For the uninitiated, the world’s two largest cryptocurrencies by market cap, Bitcoin and Ethereum, run on a protocol known as “proof-of-work.”
In a nutshell, computers expend computing power to solve complex mathematical puzzles to secure the blockchain that validates transactions on the network.
But harnessing that computing power is an energy-hungry exercise – imagine running a high-performance mainframe computer 24/7 and you get the idea.
And that energy demand has long been used as a criticism of cryptocurrencies, that they are a wasteful use of power.
Short of shifting to alternative means of securing the blockchain, cryptocurrencies for the most part have had to make do with “proof-of-work” warts and all.
But that may be set to change as cryptocurrencies race towards what’s known as “proof-of-stake.”
Instead of expending large amounts of computing power to secure a blockchain, “proof-of-stake” works on the basis that consensus mechanisms (to determine which transactions are valid and which are not) select validators (to secure the blockchain) in proportion to their quantity of holdings in the blockchain’s associated cryptocurrency and receive fees for doing so.
Until fairly recently, “proof-of-stake” was a major challenge for most cryptocurrencies because of the tendency of many cryptocurrencies to be concentrated in the hands of a small group of wallet addresses or “whales.”
Part of the concern of course was that these “whales” could collude to prioritize the validation of their chosen transactions or undermine the decentralization of that particular blockchain.
Yet as cryptocurrencies have evolved and their adoption grown more widespread, so has the decentralization of many of their wallets, reaching a critical point where “proof-of-stake” has become more viable than at any point in the past.
Ethereum has taken the lead to shift towards “proof-of-stake” with the upcoming London hard fork or EIP 1559 set to change the fee market and move the cryptocurrency space into a more energy-neutral ecosystem.
“Proof-of-stake” allows existing cryptocurrency holders the opportunity to generate returns on their “staked” cryptocurrency by using that to validate transactions on the blockchain.
According to a report by JPMorgan Chase c analysts, led by Kenneth Worthington, “staking” could potentially provide investors, both retail and institutional, an opportunity to generate returns from their cryptocurrency investments and facilitate more mainstream adoption.
An estimated US$9 billion worth of revenue annually is generated by “staking,” according to the report, a figure that JPMorgan Chase’s analysts estimate could balloon to US$20 billion after the launch of the long-anticipated Ethereum 2.0 next year, that will move to “proof-of-stake.”
“Not only does staking lower the opportunity cost of holding cryptocurrencies versus other asset classes, but in many cases cryptocurrencies pay a significant nominal and real yield.”
Worthington and his team also see Coinbase Global (-0.30%) potentially earning as much as US$500 million a year in revenues from staking by the end of 2025, when they estimate that revenues from staking could hit as high as US$40 billion.
“We see staking as a growing revenue stream for cryptocurrency intermediaries such as Coinbase and a source of income for retail and commercial owners of cryptocurrencies utilizing the proof-of-stake protocol.”
Under “proof-of-stake,” users put forward a certain amount of cryptocurrency and in return get the right to validate transactions on a network, earning more cryptocurrency in the process, delivering a yield on their initial stake.
“Yield earned through staking can mitigate the opportunity cost of owning cryptocurrencies versus other investments in other asset classes such as U.S. dollars, U.S. Treasuries, or money market funds in which investments generate some positive nominal yield.”
“In fact, in the current zero rate environment, we see the yields as an incentive to invest.”
Staking to secure a blockchain is not to be confused with staking in decentralized finance or DeFi.
While DeFi is far more speculative in the sense that the bulk of yield generated is in the native DeFi token and most of the borrowing that takes place in DeFi is linked to speculating on other cryptocurrencies.
“Staking” to secure a blockchain serves a fundamental role to validate transactions without the energy-hungry practice of a “proof-of-work” protocol.
According to the JPMorgan Chase report, the current market cap of “proof-of-stake” cryptocurrencies is estimated at some US$150 billion.
But the potential to earn yield through staking, dramatically changes the complexion of cryptocurrencies as an investable asset class and addresses two primary concerns – the lack of yield generation and the energy needs for securing cryptocurrencies.