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Investors Guide to Crypto Staking

Investors' Guide
to Crypto Staking

Staking is as a foundational mechanism that ensures the security and sustainability of Proof of Stake (PoS) blockchain networks like Ethereum, Solana, or Aptos. This decentralized consensus mechanism not only safeguards the network but also grants rewards to participating investors in exchange for validating transactions on the blockchain.

Staking Guide PDF

Staking explained

Introduction

Investment strategies constantly evolve as investors seek avenues to maximize returns from their assets. Traditional finance has long relied on various instruments like bonds, stocks, and money market funds to generate income.

The amount of income depends on how risky or safe the instrument is perceived by the market. The emergence of crypto and digital assets has introduced novel approaches to leveraging digital assets for income generation, one of which is staking.

Given the unique driving factors, staking may offer a source of yield which is uncorrelated to traditional asset yields potentially enhancing overall income stability for investors.
Unlike securities lending, staking doesn't involve counterparty risk, as the staked assets remain in the blockchain ecosystem, but it can tie up investor crypto for a short period when staking starts or stops (often referred to as bonding and unbonding period).
Staking involves investors pledging their crypto assets as collateral to validate transactions on a blockchain network, thereby contributing to its security. In return, they receive additional tokens as rewards.
Staking can be seen as similar to equity dividends, however only those who vote and engage in the company's governance have the right to earn a share of the profits.

Within the following, this guide delves into the fundamentals of crypto staking, exploring its principles, advantages for ETP investors, associated risks, and how Bitwise can offer support in navigating this terrain.

Example: Ethereum Yield vs Other Yields

What is Staking?

Proof of work and proof of stake are two different ways of achieving consensus on a blockchain network. Consensus means that all the nodes (computers) on the network agree on the validity and order of transactions. This is important to prevent fraud, such as double-spending or altering the history of transactions.

Proof of work is the original consensus mechanism used by Bitcoin and some other cryptocurrencies. It involves solving complex mathematical problems that require a lot of computing power and energy. The nodes that solve these problems are called miners, and they are rewarded with newly created coins and transaction fees.

Proof of stake is an alternative consensus mechanism, used by Ethereum and other blockchains, that aims to address some of the issues of proof of work. It does not require solving difficult puzzles, but rather selecting validators based on how many coins they stake (deposit) on the network.

Staking is a mechanism that allows investors to participate in the validation process of a blockchain network and earn a return on their staked assets.

1Blockchain technology enables peer-to-peer transactions without the need for a trusted intermediary such as a bank or a financial institution.
2Peer-to-peer transactions require a consensus mechanism to ensure that the transactions are valid and consistent. For instance, if one party makes a payment to another, there needs to be a way to verify that the payer has sufficient funds in his or her account to make the payment.
3In traditional finance, a bank often acts as the intermediary that verifies and settles the transactions.
4A blockchain network has different consensus mechanisms to replace the role of the intermediary. Staking is a prominent consensus mechanism that supports the validation and confirmation of new transactions. To stake, investors allocate (“stake”) their crypto assets to a blockchain network. These crypto assets are then used to validate network transactions.
5Staked assets represent the minimum holdings required by the network to enable the validation and confirmation of new transactions. These holdings are denominated in the native currency of the network.
6As an incentive for allocating their assets, investors receive a return which is known as a staking reward (in addition to potential market returns). The amount of staking rewards varies for each network.
7Networks that use staking to confirm transactions consume far less energy than alternative mechanisms and are therefore considered more environmentally friendly.

Benefits to the Blockchain Ecosystem

Staking with ETPs

When it comes to staking, investors have many options. Utilising an ETP wrapper stands out as one of the most efficient, secure, and reliable methods to earn staking rewards.

The Key benefits of staking using Bitwise Staking ETPs are:

High operational efficiency
Low cost
Higher rewards potential vs other ETPs and staking options
Rewards automatically compounded
Liquidity, no lock up periods - investors can sell at any time on exchange
Transparent, benchmarked performance
Secure, no lending

	Staking ETP	Liquid Staking Derivative	Institutional Staking Derivative	Solo Staking
Liquid	Yes	Yes	No	No
Trading on regulated exchange	Yes	No	No	No
Slashing risk	Low	Low	Low	High
Minimum investment	Low	Low	Very High	High (32 ETH)
Execution layer rewards potential	Higher	Higher	Lower	Lower
Staking fee	10% *	10%—25%	Depends on AUM	0%
Benchmarked	Yes	No	No	No
Operational complexity to set up	Low	High	High	High

* The staking service fee is paid to the issuer of the ETP to cover for staking related fees

How Staking with Bitwise ETPs works

1
Bitwise securely “stakes” the underlying assets of specific ETPs on a robust platform managed by professional, institutional-grade staking providers. In all cases, the private keys for these staked assets remain segregated and held in cold storage at regulated custodians. This means there is no third-party counterparty risk (unlike securities lending)
2
The staking provider stakes the assets on behalf of the ETP.
3
The staked assets are used to secure the network and generate returns.
4
Staking rewards are reinvested into the ETP daily, adding to the ETP\’s performance.
5
The staked assets can be withdrawn at any time, there is typically a waiting period before assets are returned. This period can range from 0 days to as long as 6 months depending on the protocol (though typically it is one month or less). To solve this problem, Bitwise has developed proprietary liquidity bridging processes to manage the liquidity needs of an ETP considering these lock-up periods. Meaning investors can not only trade un-impacted in the secondary market and redeem in the primary market on a normal T+1 to 2 settlement cycles, without facing any counterparty risk. The above-mentioned liquidity bridging process is provided by conventional financial market players, not through so-called decentralized autonomous organization also known as staking platforms.

