11 min readSome crypto ETPs come with the option to stake your crypto, i.e be rewarded for holding assets. In this article, we will outline how Staked ETPs operate, and what their benefits are.
Proof of Stake: The Mechanism Behind Staking Crypto Assets
Blockchains are decentralised systems: in the absence of a central authority, the community is responsible for maintaining the security and reliability of the network. To do so, there are two main consensus algorithms at work in blockchain networks: Proof of Work (PoW) and Proof of Stake (PoS).
In Proof of Work systems, such as Bitcoin, miners compete to solve complex mathematical problems to validate transactions and create new blocks. They are rewarded with newly minted tokens for their efforts. However, PoW networks consume large amounts of energy and resources, prompting the development of an alternative method known as Proof of Stake (PoS).
In Proof of Stake networks, such as Ethereum, Cardano, and Polkadot, token holders "stake" their tokens to help validate transactions. Validators are chosen based on their staked amount, and they earn rewards for contributing to the network's security.
This explains why blockchains would want to pay holders for “simply” holding on to their tokens. It’s to encourage them to participate in keeping PoS-based blockchains secure and reliable. By staking tokens, holders can validate transactions and create new blocks, ensuring the blockchain runs smoothly.
Staking in Action
The two main uses of the word staking refer to:
Depositing tokens into an application to support a service offering for users, and
Locking tokens on a network to propose, attest, and add blocks to a blockchain.
Staking tokens involves locking them up as collateral in order to participate in the network's governance and earn rewards. This system provides validators with a financial motivation to act in accordance with protocol rules and maintain the integrity of the network, which benefits all participants. In the event that a validator fails to fulfil their responsibilities, they may face consequences such as losing a portion or all of their collateral.
Because staking implies a high degree of technicity, many stakers delegate this activity to third-party providers - sharing rewards with them.
Staking comes with many advantages, both for the blockchain itself and for asset holders.
Benefits of staking for the blockchain:
Increased decentralisation of the network: to take part in the network’s decision-making process, investors only need to set aside an amount as collateral (and not set up expensive computers to mine crypto as in PoW). As a result, more people are in charge of the network’s integrity and stability.
Reduction of the circulating supply: as investors are rewarded for long-term holding of the token (via staking rewards), they are incentivized not to sell,potentially allowing a rise in value. Investors are also encouraged to stake their rewards, in order to avoid inflation.
Eco-friendly process: PoS consumes significantly less energy than PoW. The Ethereum Foundation estimates that switching from PoW to PoS reduced energy consumption by roughly 99.95%.
Benefits of staking for asset holders:
Earn a passive income through rewards: as we have seen, you don’t have to actively manage your crypto to make money through staking. Simply lock it as a collateral, and the code does the work for you.
Potential increase in value of tokens over time as the network becomes more secure and valuable.
There is one drawback to keep in mind, however: staked assets are locked up and not easily tradable. That’s the trade-off you have to make for the passive reward system.
When you stake your digital assets, you're essentially locking them up and turning them illiquid, meaning they cannot be easily traded or transferred until the staking period is over or until you withdraw your stake.
The lack of liquidity may be considered a drawback for some investors or traders who prioritise having the ability to move their assets quickly and easily. This is because staked assets cannot be readily used for other purposes or traded on other platforms, which can limit their flexibility and accessibility.
Staking Crypto ETPs: the Easy Path to Proof-of-Stake Rewards?
An exchange-traded product (ETP) is a type of financial instrument that allows investors to gain exposure to the price movements of an underlying benchmark or asset without having to own the asset itself.
Our article What are Crypto ETPs provides more detail on the key features and typical structure of crypto ETPs.
Crypto ETPs have a few main advantages for investors:
Regulation. ETPs trade on regulated securities exchange, and as such follow strict rules and transparency guidelines for investors’ protection.
Convenience. You can buy and sell ETPs through your broker, just like you would for stocks and shares. They can be seamlessly added to your current portfolio along with other investment products, making management easy.
