The Takeaway:

  • Coinbase Custody is offering staking services to institutional clients, starting with Tezos.
  • Client assets will remain inside Coinbase’s fully insured cold storage at all times, mitigating risk to investors.
  • Since staking requires some funds to be kept online, Coinbase will put up its own coins, assuming the risk.
  • After deducting Coinbase’s fee, clients can expect to earn about 6.6 percent annually, the firm says.

Coinbase’s custody arm is trying to entice its institutional customers into the brave new world of staking crypto assets for profit.

Starting with the Tezos proof-of-stake (PoS) network, San Francisco-based Coinbase is offering clients the opportunity to make a return on their XTZ, that blockchain’s native token, the company announced Friday. After deducting Coinbase’s fee, investors can expect an annual return of around 6.6 percent, the firm estimated.

While that may sound alluring in a world where 30-year U.S. Treasury bonds yield less than half as much (and once-skyrocketing crypto prices are flatlining), investors will have to get comfortable with a highly complex arrangement. But staking is poised to become a bigger opportunity down the line, given that the second-largest cryptocurrency by market cap, ethereum, is expected to migrate to a PoS consensus system eventually.

Stepping back, unlike bitcoin’s proof-of-work (PoW) mechanism – which relies on excessive computation by miners – proof of stake requires participants to have skin in the game by depositing assets to the network and then helping validate decisions about which transactions and blocks should be added. For doing this, they receive payouts much like traditional miners in a PoW system. Users can also be punished by having their stake slashed for not helping or actively hindering consensus.

Moreover, participants who have assets to stake but don’t want to take part in the rather involved process of validating transactions and blocks can instead delegate their assets to someone else. Participants who choose to stake their crypto assets earn passive income on it, which ranges from around 5 percent to 25 percent annually, depending on the network and the level of participation.

The rub for investors is that generally speaking, validators running proof-of-stake nodes (known as “bakers” on Tezos) must have some funds online and so effectively “hot,” in crypto security parlance. That means these funds are more vulnerable to theft than when the private keys controlling them are kept offline, in so-called cold storage. 

To win over institutional investors who might be unsure of the risk/reward profile of PoS, Coinbase Custody is guaranteeing to its customers that all staked coins will stay in fully-insured cold storage. To do this, the company will post the necessary bond to bakers out of its own pocket. In this way, there is “zero risk” to its custody clients, Coinbase claims. 

Sam McInvale, head of product at Coinbase Custody, told CoinDesk,

“One of the reasons we are starting with Tezos and then following on with other delegated PoS networks is specifically because we can keep our clients’ funds that we will be staking in cold storage at all times.”

In the case of Tezos, bakers must post a bond equal to 10 percent of the total being staked, said McInvale. So if clients deposit $100 million worth of XTZ to coincide with the launch of the service, Coinbase would post a bond of $10 million worth of the tokens to its baker to meet that, he said.

“The way we are doing that is Coinbase Custody would go and buy $10 million worth of Tezos and post that bond so it’s our funds that are at risk, never our clients’. So we could suffer a loss if we were to get hacked, but our clients’ funds will always be safe,” said McInvale.

Custody clients with XTZ holdings will be automatically delegated from cold storage to the Coinbase baker. The firm does not currently have plans to allow its custody clients to delegate to other (external) bakers.

In the coming weeks, Coinbase will be adding governance support for the Maker (MKR) protocol which created the Dai stablecoin, currently being integrated into over 200 projects. Coinbase said it will also add Tezos voting in Q2 and hopes to add other reputable PoS chains, mentioning Cosmos, Polkadot and potentially Algorand later this year.

To be clear, though: The staking service Coinbase Custody is providing with XZT, and other blockchains down the line, is separate from tokens under consideration for listing on the company’s exchanges (though Tezos is also under consideration in this respect.)

It also should be noted that the newer PoS networks, including Tezos, have multiple keys, so the keys used to spend or withdraw assets are not the same as staking keys, which delegate funds. (Think of when a hotel puts a hold on your account as a deposit on a room; the cash is locked but has not left your account). So, the risks associated with staking are more to do with losing out on rewards or being shut out of staking cycles if the keys are stolen.  

While he would not…

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