ consent, it needs to stop. But the idea of helping their clients earn revenue on their otherwise dormant coins, and charging a fee for doing so, is surely an attractive one for both sides,” writes Casey.
“If we leave the blockchain philosophy behind and get to the main issue of cryptocurrency exchanges using the Proof-of-Stake protocol as a financial service, this is not some breaking news. Different projects at different times tried to implement this service. One of them was the Russian Waves which, in 2017, opened the opportunity to holders of their tokens. The difference between Waves and [other] cryptocurrency exchanges was that [Waves] did this according to the same blockchain philosophy, that is, in a decentralized way. But this doesn’t change anything,” as Roman Zabuga, an official representative of the Wirex crypto bank, told DeCenter. He also noted that Wirex does not yet apply such a mechanism of monetization of services: “We are cautious in choosing the coins that we list in our crypto wallet. If we add ‘stablecoins,’ we may consider such an option.”
At the same time, experts agree that the market demand for such services is evident: “Hedge funds, VCs, and whales are holding tons of illiquid tokens that could be supporting networks and generating additional revenue, but spinning up and managing nodes is not something they can or want to handle themselves,” write the researchers of Token Foundry, a subsidiary of ConsenSys.
Evan Prodromou, the developer who in 2017 tokenized his time releasing Evancoin, says: “There is definitely an advantage to pooling resources. That’s why ‘real’ banks exist. There will almost definitely be commercial and community pools for Proof-of-Stake currencies. Disunited small holders will have a disadvantage compared to organizers of pooled resources. This is a feature, not a bug. Working together gets us all invested in a project, and it’s that level of shared belief that makes the currency valuable. Deeper integration between currency users and owners gives us deeper ties and deeper commitment.” He also noted that staking-as-a-service opens up new investment opportunities for market participants: “Financial services like PoS-pooling are helpful to crypto investors. They provide a stable, conservative growth opportunity. Volatility is an important advantage of crypto assets over other more traditional ones, but it is good to be able to serve different parts of people’s investment portfolios. Right now, cryptos are all in the high-risk, high-reward end of the spectrum. Having some low-risk, lower-reward investment opportunities is good, too.”
Managing partner of United Traders Anatoly Radchenko also sees the arrival of such services as a logical step. In a conversation with DeCenter, he said that he still had no idea where the spread of PoS currencies would lead but was confident that huge marketing budgets would merge into large exchanges, which, together with a decrease in fees, would squeeze out small players. “Exchanges are, in fact, banks, or brokers 2.0, or fintech solutions for banks. The very same centralized agents will simply propose decentralized solutions for particular paranoids. All those who came to the crypto market from 2016 to 2018 and already passed the KYC have obviously agreed to the risks of central counterparties. So I don’t expect strong changes here,” he said.
The possible increase in the popularity of such services resulting from the spread of PoS currencies leads to the same questions that the Proof of Keys campaign was devoted to on January 3–in particular, monetary sovereignty. “The time has come for us to test what we have created. Trust in numbers yet we trust in exchanges, in people, in corporations. On the 3rd of January 2019, 10 years on, let us all withdraw our BTC to wallets we control. Let’s see if it is all there, let us see who fails, let us see the network work. We lose nothing, we risk nothing, those companies and exchanges that cannot be trusted will be exposed. We must assert control, we must prove this is ours,” as the user who started the campaign wrote on Reddit.
At the same time, the goal of the campaign was not only for people to prove ownership of their own Bitcoins but also to find out whether their funds are used without their knowledge, and if so, for what. The whole thing has turned out to be a litmus test: according to a report on the official website of the Proof of Keys, some exchanges, including Bitfinex, HitBTC, and Robinhood, failed. Investor Trace Mayer, who provided broad coverage of the campaign, suggested celebrating every January 3–the “birthday” of the Bitcoin’s genesis block—with such a campaign. And in the future, in particular, with the mass use of staking services, the need for such checks may indeed increase.
Token Foundry employees—token designer Viktor Bunin and research lead for staking-as-a-service Collin Myers—described how staking services can take the path of bank lending and inherit all its flaws. “Imagine there’s a box. Any money you put in it grows. The longer you leave it in there, the more it grows. What percentage of the time do you want your money to be in that box? 100%. How much of your money do you want to be in that box? 100%. What if a large, trusted financial institution were to come to you and say: ‘You can leave your money (tokens) with us and we’ll put it in the box for you (stake it). You get a nice return and in the meantime you can have these deposit slips that will always be redeemable for the tokens you’ve left with us.’ Doesn’t that sound like a good deal? You get to eat your cake and have it too. And because this institution is so trusted, these deposit slips trade for par value with the underlying asset and are accepted by all the usual vendors you normally interact with. Congratulations! We’ve come full circle to reinventing fractional banking!”
