Alex Fatuliaj
August 15, 2023
Tokenomics Tuesday
Startup Saturday

What is staking?


In the context of cryptocurrency and blockchain, staking refers to the process of "locking up" a certain amount of a particular cryptocurrency / token within the protocol's platform or surrounding ecosystem (e.g. in a liquidity pool).

There are different options for implementation: for instance, the staking can be locked for a particular timeframe where the user cannot unstake and retrieve their tokens, or can be liquid, there could be unstaking fees, different tiers, and things like that.

How can projects implement staking ?


POS


Staking can be implemented in Proof of Stake (PoS) blockchains for users to participate in the process of validating transactions and securing the network. In return for contribution to the network's security, stakers are eligible to receive block rewards or a portion of the transaction fees generated by the network (assuming they conducted the validation); on the other hand, the validator's stake will be slashed (i.e. taken from them) if they're malicious. In this way, staking incentivises users to be good actors.

Non-POS


Staking has also been popularised as a utility for non-PoS projects whereby users stake the token for the purposes of governance, or purely to earn a yield. When it comes to governance, the non-PoS projects can benefit from a similar incentivisation of good behaviour by ensuring voters put up collateral prior to enacting change on the ecosystem; this will be discussed in much greater depth in our future governance one-pager, as it's a rabbit hole in and of itself.

However, when it comes to purely earning a yield via fee redistribution or additional tokens coming from a tranche, which is what a lot of projects offer, staking can be seen as a method of user acquisition or retention.

Staking is also used to lock up tokens to make the real circulating supply less, thereby meaning that it’s easier to manipulate the price - in most cases, projects like staking because new demand will increase token prices by a greater extent.

Should staking be used to acquire users or for user retention?


From the perspective of a non-PoS crypto project, offering staking rewards can be seen as a way to acquire new users, similar to other forms of marketing or user acquisition efforts but without any upfront costs, per se; by allowing users to earn a yield by merely buying and staking the token, the project attracts new demand and takes away the liquidity from the market, which is also beneficial on short term price action.

However, it's important to understand that staking should not be seen as the primary driver of user acquisition or retention. While it can certainly attract new users, we need to carefully think about what users we're actually attracting, how we're doing it, and other elements, because from the perspective of the user staking provides yield regardless of the staking implementation. This comes with four crucial questions:

  1. Who are you rewarding?
  2. Where are the rewards coming from?
  3. What is your contingency plan for supply shocks?
  4. Are you bordering on security laws?

1. Who are you rewarding?


PoS protocols
reward validators for confirming transactions and validating the network. This is a healthy mechanic whereby people put up their capital in order to protect the ecosystem and get rewarded.

Non-PoS protocols either reward users, or speculators (merely token holders).

  • Users are fine to reward because they bring traction, volume, revenue, or anything else that adds value to your core business.
  • But rewarding merely token holders means you’re rewarding literally anyone that holds your token, be they a user of your platform or not. Speculators that come purely for yield are vagrants – they shift their capital to wherever gives the greatest APY and security. They benefit your project by reducing supply and increasing demand, but this comes at the long term cost of actual users, as explained next.

Your priority should be the users, not a secondary objective!

2. Where are the rewards coming from?


Rewards typically come from these three avenues:

A. Newly Minted

✔️Near zero cost for user acquisition.

❌You’re inflating supply. Although the effects of inflation are not reflected on price immediately, eventually stakers cash out, which has negative impact on price action that will be felt by the people who actually use your product. To balance this selling, you must create sufficient demand for the token via a good product and utilities.

B. Taxes

✔️Collecting fees/taxes and giving back to stakers is great for supply control and creating a circular economy.

❌Who are you taxing? Taxing active users to reward vagrants isn't good for user retention. Moreover, it requires your protocol to have users to tax: you can’t offer good staking rewards to attract users if you need users to offer good staking rewards. However, do you need to? If you have a good product, upselling it with “staking rewards” merely dilutes your proposition (most of the time).

C. Buy-backs

✔️Doesn't artificially inflate supply or tax active users.

❌You could be spending that revenue on R&D, BD, marketing, etc. which can yield greater long-term results.

3. What is your contingency plan for supply shocks?


As mentioned already, in Non-PoS protocols stakers are governors and speculators. With the latter, if a better opportunity arises, or if they sense that you'll reduce the staking APY, they will sell. Furthermore, if FUD occurs, they will cash out instantly because they have no loyalty to your project.

If the majority of demand comes from stakers looking for a yield, even with otherwise a great product, this massive supply shock will completely kill your project because it will lead to huge sell pressure which will crash the price of your token. It is essential to have a contingency plan to counter any supply shocks whether they are anticipated or not. Here are some ways you could limit the damage of a supply shock:

  • Announce a surprise partnership;
  • Have a sizeable token burn;
  • Announce/release a new token utility;
  • Announce project developments;
  • Run a marketing campaign.

These will all introduce new buy pressure, but ultimately your protocol needs to provide real value to users to ensure an impactful counter to the sell pressure can be implemented.

4. Are you bordering on security laws?


Your token stakers get a portion of your company revenue (i.e. direct revenue sharing or profit redistribution), then your token likely falls under securities regulation.

There are ways around this, such as creating an automated system whereby the rewards are not determined manually by the project team but instead are coded into the smart contracts, or having the rewards be determined by the users via a DAO or some other governance structure (we’re not lawyers, this is not legal advice).

However, eventually the law will catch up. Keep this in mind if you want to be here by 2030.

Conclusion


Fundamentally, it's all about ensuring you're doing what's best for the project over the long term. Once you set a precedent, it's hard to dial down staking rewards without detrimentally affecting your protocol and/or token price. However, if you plan carefully, include staking changes in your roadmap from the get-go, act transparently, and otherwise operate in good faith, staking can yield excellent results.

We are not telling you whether to implement staking or not, we are instead providing a framework for what you should think about prior to implementing staking, and reminding you to not use staking as a primary user acquisition tool for longer than absolutely necessary.


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