Coinbase’s custody arm is trying to entice its institutional customers into the brave new world of staking crypto assets for profit.
Starting with the Tezos proof-of-stake (PoS) network, San Francisco-based Coinbase is offering clients the opportunity to make a return on their XTZ, that blockchain’s native token, the company announced Friday. After deducting Coinbase’s fee, investors can expect an annual return of around 6.6 percent, the firm estimated.
While that may sound alluring in a world where 30-year U.S. Treasury bonds yield less than half as much (and once-skyrocketing crypto prices are flatlining), investors will have to get comfortable with a highly complex arrangement. But staking is poised to become a bigger opportunity down the line, given that the second-largest cryptocurrency by market cap, ethereum, is expected to migrate to a PoS consensus system eventually.
Stepping back, unlike bitcoin’s proof-of-work (PoW) mechanism – which relies on excessive computation by miners – proof of stake requires participants to have skin in the game by depositing assets to the network and then helping validate decisions about which transactions and blocks should be added. For doing this, they receive payouts much like traditional miners in a PoW system. Users can also be punished by having their stake slashed for not helping or actively hindering consensus.
Moreover, participants who have assets to stake but don’t want to take part in the rather involved process of validating transactions and blocks can instead delegate their assets to someone else. Participants who choose to stake their crypto assets earn passive income on it, which ranges from around 5 percent to 25 percent annually, depending on the network and the level of participation.
The rub for investors is that generally speaking, validators running proof-of-stake nodes (known as “bakers” on Tezos) must have some funds online and so effectively “hot,” in crypto security parlance. That means these funds are more vulnerable to theft than when the private keys controlling them are kept offline, in so-called cold storage.
To win over institutional investors who might be unsure of the risk/reward profile of PoS, Coinbase Custody is guaranteeing to its customers that all staked coins will stay in fully-insured cold storage. To do this, the company will post the necessary bond to bakers out of its own pocket. In this way, there is “zero risk” to its custody clients, Coinbase claims.