The authors write that soon after the implementation of such a system, it will inevitably move from issuing deposit slips on a 1 for 1 basis to 1:1.1, 1:1.2, and so on, which will lead to a classic banking crisis resulting from the insufficient backing. “We will be right back where we started, easily susceptible to economic crises with no hard money and no faith in our financial institutions. The lending of value to generate more value is one of the oldest tricks in the book. There is a reason that global debt markets are the most deep and liquid markets in the world. All that’s needed is a store of value that is widely accepted by the masses and then the same practices can be applied to it that humans invented many moons ago. Fractional banking is actually just the first step, because once you have deposit slips, you’re able to unleash the full marvels of financial wizardry and all its accompanying innovation,” the researchers say, noting that the global OTC foreign exchange (FX) derivatives markets alone had notional amounts rise to a record high of $95.7 trillion at the end-June 2018. “In fact, being digitally native will only expand the product selection as smart contract capabilities add a previously unavailable tool to the arsenal.”
What to Do?
Bunin and Myers draw attention to the fundamental difference between the PoS and PoW algorithms: PoW only earns through lending while PoS can also earn through staking.
Accordingly, one can’t expect cryptocurrency holders not to try to profit from the opportunities “locked” in their coins, which means that there must be safe and not-threatening-with-centralization ways to put their PoS savings to work.
Casey sees decentralized staking solutions, such as the proposal for creating block producer pools on the EOS network (by analogy with the mining pool system), or multi-sig custody arrangements as a way out.
Prodromou is optimistic and hopes that the problem of centralization may not arise at all in this context. “With the question of decentralization, the blockchain community has done a good job in the past taking pragmatic steps to avoid central authorities from controlling the chain. A good example is community efforts to balance out the membership in Bitcoin mining pools to avoid the 51% attack problem. Community members have shifted their mining resources to different pools, possibly at personal cost, in order to avoid centralization attacks. All of which is to say that theoretical issues often end up not being practical issues, because we all have a stake in avoiding the theoretical problem.”
Bunin and Myers offer a more radical solution that should put the control of funds exclusively into the hands of users. In their opinion, cryptocurrency holders should be “truly self-sovereign” not just in how they spend tokens, but also in how they hold them and stake them.
And here a new angle emerges, under which we can examine the current situation with centralization and its origins. The white paper of Bitcoin posed the problem of trusted third parties in electronic payments that spread with the flourishing of online trading, and offered its solution in the form of online payments that can be sent “directly from one party to another without going through a financial institution.” If we are talking about retailers who are currently accepting Bitcoins, the system works as intended. White paper of Bitcoin does not address the methods of storing cryptocurrencies, let alone the threats associated with PoS systems that were first described only four years later. All these problems arise as the technology develops and can strongly differ from Satoshi’s “vision” and ideals of decentralization. Besides, cryptocurrency was created by cypherpunks, but they are not the only ones to use it. And if an ultimate goal is the mass adoption, then an ordinary user has the right to value convenience above all. “In spring 2017, cryptocurrencies began to move away from their fundamental principles of ‘confidentiality’ and ‘independence from the state’ when we saw the peak growth of participants in a cryptocurrency economy. At the same time, the functions of an independent disposition of own funds (in cryptocurrencies) still remain, although they can be cut down, and in the future, cryptocurrencies may become just another form of money—and not what Nakamoto intended them to be,” as Roman Zabuga said.
But from the standpoint of crypto maximalism, Bunin and Myers seek to eliminate the intermediation of pools as a potentially centralizing element. “The biggest challenge we face is building self-sovereignty into the system from the start. People do not want to work to be self-sovereign; they will not choose it,” Bunin and Myers write, stating that if the process is too complicated, people will assign the work to a trusted third party, following a usual pattern. “Staking needs to be accessible to even smaller amounts and on lighter devices, and fund rebalancing between staked tokens and accessible funds should be automatic.”
