In search of Yield – Crypto Staking Solutions are Coming of Age
The State of Staking
Currently, staking accounts for $8 billion in crypto activity, and $15.4 billion of all crypto tokens can be staked, according to Binance research. Staking happens in many prominent crypto platforms, like Binance Staking, and is an increasingly popular activity. Binance Research estimates that the volume of staking activity will more than double once Ethereum, the second-biggest and most capitalised cryptocurrency in the world next to Bitcoin, introduces staking.
In the crypto realm “Staking” is used as a means of providing a return on one’s investment over and above the capital gains acquired from price increases. One of the complaints many have when coming from the legacy money realm is that Bitcoin and its Proof-of-Work model (PoW) does not provide a passive income form of return on investment over and above capital gains—something investors are used to in the traditional investment classes, in the form of dividends on stocks and equities, interest payments on bonds, and even rental income from real estate. This is one of the things that staking protocols are seeking to add that has been missing from much of the decentralised finance (DeFi) protocols.
There are multiple staking solutions provided in the market today with variations on the staking theme, such as Proof-of-Stake (PoS) and Delegated Proof-of-Stake (DPoS) being the most common. Staking rewards can vary from a small percentage to as much as 67% with varying lock up times and token inflation rates.
At its core meaning, the PoS model is structured on an algorithm that uses a ‘pseudo-random election process to select a node to be the validator of the next block, based on a combination of factors that could include the staking age, randomization, and the node’s wealth’ according to Binance research. In a PoS model, you stake some of your assets via a node to validate a new block. The more assets staked, the higher are the probabilities that they would end up validating a block. There is a period of time after the block is validated in which the block can be challenged and potentially proven to contain illegitimate data. If the block turns out to be illegitimate or if your staking node is offline, some or all of your staked amount will be taken or “slashed.” If legitimate, you’ll get back your staked assets and an additional reward.
Fundamentally, it is a shift from “mining” the coins to extract its digital value as is done with the current PoW system to “minting” a block in a Proof-of-Stake algorithm. Moreover, the PoS model will offer institutional investors better security as it will be more costly to attack.
The Ethereum makeover
You can think of Ethereum 1.0 as a prototype. We had to release something that we knew wouldn’t be scalable to prove that you could build decentralized applications.” — Joe Lubin
Ethereum 2.0 is set to go live in 2020 but through various phases. Phase 0, which is due out late summer early fall, is a core upgrade of its entire ecosystem from a Proof of Work (PoW) model over to a staking based security model - Proof of Stake (PoS) security model. As a less energy intensive means of confirming transactions than the mining done on proof of work protocols like Bitcoin, staking is intended to enable decentralized settlement of transactions without so much of an investment in mining hardware and energy usage. Designed to allow for fast, cheap, and secure transaction settlement at scale, staking protocols are becoming more commonly used as a means of achieving decentralized security along a spectrum of decentralization.
For ETH 2.0 to successfully launch, however, it will require 16,384 validators to stake their ETH in a deposit contract according to ConsenSys’ report. This means a strong commitment of ETH holders to voluntarily stake their funds is required for this transition to positively happen.
Many users in the cryptocurrency realm have been anxiously awaiting the ETH 2.0 upgrade to PoS that is due to happen this summer. In fact according to a New Ethereum 2.0 Ecosystem Report, over 65% of all 300 respondents surveyed plan to stake their ETH. The scaling upgrade will offer large ETH holders a means of earning passive gains on their holdings while allowing the system to scale globally as it needs to do in order to effectively achieve mass adoption. Ethereum is sometimes described as similar to the electrical grid, providing the utility platform for all the other coins built on top of it. There is an ongoing demand for ETH from all users of all the ERC 20 tokens and for DeFi protocol transactions that need ETH to pay the “gas” transaction fees that are currently rewarding the miners providing the proof of work. When ETH 2.0 launches its PoS protocol those gas fees will be divided up proportionately among those staking their capital in ETH. By shifting to a PoS protocol ETH will be able to handle a much higher rate of transactions per second without risk of centralization of the miners as with its current PoW approach. Many consider its current PoW system even more centralized than Bitcoin, claiming it is much more difficult to run both mining rigs and full nodes. This argument will become invalid once ETH 2.0 has launched, with the intent to simultaneously lower the gas fees required for each transaction. If and when it works, ETH 2.0 will make the Ethereum ecosystem faster, cheaper, and more decentralized.
Who’s already onboard with staking?
Many exchanges have begun allowing for staking rewards to be paid out as incentive to hold coins on the exchange, trading convenience for rewards as some of these coins require some technical proficiency, by sharing a portion of those with rewards with the exchange providing custody of the coins and enabling the earning of staking gains. Binance has been leading the way enabling traders to earn passive income on the coins entrusted to the exchange while they’re waiting to trade. Coinbase has begun to offer similar features on its exchange platform, and others are following suit. In fact according to the Block, a reported $1.2 billion has been invested in companies focused on building up client services and the institutional infrastructure eg lending, staking, brokerages and market maker platforms since 2014.
