As institutional interest in staking grows, how do we ensure that this does not compromise blockchain network decentralisation?

The decentralisation of blockchains goes well beyond a political or social ideology. It is critical to its very existence; only by moving to a higher degree of decentralisation can blockchain technology deliver on its promise to create a network that is more inclusive and immutable, and reduce the number of single points of failure within it. While every blockchain approaches decentralisation in a different way, the technology as a whole shares the common belief of creating a secure network that is beyond the control of a central institution. 

The role of staking in decentralisation

Staking has a pivotal role in this decentralisation of the blockchain. For specific proof-of-stake tokens (e.g. Solana, Avalanche and, more recently, Ethereum) the number of tokens staked on the blockchain dictates the capacity at which transactions can be verified and, in turn, how secure the network is as a whole. The introduction of staking was particularly revolutionary as it lowered the barrier to entry associated with proof-of-work tokens such as Bitcoin. Participants no longer needed specialised computer hardware to help verify transactions; this substantially reduced the consumption of energy, thereby unlocking the potential for greater geographic decentralisation as participation in the blockchain becomes more affordable and accessible to all.  

The increased institutional interest in staking

Institutions are now taking an increased interest in staking as it offers a more predictable long-term source of income in crypto that is both scalable and long-lasting. The blockchain always needs transactions to be verified, and the yield collected from staking provides both increased revenue and security. Since every blockchain needs to continuously achieve consensus to remain operational, staking yield from new supply will continue indefinitely, regardless of the demand on that blockchain.   

There has also been a growing demand for staking from investors who are now more knowledgeable on the yield opportunities within crypto. Asset managers have learned how to put their assets to work on the blockchain, and this increased demand for participation has fueled the emergence of institutional-grade services to serve this market. Investors are now able to participate in staking through reliable infrastructure and tooling, protected by a stronger level of insurance and liability coverage. 

The risks of this increased institutional interest

Of course, this increased institutional interest does come with its own risks. We are beginning to see centralisation with preferred providers and platforms. Institutional capital is often staked to either public or white-label nodes, which are driven by the activity of retail investors. Platforms such as Coinbase and Lido account for more than 40% of the staking activity on Ethereum. It’s a difficult problem to tackle; particularly as institutions continue to gravitate towards those trusted providers in the industry.

Fortunately, most investors and staking-as-a-service providers do understand the importance of decentralisation and the counterproductivity of a large number of a blockchain’s tokens being staked with a single validator or through a smart contract. We are beginning to see the number of institutional-grade services in the staking industry increase, which will help to keep the network decentralised while still meeting the security requirements and capital efficiency sought by institutional investors. These investors will always need secure access to PoS assets and the ability to participate easily, and so the onus falls on the industry participants to not only educate investors about the importance of decentralisation, but also ensure that they have the right tools to access decentralised staking offerings. 

Promoting a decentralised blockchain

As well as actively promoting decentralisation, it’s important that service providers consider their own decisions when looking at who hosts their staking validation. One approach is to use a solution layered on top of blockchains; Distributed Validator Technology (DVT) with companies like Obol and SSV show early promise of further validator decentralisation. Liquid staking platforms should be even better at diversifying validator sets, without compromising performance and reliability requirements of providers.

It should also be noted that the founders of blockchain protocols and Decentralised Autonomous Organisations (DAOs) also have a role to play in fostering network decentralisation. It could, and perhaps should, be a requirement for early investors as well as larger ecosystem participants to work with a diversified set of providers. While this may go against their yield-optimisation strategies, investors may need to compromise and take a small hit on revenues in the interest of ensuring sustainable blockchain growth. 

Diversifying the number, and locations, of service providers may cause a headache for regulators, as they will want to know who and where these validation services are. However, while a more decentralised blockchain may go against the grain of more regulatory control, it’s important that regulation caters to decentralisation rather than the other way round. 

The future of the blockchain, and staking, with institutions involved

Despite these concerns, institutional involvement in the blockchain should be seen as positive momentum for the crypto industry and staking in particular. Institutions bring with them an influx of capital, which is needed for blockchains to foster ecosystem growth and attract developers. Institutional investors will often commit larger investments over longer periods of time too, and this should help balance any short-term volatility that can have adverse effects on market sentiment. The key for the industry is to ensure that the products serving these institutions help preserve decentralisation.    

As crypto as an industry matures, we are now seeing the emergence of novel staking-based financial instruments, such as fixed income products where the exposure is given to the staking yield only and across multiple PoS networks. This attracts much higher levels of institutional interest and inflows, and so the appropriate measures need to be taken to ensure that these blockchain ecosystems thrive in a sustainable manner.ù

By Marius Smith, Head of Strategy at Finoa.

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