San Francisco-based exchange Coinbase is offering to hold the hands of institutional crypto customers – which means VCs, crypto hedgies, and family offices – if they happen to be on the fence when it comes to participating in next-generation proof-of-stake networks.
Proof-of-stake (PoS) is an algorithm which brings blockchains to consensus. Instead of burning about as much electricity as a small country to validate transactions on a network (like bitcoin does), PoS requires participants to have skin in the game in the form of depositing assets, by which they can earn more for good behaviors when blocks are formed. But those same stakers can also be punished and have their assets slashed if they go offline, or behave irrationally, or nefariously.
Coinbase is starting with Tezos, one of the largest ICOs back in 2017 which raised about $240 million, a sale which many accredited investors took part in. Coinbase is offering to delegate client funds while keeping the actual coins (XTZ tokens) in fully insured cold storage.
Coinbase Custody announced its Tezos offering in a blog post today:
“Most Coinbase Custody clients are investment managers and fiduciaries to their LPs. Participating in POS networks has raised an interesting tension for them: to stake or not to stake?”
“Prior to today, the risk necessary to actively participate in staking has mostly outweighed the return and therefore forced many institutional investors to sit on the sidelines. Our track-record of running secure crypto infrastructure coupled with our regulatory license and insurance program changes that calculus,” Coinbase said.
Without going into an inappropriate level of detail, Tezos holders have two private keys: one for “baking” (staking, earning block rewards) and one for withdrawing and spending assets (more like the traditional ownership key of crypto.)
Sam McInvale, head of product, Coinbase Custody told Family Capital, “The reality is almost all of these use cases are supported with cold storage in mind and certainly as you look to the newer chains that are coming out that have not launched yet, they are all launching with multiple keys to natively support engaging in those activities from cold storage.”
In order to bake, some 10% of delegated assets have to be online in a hot wallet. Anything connected to the internet is subject to the usual risks associated with hacks, insider thefts, wars, famine etc. However, Coinbase is keeping those ownership keys offline in a cold vault and posting the 10% bond itself on behalf of clients.
This all sounds great; you can’t lose. But Coinbase is taking its cut. The average PoS block rewards on Tezos are around 8% per annum. Coinbase said it will take between 20-25% of the 8% rewards earned by clients – so what you get with Coinbase Custody on Tezos is about 6.5%.
The more adventurous ICO investors out there, who are familiar with PoS networks, will know that if you self-bond and use one the many “staking-as-a-service” offerings out there (Figment, Battlestar, Cryptium) you can earn double what Coinbase is offering on your Tezos assets.
In the case of self-bonding, your assets are pooled with many others and not held in segregated accounts, as they are with Coinbase. This isn’t a big deal, however, say professional crypto stakers; Coinbase did it simply to appease New York State regulators.
“For right now we think it’s the best way to step into this new world by keeping our clients absolutely safe – making sure we can represent to our insurance providers, our regulator etc that we are not treating these assets any differently,” says McInvale.
Staking service Battlestar Capital founder Jason Stone said the option for people to stake in a non-segregated account fashion actually nets 12.5 -14% on Tezos annually.
Stone told Family Capital: “This is because you are running a self-bonding strategy that basically makes the pool a singular entity, as opposed to a delegator and a bonder, which is a race to the bottom strategy.”
“Yes, Coinbase entering the market is scary,” he says. “But I am personally not that scared because I don’t really view them as a competitor directly to our business.”