According to Binance research as of October 2019 the largest 10 cryptoassets, including Ethereum leading the pack, that are supporting (or planning on supporting) staking represent a cumulative market capitalization of $25.8 billion.
What we have is evidence of a nascent market rapidly evolving and maturing to allow for managing a variety of cryptoassets across chains and exchanges as well to provide more services to allow for more institutional participation. Currently 42% of active hedge funds are already staking - a clear sign that crypto market staking activity is ramping up. Taken altogether this highlights the importance for institutional investors to choose the right custodian who can scale and grow as they do.
The Role of the Institutional Crypto Custodian
There are many variations on custodial options today for private keys, with some allowing for self-custody on your own hardware devices versus others requiring you to custody your keys with a custodian in order to earn your staking rewards.
In a sector built on the premise of decentralization, providing crypto custody solutions that support institutional investors across the entire spectrum of the crypto industry, be that safekeeping assets, transacting on-chain, on-exchange, facilitating settlement, navigating DeFi protocols or staking is now a necessity.
Cold storage was used first by many exchanges and custodian wallet providers, as it was the only option that could be insured via specie insurance market. But cold storage solutions are reliant on physical access to private keys for every transaction, and given the shift from passive to active strategies, it is now too slow and too expensive for many institutional fund managers.
The other issue with cold storage is the reliance on omnibus accounts. Physically managing large numbers of keys is uneconomical, so a practical solution is to commingle client assets into a single omnibus account address. This raises the questions, “Who do those assets now belong to? What happens to them in case of liquidation? Are the funds being used for unauthorized purposes?
Cold storage omnibus accounts makes it impossible to independently and easily audit the accounts. Instead of using a blockchain explorer, users and auditors now have to rely on proprietary extracts from the service provider. What happens if the provider's private ledger becomes unavailable? Fund managers, administrators, accountants and auditors are forced to once again reconcile records, instead of taking advantage of the distributed ledger
Many exchanges have begun allowing for staking of coins as well that are held on the exchange and kept available for trading but in return a portion of those rewards are shared with the exchange itself. All of these clearly have benefits, drawbacks, and risks. By storing funds on exchanges that allow margin trading, whether they use cold storage or some other method, depositors are exposed to counterparty credit and liquidity risks.
This is where crypto custodians can add value and avoid these risks as custodians like Trustology don’t actually lend clients assets out but rather facilitate it with their explicit agreement. Over 80% of crypto funds agree according to a PwC’s 2020 Hedge Fund Report, which cites them as preferring to keep their coins held by an insured crypto custodian as it avoids the counterparty risk incurred by keeping one’s coins on any exchange and satisfies regulatory requirements to legally operate.
With the PoS protocols coming of age offering for instance the potential to lock up 1% to 5% of all ETH for interest-bearing yield and a budding DeFi ecosystem, many investors will likely benefit greatly from partnering with projects that can integrate with those systems well, allowing for the passive income streams their investors are used to in the stock and bond markets.
Forming strategic alliances with third party custodians like Trustology can do just that and here’s how.
Crypto markets are fast moving yet risky, so investors need a custodial solution they can go to market with quickly, without huge upfront investment or costs. They also need to comply with all of the existing regulations, so they need a compliant solution, one that is secure, reliable, resilient, scalable, fast, easy and cost-effective. They also typically serve multiple customer segments, so to reduce operating costs, the same solution should work across their entire customer base. Enter Trustology.
Users choose solutions with a great user experience, so we designed our solution with simplicity and convenience in mind without compromising on security or compliance.
By using a combined infrastructure of front-end software flexibility and end-to-end hardware security leveraging mobile phone secure enclaves, institutional-grade hardware security modules (HSMs), secure data centres and encryption, it becomes possible to create as many keys for users as they need, whilst ensuring keys are kept equivalent to if not better than cold storage security. We also go the extra mile to secure encrypted wallet keys.
We are not the only service provider using HSMs to provide custodial services to crypto traders or crypto funds. There are others, but the devil is in the details. By re-signing transactions with our proprietary firmware running inside HSMs, we mitigate an important attack vector. HSMs may keep the wallet key safe, and other providers sometimes use some form of end-user hardware to authenticate transactions, but hackers can still compromise the transaction if policy validation and re-signing is performed in software which we don’t do.
We, thus, prevent man-in-the-middle attacks and asset-protecting private key theft by signing network transactions with keys using our custom firmware operating inside hardware security modules only once all policy specified user-signed instructions have been collected. Also, we keep many encrypted backups of the asset-protecting private keys, so losing the phone does not mean losing your assets as it does when you lose your hardware wallet, and it takes less than fifteen minutes to register a new phone to recover access. We audit everything and monitor our systems for suspicious behaviours, both external and internal.
Segregated keys and instant transactions
We have developed a fully segregated key and transaction stateless architecture that ensures client accounts are always kept separate. This not only avoids the risk of not being able to identify who the funds belong to, but avoids the need to reconcile account balances when working with administrators, accountants and auditors
Our wallet keys are only ever created and used by our firmware inside programmable HSMs, but when not in use, they are encrypted, stored and backed up in the cloud. This allows us to operate a reliably fast and resilient service, that is cost-effective as it’s capable of supporting a near infinite number of keys, with clusters of cloud and HSM resources spread across multiple regions, ready for seamless failover and scale-out if and when needed.