That is, users should be able to make a profit in the most “lightweight” way possible. Another point that researchers pay attention to is the need to reduce appetites and sacrifice some profit. So, if staking by the principle of fractional banking provides the user with an ideal opportunity to keep all the funds in the stake all the time and use them simultaneously (with deposit slips analog), with self-staking, users will have to reduce the amount of money and the amount of time. The authors propose to keep 95% of the money in the stake 95% of the time, and thus, “the difference in staking rewards will be imperceptible and individuals will be able to become truly self-sovereign, with total ownership over their financial lives.”
This position is based on the priorities of decentralization and the lack of control from the “big brother.” “We must remain vigilant to the risks of staking if we want the decentralized world of self-sovereign individuals we’re buidling to remain that way,” write Bunin and Myers. Some crypto enthusiasts, however, are more flexible in their views and make allowances for the “imperfections” of the end user.
In a recent interview, Charlie Lee (Coinbase’s former Director of Engineering) said that for technically unqualified users, storing cryptocurrencies on a computer is the same thing as keeping money under a mattress. “If they have the ability to secure it themselves, I would recommend people secure it themselves. But the reality is Coinbase does a better job at securing coins than the average person […] If you are not technical enough, or if you don’t know enough to secure your coins yourself, it’s better to leave it on Coinbase than to keep it on your computer which has malwares and you don’t do backups properly, so there’s various ways that you can lose coins that way,” Lee said. Continuing this thought, we can conclude that the same class of non-tech-savvy users may also benefit from the staking service, in which the exchange does all the work, and the holder of funds only thanks it with interest while receiving their income.
Roman Zabuga notes that the search for compromises has already begun and, in fact, for the industry to live and develop, both sides must make concessions: “Is staking-as-a-service a threat to decentralization? In fact, no, since the decentralized component in the cryptocurrency economy is not so great. The main applications that allow for the use of cryptocurrencies are centralized, and therefore, controlled by the authorities. But I would not call accountability a ‘threat.’ On the contrary, this phenomenon offers users additional guarantees. In fact, this is a fascinating point, as here we see a clash of interests of the cypherpunks and the anarchist cryptographers with the interests of government authorities. And this should evolve into a kind of symbiosis, both parties need to find a consensus for which dialog is necessary. There is no open, public dialog, but there are closed ones (some started eight years ago), which, in fact, contradicts the principles of blockchain. But the main thing is to find a consensus that is difficult to achieve while respecting the principles of decentralization.”
And this is not the first case when it is possible to mark the roll of cryptocurrency in the direction of fiat models, and a “purely peer-to-peer version of electronic cash” without a trusted third party obtaining all the features of ordinary cash. Users store cryptocurrencies on the exchanges, use custodians, and will soon even be offered cryptocurrency-based “smart banknotes” that can be used for payments just like ordinary banknotes.
“Convenience and user interfaces are the Goliath that always defeats David. We could all use cash instead of bank cards, but we were wooed by the convenience of writing off fractional amounts and not having to carry sliced up pieces of paper,” as said by Alexander Garkusha, the co-founder of Modern Token, in a commentary for DeCenter.
PoS vs. PoW
The “root of all evil” obviously lies in the development of PoS models for creating cryptocurrencies, which, while solving the problem of energy consumption, almost always carry the threat of centralization. Which concept will win, according to experts, depends on demand and adoption, stopping “bad PoS” will not work, and the advantage in promoting one or the other protocol is paradoxically far from the control of the developers. “According to the basic evolution rule, everything that can be created will be created, including currencies that require a certain amount of coins to participate in staking. Long-term sustainability depends on the response from the public, consisting of enthusiasts and rational investors. The cypherpunks I know do not respect any of the cryptocurrencies; in their opinion, the mining and management of the development of cryptocurrencies are way too centralized. Enthusiasts are all different, and investors are the same: rational thinking does not depend on education; otherwise, the logical sciences would be impossible. If it is profitable, they will invest in Crimea. As for the PoW/PoS holy war, the answer, of course, depends on the respondent’s religion. For me, Sasha Luss is better than Salma Hayek, freckled blondes are better than brunettes, and the elegant mathematics of the authors of the Ouroboros and Algorand algorithms is better than my ability to understand industrial cooling. But tastes differ. Of the unambiguous, it is clear that the struggle between currencies stands at the level of UX/UI, bizdev teams, partnerships, press releases, and integrations, while intellectual exercises of technical monkeys, of course, bring epistemological pleasure, but have nothing to do with business,” as Alexander Garkusha told DeCenter.