Pledge as a Service: An Emerging Cryptographic Track Ready to Launch

Source: Crypto Asset Management Company Bitwise

Compile and organize: Mary Liu

EthereumA technical upgrade called The Merge has been completed, changing the consensus mechanism of the network from workload proof to equity proof. It is expected that this change will reduce the carbon consumption of Ethereum by 99%, reduce its inflation rate by 75% - 90%, and provide long-term investors with the potential to obtain a 4-8% yield through qualitative positions.

This change is reshaping the crypto economy, and will pledge to the front and center of investors' attention. Among other effects, it has also spawned a new generation of service providers that help investors pledge assets and earn income.

This paper focuses on the rise of these staking as a Service (STaaS) providers, and analyzes their operation mode, available revenue, advantages and disadvantages, costs and relative market share.

Why do people pledge encrypted assets?

Pledge involves making financial commitments to the blockchain in its original assets to protect the network. Due to its security and decentralization features, it is a basic component of the blockchain infrastructure.

The main motivation for users to pledge encrypted assets is to earn additional income.

The revenue comes from the transaction fees paid by network users and the new issuance of network native encryption assets. Different blockchains provide different benefits (Ethereum is not the only blockchain that allows pledge). These benefits will change over time, depending on a variety of factors, including the number of holders participating in the pledge process, the proportion of total pledge supply and other variables related to network use.

For Ethereum, the total APY of people participating in the pledge can reach up to 8%. Although in the long run, with more participants entering the market and saturation of pledge reward distribution, these yields may decline, but it is expected to remain within the range of 4-8%.

However, the pledge is not without risks and challenges.

One challenge is that recently, due to high capital commitments and complex hardware requirements, most investors have difficulty in obtaining pledges. For example, the pledge on Ethereum requires the operation and maintenance of a 24/7/365 dedicated computer connected to the Internet (called the "verifier"), and the deposit of at least 32 ETHs to activate the verifier software (about 50000 US dollars at the current price).

Another risk related to the pledge is that a person's pledged assets may be confiscated or "Slashing". This design mechanism helps ensure that the verifier consistently implements network security. Suppose that the people running the Ethereum pledged infrastructure missed the software update or the equipment was powered off; In this case, even if there is no malicious act, the network security will be negatively affected, so a part of the ETH pledged by the user will be automatically reduced. Generally speaking, the reduction is similar to the fee charged by the bank from the customer's account when the minimum balance and other requirements are not met.

Pledging on Ethereum highlights another disadvantage of this process: Pledged assets are usually affected by the lock up period, which may be relatively long in some cases.

For example, ETH, a pre startup test network of The Merge pledged on the Ethereum beacon chain, will be locked in March 2023 (the earliest) from December 2020. In view of the price fluctuation of Ethereum, this will bring significant risks; If the market falls sharply, a yield of 4-8% cannot make up for the loss at all. Nevertheless, the locked pledge ETH is necessary for the enforcement of the Slashing mechanism, and the pledge reward reflects this risk: the earliest pledger of Ethereum has obtained more than 20% APY.

These barriers have spawned a new class of service providers that reduce the financial and technical barriers related to pledge by aggregating and pledging encrypted assets on behalf of users. Pledge as a Service (STaaS) providers deal with technical challenges, costs and risks related to different aspects of pledge, and provide another option for investors who want to obtain pledge income but do not have technical knowledge, capital requirements or risk appetite from bank pledged assets.

In addition to the technical nuances in dealing with pledge, an important value proposition of StaaS is that if the supplier's verifier has problems, the service provider, not the customer, will be punished by the asset forfeiture mechanism.

How do pledge as a service (STaaS) providers grow?

So far, STaaS providers are seizing a large part of the pledge market. Before The Merge, they accounted for more than 50% of the $21.1 billion pledged ETH on Ethereum.

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Source: Bitwise Asset Management, data from Dune Analytics, as of August 29, 2022. Note: "Pledge service" includes liquid pledge, centralized exchange and pledge pool, excluding other types of pledge.

STaaS providers obtain a portion of the pledge proceeds from the pledged assets of customers in exchange for their services.