The other benefit enabled by segregated keys and instant transactions, is the ability to work with DeFi protocols. Something that cold storage solutions simply cannot support. DeFi dApps, Uis, and business logic relies on access by segregated keys, and real-time interaction. A cold storage omnibus account operator or a centralised exchange would in effect have to rewrite dApps’ smart contracts and UIs, and sign them in seconds, not hours or days as is the case now. The alternative is to use a client-side solution, but that lacks the security offered by a custodial wallet service. By integrating a MetaMask extension with TrustVault, we have created a unique value proposition.
Risk management and safeguard controls
Our solution enables convenient trading integration with staking rewards still earned through its integrated multi-signature hot wallet that provides institutions the flexibility, speed, and security demanded by fund managers. In doing so, Trustology, as a crypto custody service provider, assumes the risk and responsibility of a bearer asset that funds are often prohibited by law from holding on their client’s behalf.
As we manage the keys and proxy transactions, users are simultaneously relieved of the need to secure keys and enforce access, multisig, whitelisting, and AML controls as we manage this as a service provider on-chain, on-exchange and across Defi dApps. Every user is KYC'd, and every transaction is KYT'd and unlike a hardware or software wallet, TrustVault accounts can always be recovered.
Convenience and speed
Many businesses need to receive, store, and quickly transfer cryptoassets on multiple blockchain networks, custody accounts, exchanges and/or across Defi dApps. Doing so with ease and security is a high priority for those businesses. Trustology’s TrustVault Business Account solution provides a custodial wallet service arrangement that keeps assets safe, insured and instantly accessible. Unlike cold storage custody, which can take hours or days to submit transfers, TrustVault reduces transactional delays to a sub-second. By enabling passive income on long term holdings through the earning of staking rewards we’ve added yet another level of value to Trustology’s offering to the crypto realm.
With the increasing use of leveraged trading, speed and reliability are now essential differentiators if a customer's open position liquidation is to be avoided. Our fully automated solution, based on a stateless architecture pattern, allows for fast 24x7 sub-second transaction signing under variable load, or partial geographical outages. As an added bonus, automation keeps operating costs low, allowing funds to be more competitive, address a wider user base, and achieve higher margins.
Trustology takes responsibility for running full nodes or partnering with trusted third-parties on the client’s behalf and have developed our own price indexers. We also offer alerts by email, push notifications, and webhooks, all while using a range of market data feeds to calculate balances in a currency of your choice.
As with cold storage solutions and yet unlike self-custody, the assets locked by keys kept in our custody are insurable. Through Aon, Trustology has secured a tailored insurance policy covering the theft, loss or destruction of digital assets in our care. The policy has been placed with a panel of insurers with an S&P rating of A+ and above.
Many crypto businesses involved in trading are increasingly looking for DeFi support to maximise earnings potential across lending, borrowing and staking. The issue here is that many DeFi protocols require users to meet margin calls for their collateralized positions and there is no functionality baked into defi protocols to ‘alert’ users on margin calls that are due. Hence, it's all too easy to miss the call and have your position liquidated. Additionally, DeFi relies more extensively on the use of segregated accounts in real-time. Our integration with MetaMask allows users to securely access defi apps and sign any Ethereum based transaction using their private keys rather than their MetaMask browser wallet keys which puts them at risk of getting hacked. This combined with our segregated account structure and resigning technology puts our clients in the best position possible to transact across chains and assets as we are blockchain and protocol agnostic.
Integrating through our APIs
Trustology is integrated with crypto exchanges via APIs, making it safer, easier, and more convenient for users to transfer and withdraw funds between their trading and custody accounts, either with the web app, or via APIs. Many trading accounts also do not support multisig, or whitelisting of withdrawal addresses. By using our solution, where we take over withdrawal APIs and time-sensitive one-time-password secret keys, we offer the same level of security for assets held on exchange but more importantly affords clients with the means to demonstrate mitigating fiduciary and holding risk. Users also gain added convenience by no longer needing to sign in to all of their exchange web apps and constantly refresh to track their transfers.
In Crypto Markets, Timing is Everything
The coming upgrade with ETH2.0 is the most significant in the blockchain’s history to date. We believe it represents a step-change for decentralised finance, both in terms of performance and scalability, that will spearhead the long awaited mass adoption, along with the opportunity to earn interest on ETH via staking.
Six high-profile crypto startups were selected to participate in an Ethereum 2.0 staking pilot project run by ConsenSys Codefi, a new product suite for commercial applications of decentralized finance (DeFi). It is administered by Ethereum-focused incubator, ConsenSys. The announcement was released on 16 June 2020, and Trustology features amongst the six selected.
ETH2.0 brings to the forefront the need for bank-grade secure, but lightening fast, custody solutions. Thanks to our custom HSM firmware in HSM, we are able to lead the market in offering a fast and scalable custodial wallet solution both for investors looking to stake on ETH2.0, and for validators involved in staking operations.