An Introduction to Crypto Staking in the Intricate World of Decentralized Finance

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Regardless of whether you are an early crypto adopter or just getting a grip on it, chances are you have heard of “staking”. This blockchain phenomenon that now boasts over $59 billion in locked funds is aimed to replicate the ways that traditional financial institutions make money. In layman’s terms, it means that DeFi allows the public to participate in financial markets by providing liquidity, borrowing and lending. And since it is blockchain that we are talking about, DeFi is of course limited to crypto only.

But how does one start in this intricate world of decentralized finance?

If you find yourself asking the same question, then consider this post a gentle introduction to staking and a dive into the decisive factors that pull certain entities and tokens to the top of the industry rankings.

Staking 101

By definition, staking is earning interest on “lending your funds.” Still, compared to traditional retail banking, where institutions lend funds to individuals and businesses, crypto staking replicates the financial market itself. On this side of the fence, the public gets a chance to earn rewards from lending or liquidity provision to crypto institutions, otherwise known as the apps where market action takes place. Such mediums are, first and foremost, the decentralized exchanges that not only attract high trading volumes ($10 billion per week, in the case of Uniswap), but also experience the need for constant liquidity in order to work right. Think Uniswap, PancakeSwap and SushiSwap. Tasty.

Every DEX and DeFi token app is akin to an ecosystem, each with a separate vision of the future, interest paid to liquidity providers and governance mechanisms. The decentralized nature of these – by any logical standards – behemoths, underlines that once you are in, your vote becomes an integral part of the ecosystem. It is like securing yourself a seat at the board of directors meeting of JPMorgan – impossible in the world of conventional banking, but very much a reality in crypto markets.

The token pairs

Final differentiating functionality that separates current DEXs from conventional crypto exchanges, like Coinbase and Kraken, is that it is not people trading against each other, but a market maker. This market-making algorithm is governed by a fixed formula that dictates how the price of a token pair is calculated. In the case of Uniswap, for example, the asset pair price is derived by multiplying the quantity of each token in the pair and having this number equate to a fixed constant.

Token pairs trading, lending and borrowing is what all decentralized exchanges and DApps run and how they earn fees. These fees are then fairly distributed among the token pairs’ liquidity providers. This is why selecting the right token is very significant for the future of your funds. Frankly speaking, this is where it gets a little bit more complicated, because DeFi houses an astounding variety of tokens. Even more so, DEXs are built to work with as many tokens as possible, and then take this idea even further by allowing users to exchange between indirect pairs – just like Bancor in the early days. So, if you need to buy EOS with XRT, but such a pair doesn’t exist on Coinbase, a DEX will fix it for you with its cross-pair smart contract and even allow you to add liquidity to such a pair.

As a liquidity provider, you will have to decide which token or token pairs to dedicate your funds to, but thankfully there are some key pillars to watch out for.

Security

The best tokens are those backed by real value carrying collateral. As an example, Wise is backed by a locked pool of ETH and BNB. The latter, as we know, depletes in supply. So, regardless of the direction the market takes, your funds will always be backed by an asset critical to the industry. Then there are tokens like Aave. Despite being backed by its native token, the $10-billion liquidity pool also provides proof that the ecosystem will not fail the next time you wake up.

The info

It always pays to find out about the project or token before channeling funds to it. Yes, DeFi projects usually come with a fleet of B747s packed with technical papers, but understanding the basics is a must. Sometimes projects pour an Indian Ocean worth of information over you just to hide otherwise obvious disadvantages of the ecosystem in question. Take a look at Maker‘s website for exemplary practice. It is clear and easy to digest, with just about everything you may need.

Community and governance

An active community is another great show of a token that does its job right. Similarly, when it comes to governance, control over what happens within the ecosystem often becomes a dealmaker to the token’s future. The same applies to the community’s loyalty, expressed in the amount of value that is locked in staking. As an example, DeFi projects like Synthetix report sums of nearly $2 billion, dedicated to the project by its following.

Final words

DeFi may seem to be overwhelming at first glance but continuing on the thought of a head start, it is best to start diving into it early. Moreover, judging by the industry’s development pace, staking will only continue to serve as a foundation for other innovative financial products that on a daily basis become even more complicated in a race to deliver higher yields.

Diana King is a PR and communication specialist for crypto and tech projects, journalist and producer.
 

Featured Image: Shutterstock/diversepixel

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