This is not a small amount:Leading DeFi Pledge application Lido In the past year (before merger!) It has generated more than 300 million dollars of revenue.

Most pledge services are not related to blockchain, which means they support multiple proof of interest (PoS) blockchains. For example, Lido supports EthereumSolanaKusamaPolygon And PolkadotEach has different collateral nuances and provides different APY. The following table shows the APY pledged on various PoS chains currently supported by Lido.


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

STaaS Provider Comparison

STaaS Providers can take many forms, from DeFi applications (such as Lido and Rocket Pool) to listed companies (such as Coinbase)。 The following table outlines the leadingEthereumPledge service providers, including their APY, fees charged and relative market share of ETH currently pledged.

The leading pledge service provider represents ETH pledged with US $13.2 billion. As of August 31, 2022, an overview of Ethereum's leading pledge service providers:

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Source: Bitwise

Centralized and decentralized services

The biggest competition in the field of Staking as a Service is the competition between centralized services and decentralized services, which provide customers with different core value propositions.

Kraken And Coinbase and other central exchanges have made use of their positioning in the encryption market to achieve success in the pledge business. Users increasingly like the one button or two button function provided in their mobile applications. Institutions prefer centralized exchanges because they are located in the United States and operate within the regulatory framework of the United States.

However, pledge through centralized service providers may have its disadvantages. For example, for a network with regular lock requirements for pledged assets, the pledge with the centralized exchange may be a one-way transaction before the assets are unlocked. In addition, a layer of trust is required between users and centralized services, as most centralized STaaS solutions are hosted.

DeFi alternatives that provide more liquidity and require less trust have emerged. These services, also known as "liquid pledge", have two significant differences from non liquid services.

First, once investors pledge their assets, the service provider will issue a separate token to the investors, representing the investors' claims on their pledged assets and accrued returns. This token, known as "Liquid Staging Derivative" (LSD), can be used as collateral to borrow money or earn income on DeFi applications such as AAVE and Curve. Secondly, if users need to sell their positions before their pledged assets are unlocked, they can sell this LSD in the secondary market. In this way, LSD allows users to get rid of the liquidity constraint of locked assets. However, this is not a risk-free transaction: during periods of volatility, LSD can be traded at a price lower than fair value, reflecting the "cost" of this liquidity.

It is valuable for users and investors to bring interoperability and liquidity to pledged assets. The absolute demand for liquid pledge solutions is proof that Lido has pledged assets of more than 7.4 billion dollars in the five blockchains it supports, and enjoys 30.1% of the market share of the total pledged ETH. Perhaps this is why Coinbase launched a new liquid pledge product called cbETH for pledged ETH.

Lido   30.1% market share:

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

Lido's stETH token is the most popular liquidity mortgage derivative. At present, $2.3 billion of stETH is used as collateral for such DeFi lending applications as Aave and Maker. At the same time, Curve, one of the leading decentralized exchanges, provides $1.1 billion of liquidity for the stETH trading pair. Therefore, investors are not only the first to invest in pledge, but they are also using liquidity pledge services and the composability of DeFi to expand the APY and utility of pledged assets.

Market opportunity and potential of STaaS

Staking as a Service has gained great attraction. The fact that the dominant position of proof of equity network relative to the entire encryption market is snowballing shows that the demand for STaaS will continue to grow.

JPMorgan estimates that the overall transformation from PoW to PoS is one of the reasons why pledge has become a source of income for institutional and retail investors,Pledge may develop into an industry that generates more than $40 billion of revenue annually.

We expect the STaaS market to become more competitive as new suppliers flood in to take advantage of the opportunities represented by the pledge. This is usually beneficial to cryptocurrency, increasing the flexibility of the network and diversifying the risk of more participants - after all, this is the meaning of pledge.

Although it is unclear who will become the long-term market leader in this field - whether it is a centralized or decentralized pledge provider or a new type of STaaS provider that we have not yet seen - it seems likely that, with the development of the PoS blockchain, the Staking as a service provider is in a favorable position and can benefit from this growth.