Is staking the new HODL? One recent analysis showed that 20% of all Ethereum is tied up in staking, and some ETH developers predict this could climb to 50%.
Whether the boom in staking is good or bad for the Ethereum ecosystem is a fair question, and one CoinDesk is exploring extensively in Staking Week, but it’s not the question we’re here for today.
This feature is part of Staking Week, presented by Foundry.
Instead, let’s acknowledge the basic fact that a lot of people -- regular old investors -- now care about staking, and presumably want to do it in a way that’s smart, savvy, and as safe as possible.
Maybe you want to put your crypto to work and make some extra money, especially as it languishes in the bear market. And maybe you know the basics of staking and why Ethereum switched to Proof of Stake (if not, here’s a fine primer), but you could use some guidance from the experts. As always, this is not financial advice and you should Do Your Own Research and floss your teeth and wear sunscreen, but here are some core principles to help you get started.
Spoiler alert: The secret sauce is something we rarely hear about in crypto: Boredom.
1. Think T-Bills
It’s easy to get distracted by the exotic staking possibilities -- obscure coins offering juicy rewards -- but the first and most important principle is to remember why you’re doing it in the first place, says Felix Lutsch, an advisor at staking company Chorus One. “Why you would stake on a personal level is mostly to avoid getting inflated by the new tokens that are minted,” says Lutsch. “It’s a bit like buying treasury bills.” With U.S. Treasury Bills, maybe you only earn a 3% yield but at least you’re (hopefully) outpacing inflation, and it’s better than keeping your cash in a near 0% savings account.
2. Watch out for incestuous collateral
Okay, it’s true that “incestuous collateral” is a phrase I just made up. But it seems like the best way to describe the twisted -- even dirty -- scenario where the collateral backing one asset class is the exact same as the asset it’s backing. Pawel Laskarzewski, a DeFi expert and CEO of Nomad Fulcrum, uses the traditional finance example of “The Big Short” to explain the problem: In 2008, many of the banks’ sketchy mortgages were “backed” by warped versions of these same dodgy mortgages (often masked in a bundle), so when the mortgages failed it toppled the entire system.
“In the crypto world, the staking solutions are very often connected to some kind of over-collateralized lending protocols,” says Laskarzewski. “We secure one crypto with another crypto, which means we use one class of asset to secure another asset of the same class.” Laskarzewski says this kind of over-leverage is how we see “massive liquidations in crypto with billions lost by the users.”
3. Focus first on the underlying asset, not the staking
One of the biggest mistakes that rookie stakers make, says Lutsch, is to get so enamored with staking returns that they overlook the underlying project. “This is one of the core places where retail users lost a lot of money last year,” says Lutsch. The classic example is , the failed stablecoin project. The project offered an alluring yield on USD, but “once you looked into it, you realize that it’s all based on the stability of the mechanism,” and that most people didn’t understand how the system worked, says Lutsch. Be suspicious of black boxes.
To minimize the risk of these kind of meltdowns, Lutsch recommends first investing in an actual project or token you believe in -- like Ethereum -- and then thinking of staking as the icing on top.
4. Swim in the pool if you know the risks
Staking pools like Lido, Stakewise and Rocket Pool are “quite an innovative idea,” says Dr. Steve Berryman, CBO of Attestant (a staking company). Normally, on your own, you’d need 32 ETH to set up as a validator and stake directly. This requires tech-savvy, infrastructure, and its own set of risks. (What if you set it up wrong?)
With Rocket Pool, for example, you “only” need 8 ETH to become a node operator, as a clever system of smart contracts fills up the rest of the pool. (In other words, your 8 ETH are the anchor in a block of 32, and the other 24 are made of small chunks of ETH from randos.) As a de facto node operator -- without having to actually handle the physical infrastructure -- you earn rewards and can likely earn a higher return than vanilla staking on a platform like Coinbase.
You’ll also receive “liquid staking tokens” for the Ethereum you pledge to the network, such as stETH for Lido and rETH for Rocket Pool, which can be used on DeFi Applications. In theory this juices your returns and lets you do something useful with your ETH while they’re pledged to the network, but Berryman says that these pools do contain some sneaky extra risk, such as “slashing” (when your validator is slashed or penalized by the network because of some mistake) or the fact that collateral in Rocket Pool is held in RPL, so a plunge in RPL could leave you exposed. Given the extra risks and rewards, Berryman says strategy for bigger players is “is to put 10% into Rocket Pool [or Lido] because they like that bit of extra yield, and they understand the risks associated with it.”
5. Beware over-leverage
The phrase “yield farming” has somewhat gone out of fashion, but that’s essentially what you’re doing when you plunk USD in one staking protocol, then get liquidity tokens in return, and then you put those new tokens into another staking protocol, then get more liquidity tokens in return, ad infinitum. This is leverage. It can net you 5X the typical returns, says Laskarzewski, but he warns that “once something goes wrong, you’re completely liquidated because you are over-leveraged.”
6. Vet the underlying project
Who’s on the leadership team? What’s their track record? Does the underlying project seem legitimate? “The main mistake people make is not thinking of the connection between the project and the yield,” says Lutsch. Especially in the number-go-up delirium of a bull market, the yield might look frothy and tempting, but then you later learn of glitches in the system or outright fraud. This is why Lutsch says it’s so crucial to vet the underlying asset, or as he puts it, “If you don’t trust the underlying project, don’t trust the yield.”
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7. Embrace boredom
So much of crypto trading involves wild price fluctuations, jolts of adrenaline, and the feelings of elation or despair. Staking should be the opposite. If you are earning a steady (but relatively modest) yield on your capital and not thinking about it very often, good, then you’re doing it right. “It’s a very boring thing, at some point,” says Lutsch. “You’re just earning yield over time. There’s not much to it.”
Edited by Ben Schiller.
