Swiss financial institutions are increasingly offering opportunities to trade digital assets. This fulfils a steadily growing customer need and makes an additional asset class available. In addition to trading, there is also increasing demand from customers for other income opportunities, including staking.
Staking enables owners of digital assets to earn passive income by making their assets available for the operation of the blockchain and receiving rewards ("staking rewards") in return. The assets ("at stake") are used to secure and validate transactions on blockchains that are based on a proof-of-stake consensus mechanism (e.g. Ethereum, Tezos, TRON). The Staking locks the assets in favour of a "validator node", which validates the transactions of the network.
Staking does not require specialised hardware or high energy costs, as is the case with proof-of-work networks (e.g. Bitcoin). This reduces barriers to entry and environmental impact, which are increasingly important to customers. Staking provides a regular and predictable source of income that depends on the number of assets staked, the duration of staking and the distribution rules of the blockchain. Staking increases the security and decentralisation of the network by increasing the incentives for participants to trade honestly and protect the network.
An analysis of the risks
In return, however, this means that if a validator node misbehaves, whether intentionally or due to technical failure, this can lead to the partial or complete destruction of the assets used (so-called "slashing").
The biggest challenge in offering staking is due diligence and the selection of a suitable validator as a counterparty. Staking is often not operated by one's own validator nodes, but is outsourced to service providers in this area.
- Counterparty monitoring: Staking requires trust not only in the technical aspects of the network, but also in the reliability of the validators. An error or negligence in the operation of the validator nodes can lead to a loss or reduction in the assets used, which, in addition to reputational damage, can also raise questions about liability and compliance with the duty of care towards customers. Service providers in this area are often not yet as professionalised and transparent as would be desirable for a financial institution. There are hardly any standardised audit reports that would take into account the inherent risks of the service. And there are hardly any reliable assurances regarding the availability and integrity of processing.
There are other challenges that are also closely linked to technology:
- Monitoring market risks: Staking is subject to the volatility and price risk of digital assets. The value of the assets used can fluctuate significantly depending on the market situation, which can affect the profitability of staking. Staking can also limit the liquidity of the assets, as they are locked up for a certain period of time ("lock-up" or "withdrawal" period) and cannot be used for other purposes, which limits the flexibility and diversification of customers.
- Legal uncertainty: Staking is not immune to regulatory and legal uncertainty. The legal treatment and taxation of staking income can vary and change from jurisdiction to jurisdiction, which can lead to increased compliance burdens and legal uncertainty. In addition, some networks may be targeted by regulators who may question their compliance or legitimacy, which may lead to a ban or restriction on staking.
Summary
Staking is an innovative and promising method of securing and validating digital assets that provides passive income for the invested customers and a contribution to the network. Financial institutions can use staking to expand their digital asset offering and respond to customer needs. However, staking also has its challenges and risks that require careful consideration and research. One should be aware of the technical, financial and legal aspects of staking and weigh the potential costs and benefits to decide whether and in what form staking can be offered.
