Staking as a Service: An emerging crypto market ready to take off

Ethereum has completed a technical upgrade called The Merge, which changes the network's consensus mechanism from proof of work to proof of stake. The change is expected to reduce Ethereum's carbon footprint by 99%, reduce its inflation rate by 75%-90%, and provide long-term investors with the potential to earn 4-8% returns through staking positions.

This change is reshaping the crypto economy, putting staking front and center for investors. Among other effects, it is also giving rise to a new generation of service providers who help investors stake their assets and earn a yield.

This article focuses on the rise of these Staking as a Service (STaaS) providers, analyzing how they operate, available benefits, pros and cons, fees, and relative market share.

Why do people stake crypto assets?

Staking involves making a financial commitment to a blockchain in its native asset to secure the network. It is a fundamental component of blockchain infrastructure due to the security and decentralization it provides.

The main motivation for users to stake crypto assets is to earn extra income.

The benefits come from transaction fees paid by network users and new issuance of the network's native crypto assets. Different blockchains offer different benefits (Ethereum is not the only blockchain that allows staking), and these benefits will change over time depending on a variety of factors, including the number of holders participating in the staking process, the percentage of the total supply staked, and other variables related to network usage.

For Ethereum, the total APY for those participating in staking can be as high as 8%. While these yields may decline in the long term as more participants enter the market and saturate the staking reward distribution, they are expected to remain in the 4-8% range.

However, staking is not without risks and challenges.

One challenge is that staking has been difficult to obtain recently for most investors due to high capital commitments and complex hardware requirements. For example, staking on Ethereum requires running and maintaining a dedicated computer (called a “validator”) connected to the internet 24/7/365 and depositing at least 32 ETH to activate the validator software (about $50,000 at current prices).

Another risk associated with staking is that one’s staked assets can be confiscated or “slashed.” This design mechanism helps ensure that validators consistently enforce network security. Suppose someone running Ethereum’s staking infrastructure misses a software update or has a power outage; in this case, even if no malicious behavior is being performed, the security of the network is negatively impacted, so a portion of that user’s staked ETH is automatically slashed. In layman’s terms, slashing is similar to the fees that banks charge from customer accounts when they don’t meet minimum balances and other requirements.

Staking on Ethereum highlights another drawback of the process: staked assets are often subject to lock-up periods, which in some cases can be relatively long.

For example, ETH staked on Ethereum’s beacon chain — a pre-launch testnet for The Merge that began in December 2020 — will be locked until March 2023 (at the earliest). Given Ethereum’s price volatility, this presents significant risk; a 4-8% yield simply won’t cover losses if the market drops significantly. Nonetheless, locking up staked ETH is necessary to enforce slashing, and staking rewards reflect this risk: Ethereum’s earliest stakers have earned over 20% APY.

These barriers have given rise to a new class of service providers that lower the financial and technical barriers associated with staking by aggregating and staking crypto assets on behalf of users. Staking-as-a-Service (STaaS) providers handle the technical challenges, costs, and risks associated with different aspects of staking, providing an alternative for investors who want to earn the rewards of staking but do not have the technical knowledge, capital requirements, or risk appetite to stake their assets themselves.

Beyond the technical nuances of handling staking, a key value proposition of StaaS is that if a provider’s validators fail, it is the provider who is penalized by the asset slashing mechanism, not the client.

How do Staking-as-a-Service (STaaS) providers grow?

So far, STaaS providers are grabbing a large portion of the staking market. Prior to The Merge, they accounted for over 50% of the $21.1 billion in ETH staked on Ethereum.

Source: Bitwise Asset Management, data from Dune Analytics, as of August 29, 2022. Note: “Staking services” include liquid staking, centralized exchanges, and staking pools, and exclude other categories of stakers.

STaaS providers receive a portion of the staking revenue from their clients’ staked assets in exchange for their services.

That’s no small amount: Lido, the leading DeFi staking app, generated over $300 million in revenue over the past year (before the merger!).