Benefits of Staking ETPs

Staking ETPs by Bitwise make staking efficient and reliable for investors allowing for both caputuring the spot performance of the underlying asset as well as enhanced ETP performance thanks to staking. Staking rewards generated by the ETP less a service related staking fee are passed on to investors by being reinvested in the ETP.

Bitwise Staking ETPs are designed to deliver the best possible outcomes for investors and aim at offering the highest staking returns and the lowest total cost of ownership compared to other staking ETPs on the market.

Investors in Bitwise Staking ETPs enjoy daily liquidity on the stock exchange and are not limited by lock-up periods or other technical challenges of digital asset staking.

ETPs are an efficient way for investors to gain digital asset exposure while trading on traditional financial market infrastructure, with all the benefits of regulated products.

Risks associated with Staking

Unstaking and Utilization Rate Limitation

Most blockchain networks impose a waiting period before staked assets are eligible to be returned (unbonding period). The ETP wrapper enables investors to sell on exchange at any time without waiting for unbonding. Furthermore, in order to meet redemption requests in the primary market, Bitwise Staking ETPs employ a proprietary liquidity bridging process where e.g. Bitwise borrows ETH to meet redemptions of the respective ETP. This means redemption requests can be processed on a normal T+1 settlement basis without incurring any additional risks and maintaining a high staking utilization compared to other ETPs. This is a significant benefit to investors when compared to staking crypto directly and is a unique feature of Bitwise Staking ETPs.

Slashing Risk

An error in confirming a transaction or violating protocol rules can result in a penalty called “slashing,” which means some of the staking rewards are lost.

Despite staking platforms' efforts to avoid errors and incurring slashing penalties, such issues can occur because of operational aspects of the staking process.

Bitwise Staking ETPs reduce the risk of slashing by employing professional institutional staking platforms whose sole purpose is to stake assets and be able to cope with those operational challenges.

Staking Platform Risk

An investor can either stake assets on a blockchain network directly (which requires significant operational setup and oversight) or rely on a platform to provide this service.

Relying on a platform allows investors to benefit from the platform's expertise and can be an efficient way to access the benefits of staking.

Bitwise Staking ETPs use established staking providers. All of these providers mitigate slashing using a range of measures such as third-party insurance and on-chain bonds. However, exceptions may exist where slashing risk is not entirely covered.

Staking vs Lending

What are the differences?

Staking and lending, while both yield-earning methods utilizing cryptocurrency, represent distinct approaches to generating income. Staking aligns with the native principles of crypto, whereas lending is a familiar concept in traditional finance.

Staking involves users committing cryptocurrency to a blockchain network to support transaction validation. Staking helps secure the network and, in turn, compensates those who stake with rewards.

On the other hand, lending is where users agree to loan their cryptocurrency in return for interest payments, which compensate lenders for giving up their assets for a period of time, as well as for the risk that they might not get them back.

Both concepts allow users to earn passive income, but the purpose, risks and rewards diverge significantly.

Bitwise does not utilize lending in any of its ETP products.

	Staking	Lending
Purpose	Help secure the network by validating the transactions	Provide liquidity to borrowers
Mechanics	Lock up or “stake” crypto assets on a Blockchain	Lend crypto assets to an institutional lending partner, can be on a collateralized or uncollateralized basis
Rewards	Staking rewards	Lending fee
Risks	Slashing Risk, Liquidity Risk (though daily liquidity is ensured through ETC Group products)	Counterparty Risk, Collateral Shortfall Risk

Frequently Asked Questions

Yes, all Bitwise ETPs - including the staking products - can be bought or sold on exchange daily. This means investors can buy and sell on the stock exchange during conventional exchange trading hours. Additionally, to ensure Bitwise can meet daily redemption requests on the primary market, a liquidity bridging process is employed where Bitwise borrows crypto in the market to meet redemptions. This process does not expose holders of the ETP to any kind of counterparty risk.

The level of staking rewards depends on the underlying cryptocurrency protocol. Generally, staking yield depends on the amount of staked assets on a blockchain network. The more staked, the lower the staking yield. But other factors also play a part, such as transaction volumes and overall demand for block space on the underlying blockchain network.

Yes. ETP holders receive all rewards less net of relevant service provider fees and staking fees charged by Bitwise. The fees vary depending on the product and are visible on the relevant product page on our website.

Staking rewards, net of fees, are added to the Crypto Entitlement (CE) of an ETP at the end of each trading day.

Yes. The staking providers Bitwise uses for its Staking ETPs have the ability to stake directly from the ETP’s custody wallet. This means the crypto assets’ private keys never leave custody during staking and remain in cold storage.

Yes, investors certainly can (and do) directly stake their own crypto but it requires substantial time and complexity to setup and a relatively high level of expertise. In addition, significant daily oversight is required to manage slashing risk. This can also be quite expensive given the fees on community validators. By choosing Bitwise Staking ETPs, an investor can enjoy the benefits of staking through a professionally managed institutional staking platform, without the need for specialized expertise in staking (or crypto).

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Key risks of Crypto ETPs

Cryptocurrencies and products linked to cryptocurrencies are highly volatile.
You can lose some or all of your investment.
Risks of investing are numerous and include market, price, currency, liquidity, operational, legal, and regulatory risks.
Exchange traded products do not offer a fixed income or match precisely the performance of the underlying cryptocurrency.
Investment in cryptocurrencies and products linked to cryptocurrencies are only suitable for experienced investors and you should seek independent advice and check with your broker prior to investing.

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Investors' Guide to Crypto Staking