The crypto space has come a long way in the past dozen years. The days when miners worked on gaming computers in their basements – more often than not in China – are so recent they don’t even evoke nostalgia.
But the game has utterly changed. To start with, not all tokens are mined anymore. While the proof-of-work consensus protocol on which mining is based continues to be a major consideration, other means are now available to maintain a blockchain’s reliability. Proof-of-stake opens up a whole new paradigm for optimizing returns.
Meanwhile, technology has moved ahead, processes have matured, and not insignificantly, China penalized itself in May when it cracked down on bitcoin mining. Today, mining is global and the United States is asserting its leadership in this new industry. It can also be said that staking has also found a home in the U.S.
Signs of that growing sophistication are not hard to spot and often take the form of higher returns or reduced risk. Miners consolidate their operations into teams, and those teams subscribe to pools. Full Pay Per Share, a protocol for miners to share in pool payouts, has evolved into a valid hedge against individual dry spells. In the meantime, the process for determining when and how much crypto should be converted into fiat currency has become automated and auto-liquidation is now the rule.
Foundry, the Digital Currency Group subsidiary that provides U.S.-based capital access to crypto investors and operators, is in a position to know how to blend crypto’s decentralized nature with America’s highly regulated and highly transparent market to maximum effect. (Digital Currency Group is also CoinDesk’s parent company.) Over the past year, it has developed a partnership with leading trading platform Genesis, also a DCG company, to offer customers new ways to improve their capital flows.
“There’s a lot of opportunity being left on the table and together we can help monetize them through our tailored approach,” says Foundry CEO Mike Colyer.
When FiDi goes DeFi
The financial districts of New York, London and Singapore might seem unlikely places to find the future of decentralized finance, and yet such is the case. Legacy institutions are increasingly sophisticated players in the crypto space. As this old-school money pours in, and portfolio managers realize that digital assets have the same market dynamics as stocks and exchange-traded funds, more and bigger brains are figuring out new ways to earn returns on them. Foundry and Genesis made sure they had those skills in-house as that demand started surging.
When financial engineering expertise hits the blockchain, money gets harvested in both mining and staking. Just by itself, mining has led itself to at least two sources of found value:
- Crypto-backed loans. It should come as no shock that, some days, it’s better to trade in something other than crypto. That said, people don’t like to part with their digital assets because there’s no telling when markets will suddenly reverse and prices will surge to new heights. That’s why it’s great to be able to continue to hold your crypto – bitcoin in particular because of its liquidity – but use it as collateral to take out a loan. The proceeds of that loan, then, can be used to pursue any number of short-term investments.
- Derivatives. According to the World Bank, around $60 trillion worth of stocks are traded annually. The Bank for International Settlements, though, reports the annual volume of equity-linked, exchange-traded contracts is a steady $15 trillion per year. In other words, just the prospect of buying or selling a stock at a strike price in a time window is worth a quarter of its price. It didn’t take long for crypto enthusiasts to apply that logic to this new asset class.
Lending, incidentally, is a two-way street. Bitcoin Core miners can post their coins as collateral to borrow against in order to mitigate the effects of price declines. However, they can also lend their BTC to counterparties in order to produce yield to help them cover expenses or invest in adding more production capacity.
Derivatives, mostly futures and options, have a reputation for being highly speculative, but that’s largely because people hear about them only when they go wrong. On a daily basis, financial institutions and corporate treasuries engage in many thousands of such transactions every day. When done correctly as a regular course of business, the intent of derivatives is to mitigate risk by mitigating a position through an offsetting hedge. Most derivatives are insurance policies, not casino tables.
“Institutions can hedge their bitcoin exposure and offset some of that risk by trading in futures and options,” Genesis CEO Michael Moro says. “As the crypto industry continues to mature, it becomes clear that established financial services providers need to be in it. Still, prudence dictates that anyone entrusted with others’ deposits use strategies that account for the price volatility of the underlying assets.”
Genesis and Foundry see at least one other potential means to make passive income with crypto.
- Staking. An agreement to lock up your crypto holdings is essentially the same as giving a loan to an exchange. While any interest rate cited here would quickly be out of date, it’s safe to say that staking generally earns higher rates than money-market accounts, certificates of deposit and certainly saving accounts.
Staking has the distinction of being less risky than lending, which is in turn less risky than derivatives trading. It also requires the least mindshare. Account holders can just maintain their positions and earn yield. And, while derivatives and lending are intended mainly for institutional investors, staking is frequently used by retail crypto enthusiasts as well.
The major shortcoming of staking is that it doesn’t lend itself to all cryptocurrencies. Bitcoin and other proof-of-work coins do not lend themselves to staking. This is more for stablecoins and such proof-of-stake tokens as Cosmos or Polkadot. When Ethereum’s long-delayed switch from PoW to PoS is complete – and that day does appear to be coming soon – staking would also be another way of unlocking its value.
Institutions use staking rewards, combined with derivatives, to create a more sophisticated portfolio and enhance their upside potential. The either/or choice is, in this case, a false dilemma.
Pulling it together
While there are many options available to institutional investors for accessing tokens and trading them, the value proposition for Foundry and Genesis includes a partnership intended to connect these adjacent processes seamlessly.
“If you want to stake with us but don’t have the tokens yet, Genesis can help you fill over-the-counter purchases,” Colyer says. “Then you can put those in Genesis’s custody to earn yield on those by staking with Foundry.”
Additionally, the Foundry-Genesis alliance lends itself to providing white-glove services that financial institutions can use to offer the same operations under their own banner. That might be an especially attractive feature considering the current upward pressure on interest rates.
Ultimately, though, institutions want to know that they are not just swapping one set of risks for another. Operations like this alliance provide a number of mitigation strategies. To reduce the risk of loss of principal, the investor can choose to perform his own custodial duties or to relegate them to any top-tier custodian, of which Genesis is one. Genesis incidentally offers a cold-wallet solution, for which private keys are highly secure and carefully safeguarded in compliance with strict regulatory standards.
Data security is maintained by Foundry’s data centers, which are among the most resilient and fault-tolerant in the world. Their geographic diversity only adds to the uptime.
While security – not to mention privacy – is important, it’s more of an assurance to investors than a differentiator for the service provider. If an asset can be staked, a blockchain-native financial institution must excel at staking. Regardless of the tokens held, it must also excel at lending and derivatives trading. Otherwise, investors’ returns could be less than optimal.