Most staking services are blockchain agnostic, meaning they support multiple Proof-of-Stake (PoS) blockchains. For example, Lido supports Ethereum, Solana , Kusama , Polygon , and Polka dot , each of which has different staking nuances and offers different APYs. The table below shows the APY for staking on the various PoS chains currently supported by Lido.

Source: Bitwise, data from lido.fi as of August 31, 2022

Comparison of STaaS providers

S TaaS providers come in many forms, from DeFi applications like Lido and Rocket Pool to public companies like Coinbase . The table below outlines the leading Ethereum staking service providers, including their current APY for staking ETH, fees charged, and relative market share.

Leading Staking Service Providers Representing $13.2 billion in staked ETH, an overview of Ethereum’s leading staking service providers as of August 31, 2022:

Source: Bitwise

Centralized and decentralized services

The biggest competition in the staking as a service space is between centralized and decentralized services, which offer different core value propositions to customers.

Centralized exchanges such as Kraken and Coinbase have been successful in the staking business by leveraging their positioning in the crypto market. Users are increasingly liking the one-click or two-click features provided in their mobile applications, and institutions prefer centralized exchanges because they are based in the United States and operate within the U.S. regulatory framework.

However, staking through a centralized service provider can have its drawbacks. For example, for networks with lock-up requirements for staked assets, staking with a centralized exchange may be a one-way transaction until the assets are unlocked. Additionally, a layer of trust is required between the user and the centralized service, as most centralized STaaS solutions are custodial.

DeFi alternatives that offer more liquidity and require less trust have emerged. These services, also known as “liquidity staking,” differ from illiquid services in two significant ways.

First, once an investor stakes their assets, the service provider issues a separate token to the investor that represents the investor’s claim on their staked assets as well as the accrued returns. This token, called Liquid Staking Derivative (LSD), can be used as collateral to borrow or earn yield on DeFi applications such as AAVE and Curve. Second, if a user needs to sell their position before their staked assets are unlocked, they can sell this LSD on the secondary market. In this way, LSD frees users from the liquidity constraints of locked assets. However, this is not a risk-free trade: during periods of volatility, LSD can trade at a discount to fair value, reflecting the “cost” of this liquidity.

Bringing interoperability and liquidity to staked assets is valuable to users and investors, as evidenced by the sheer demand for liquid staking solutions: Lido has over $7.4 billion in staked assets across its five supported blockchains and enjoys a 30.1% market share of total staked ETH. Perhaps that’s why Coinbase has launched a new liquid staking product for staked ETH called cbETH.

Lido 30.1% market share:

Source: Bitwise Asset Management, data from Dune Analytics, as of August 29, 2022.

Lido’s stETH token is the most popular liquid collateralized derivative. Currently, there is $2.3 billion of stETH as collateral for DeFi lending applications such as Aave and Maker. Meanwhile, Curve, one of the leading decentralized exchanges, provides $1.1 billion of liquidity for stETH trading pairs. Therefore, not only are investors jumping into staking first, but they are leveraging liquid staking services and the composability of DeFi to expand the APY and utility of staked assets.

STaaS Market Opportunities and Potential

Staking as a Service has gained significant traction. The fact that the dominance of proof-of-stake networks relative to the overall crypto market is snowballing suggests that demand for STaaS will continue to grow.

The overall shift from PoW to PoS is one of the reasons why staking has become a source of income for both institutional and retail investors, and staking could grow into an industry that generates more than $40 billion in revenue per year, according to JPMorgan estimates.

We expect the STaaS market to become more competitive as new providers emerge to take advantage of the opportunity that staking represents. This is generally good for cryptocurrencies, increasing the resilience of the network and spreading risk across more participants — which is the point of staking, after all.

While it’s unclear who will emerge as the long-term market leaders in this space — whether it’s centralized or decentralized staking providers, or a new class of STaaS providers we haven’t seen yet — it seems likely that as PoS blockchains grow, Staking as a Service providers are well-positioned to benefit from that growth.