Security. ETPs take away many of the complexities and risks associated with holding crypto assets in self-custody or on crypto exchanges. This is especially true for physical ETPs, which physically buy and hold their underlying assets. When considering Staked ETPs, investors should check to ensure any staked coins do not move from the secure custodian where they are stored, and the ETP remains 100% physically backed at all times.
Staked crypto ETPs track the performance of an underlying cryptocurrency, but also include an additional layer of exposure to the staking rewards associated with that particular blockchain. This means there are additional benefits to be considered above and beyond traditional crypto ETPs:
Liquidity. Investors who choose to stake crypto using self-storage have to lock their assets to reap rewards, essentially rendering the assets illiquid. Staked ETPs do not have this downside: they can be traded freely during market hours.
Simplicity. Staking usually requires strong technical skills should an investor decide to do it independently. Staked ETPs remove much of this complexity by ‘baking in’ staking rewards into the return of the product itself.
However, not all staked ETPs are created equal: their structure can differ greatly from issuer to issuer across the crypto ETP industry.
Let’s explore how.
Staked Crypto ETPs’ Benefits: Accessing staking rewards through regulated products
Not all staked ETPs are created equal. When deciding on a staked crypto ETP, there are several points to consider:
Management Fees
Some ETP issuers choose to offer lower management fees for their products, and retain a portion of staking rewards in exchange for operating the ETP. However, many staked crypto ETPs do not pass these benefits on to investors: fees are not lowered, and there is no coin entitlement adjustment.
Transparent staking rewards
Are staking rewards being shared with investors in a transparent way? Whilst there are several PoS based crypto ETPs available in the market offering no staking rewards, there are also some which do offer rewards, but are not specific regarding the additional yield that investors should expect to receive over time.
Daily accrual
Do rewards accrue on a daily basis? Are investors able to see exactly how much they are being rewarded for each day that they hold the ETP?
Disclosure and mitigation of risks
Staking introduces new risks, such as illiquidity due to lock-up periods and slashing. Are all the risks fully disclosed on the issuer’s website? Are any key service providers experienced in managing and mitigating these risks?
Full physical backing
The ETP should remain 100% physically-backed at all times. When coins are staked, are any private keys kept securely with an independent custodian? Do the coins ever leave the issuer’s control?
Track record in underlying crypto markets
Staking is an exciting but fledgling activity, and requires in-depth knowledge to properly manage the process. Do all relevant counterparties have sufficient experience operating in crypto markets, and specifically with PoS blockchains?
CoinShares Staked ETPs
CoinShares currently offers 8 Physical Staked ETPs, covering major PoS blockchains. What sets CoinShares’ Staked ETPs apart from similar products is their innovative approach to staking.
To ensure complete transparency, CoinShares' Staked ETPs are built to share staking rewards with investors in two ways:
A reduction of the ETP management fee;
An increase in the Coin Entitlement (i.e. the amount of crypto each unit of an ETP is worth) each day, as staking awards accrue.
Below is a table showing the level staking rewards and the management fee reductions across all CoinShares Staked ETPs:
CoinShares Staked ETPs also include several security features designed to mitigate the risks associated with staking. Further details and documentation can be found on the relevant product page for each ETP.
It is important to note that Crypto ETPs are complex products, may be difficult to understand and have a high risk of capital loss. Before investing, you should always read the information contained in the Base Prospectus, any Supplemental Prospectus, the Final Terms and the Key Information Documents and other offering documents available free of charge on the ETP’s legal documentation website under etp.coinshares.com/documents in accordance with legal requirements as well as via the relevant stock exchanges and brokers.
Is Crypto Staking a No-Brainer?
Staking can result in several benefits, including increased network decentralisation and the potential to earn a passive income through rewards. However, investors must agree to lock up their assets, causing them to become illiquid for a period of time. Staked ETPs can make the process easier to navigate, provided proper due diligence is carried out on the ETP.
You can browse the full CoinShares Physical Staked ETPs catalogue for more details on each ETP.