Table of Links
Abstract and 1. Introduction
- Stablecoins and Lending Markets
- Fixed-Rate Lending Protocols and Derivatives
- Staking Derivatives
- Staking Fees as Stable Interest
- Stabilization Mechanisms
- Some Caveats
- Diversification, Interest Rates Swaps, and Tranching
- Towards Universal Basic Income
- Closing Remarks
- Acknowledgements and References
5 Staking Fees as Stable Interest
Because staking is essential for a PoS ledger system to maintain its integrity, staking fees on the order of 10% annual rate or higher are typically offered to incentivize stakers [42]. Importantly, these fees are relatively stable. Depending on how the derivative contract is set up, the fee can go entirely towards the holder of the relevant staking derivative. In the Anchor protocol [43], one can put down staking derivatives as collateral, for borrowing money in a stable currency. Instead of forfeiting all the staking fees, the borrower can continue to earn a portion of it. The exact percentage of this split is not a constant, as we will explain in the next section. But for illustration we can assume that this split will be 1:5, meaning the borrower gets to retain 1/6 of the staking fees earned. That means they give up 5/6 of the staking fees yield, in exchange of the instant liquidity provided by having the loan. (Nominally, the ‘splitting’ is more complex in the Anchor protocol, in that the borrower pays an interest, and receives certain tokens of value, ANC, in return. But the sum total of the transaction is equivalent to losing part but not all of the staking fees earned, and for simplicity we will continue to conceptualize and present it this way.)
Like other lending protocols discussed in section 2, the Anchor protocol thereby also functions a bit like a bank in a traditional financial system. To accumulate a pool of deposited money for lending to borrowers, it accepts savings in a stable currency from savers. Because it takes a split of the staking fees from the borrower’s collaterals, that can be used to contribute towards the interests to be paid to the savers. Using the example above of a 1:5 split of the staking fees between the borrowers and the protocol, at an overcollateralization ratio of 200%, the maximum affordable interest rate can be as high as 167% the staking fee itself; each dollar borrowed attract twice as much worth of collateral, which in turn attracts 5/6 of the staking fees per collateral unit (5/6 x 2 = 167%). This is why the Anchor protocol can offer such competitive interest rates, currently at about 20% annual rate, given that the staking yield is at 12% on the native LUNA network [22] for staking (12% x 167% ≈ 20%). In other words, it exploits a source of income that is not available in traditional financial systems, and is unique to PoS networks: staking fees.
But if the interest ultimately comes from staking fees, why do savers not stake the money themselves and earn the staking fees directly? Or, assuming some savers may lack the technical knowhow and familiarity with cryptocurrencies to engage in such activity, why does the savings protocol (such as Anchor) not directly stake the savers’ money on their behalf, and use the generated staking fees to pay the interest? Why do we need to involve the borrowers at all?
There are several advantages in doing so. The first is that staking is inherently risky, as explained briefly in the last section. During the period of staking, the value of the staked currency may fluctuate. Also, if the savings protocol collects money from many savers, and proceeds to stake the entire pool of money, this may also create an unhealthy situation for the staked network. Ultimately, the PoS consensus mechanisms work well when there are many different independent stakeholders, all incentivized to make honest and reliable decisions, none of whom are ‘too big to fail’. If all the validators are chosen and supported by a single source of money, the security of the network could be compromised [41]. By having borrowers who independently make their staking decisions, and contribute staking derivatives voluntarily as collaterals, the risks and control are both diluted over many individuals. Because the loans are overcollateralized, the protocol itself is protected against the risks of defaults or unexpected falls in the value of the staked currency.
Importantly, another key advantage is that because loans are overcollateralized, if the split of staking fees mostly go towards the protocol rather than the borrower, this leads to higher staking yield than would have been achievable via direct staking (167% in the example above).
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Authors:
(1) Hakwan Lau, Center for Brain Science, Riken Institute, Japan (hakwan@gmail.com);
(2) Stephen Tse, Harmony.ONE (s@harmony.one).
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This paper is available on arxiv under CC BY-SA 4.0 DEED license.
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