As a Web3 business, focusing on maximizing cash efficiency, minimizing risk, and ensuring sufficient liquidity requires a comprehensive approach. In this article, we provide a brief understanding of crypto staking, its benefits and risks, how to start crypto staking, and accounting for crypto staking. If you need further clarifications or would like to discuss ideas, please contact LaunchFactor or professional accounting advisors recommended by AEM Algorithm.
Crypto Staking 101
Benefits of Crypto Staking
Risks of Crypto Staking
How to Start Crypto Staking
Accounting for Crypto Staking
1. Crypto staking 101
1.1 What is Crypto Staking?
TL;DR Staking is a way of earning rewards while holding onto certain cryptocurrencies similar to interest for bank balances or dividends for shares.
Crypto staking allows token holders to participate as validators by locking their tokens into a staking contract and running the associated validator software program, in order to verify and process new blocks through a consensus mechanism. The more cryptocurrency a validator stakes, the higher the likelihood they will be randomly selected to validate and process new blocks. In return, they receive associated staking rewards. Staking ensures the stability and security of a Proof of Stake (PoS) blockchain, as validators risk losing the cryptocurrency they've locked in the staking contract if they attempt dishonest behavior and validate false transactions.
1.2 Proof of Stake (PoS) Versus Proof of Work (PoW)
In the case of PoS blockchains like Ethereum, Proof of Stake uses randomly selected validators to confirm transactions and create new blocks as described earlier.
With the PoW consensus mechanism, which is used predominantly by Bitcoin, using a competitive validation method to confirm transactions and add new blocks to the blockchain,“mining” new blocks requires groups or individuals to solve complex, cryptographic puzzles.
Staking is considered to be a new way that aids in confirming the transactions. This process of confirming transactions occurs only in the cryptocurrencies that use the Proof of Stake model. So, any cryptocurrency that uses Proof of Work won’t have the staking feature–for example, the largest cryptocurrency, known as Bitcoin.
2. Benefits of Crypto Staking
2.1 What are the Benefits of Staking Crypto?
Earn passive income: Staking cryptocurrencies can provide a continuous passive income stream for Web3 companies. By staking, businesses can earn staking rewards, which are typically distributed in the form of additional cryptocurrency.
Investment Diversification: Staking cryptocurrencies can be part of the company’s investment portfolio, helping achieve diversification. Compared to traditional investment tools like stocks and bonds, staking offers different risk and return characteristics, which can help optimize the risk-return profile of the overall investment portfolio.
A Brief Comparison of U.S. Treasury Bonds and ETH staking: You'll see the annual yield in the U.S. Treasury bonds is 5.11%. In comparison, ETH has only 3.36%. This is because since Shanghai's upgrade, investors have become more confident in the validator staking layer. The amount of ETH staked in the validator pool continued to increase, and investors are doubling down on the future of blockchain technology through ETH staking, despite a worldwide capital crunch and a very turbulent time for Web3 since 2022. CFOs can position their company advantageously by adopting these new technologies and financial tools early.
The following are the ratios for the Top 8 Staking Assets, with data as of June 20, 2024:
ETH—3.36%
SOL—7.17%
ADA—2.9%
SUI—3.31%
AVAX—8.01%
APT—7%
TRX—4.27%
DOT—11.47%
In today’s environment of high U.S. T-bill yields, staking may not seem attractive. However, as U.S. T-bill yields decrease, we can expect increased interest in staking and cryptocurrency.
3. What are the Risks of Staking Crypto?
Technology Risk: Network vulnerabilities, such as attacks or bugs, can disrupt the staking process. A significant concern is the increasing prevalence of hacking. As incidents of crypto hacking continue to rise, crypto staking will likely become a prime target for hackers. There is an inherent risk that there is a smart contract vulnerability or bug. Also, validators risk staking penalties, with up to 100% of staked funds at risk if validators fail.
Liquidity Risk: Depending on how the company is staking its cryptocurrency assets, it runs the risk that it could become difficult to sell or convert the assets when needed and/or during volatile periods. CFOs need to consider the company's liquidity needs and ensure that the staking will not affect the company's cash flow for day-to-day operations.
Compliance and Regulation Risk: The cryptocurrency industry doesn’t have nearly the same sort of regulations as other financial products. It doesn’t have the same consumer protections for losses, marketing tactics/language or scams.
4. How to Start Staking Crypto?
4.1 Exchange
Most major exchanges (such as Coinbase, Binance, and Gemini) offer staking services, which you can initiate through the exchange's app or web browser. Typically, the first step is to see which tokens are available for staking. Do note that the services of the exchange might not be available in every country.
The staking mechanism and yields may vary for each token, so it is advisable to read the relevant information and staking terms provided by the exchange before starting.
The specific steps for staking in an exchange usually include the following:
Choose a token: Check the staking tokens supported by the exchange and select the token you want to stake.
Hold the token: Ensure you have a sufficient amount of the chosen token in your exchange account.
Start staking: Use the exchange's staking feature to select the amount of tokens you want to stake and confirm the staking process.
Earnings calculation: The exchange will calculate and distribute staking rewards based on the number of staked tokens and the staking duration.
Monitor and manage: Regularly check your staking status and earnings, and adjust the staked amount or un-stake as needed.
4.2 DeFi-Protocols (i.e. Lido Steth)
DeFi Staking Platforms allow cryptocurrency holders to earn rewards by locking up their tokens in a smart contract. This process, known as staking, contributes to the security and operation of the blockchain network while earning users passive income in the form of additional tokens.
5. Accounting for Crypto Staking
For the crypto staked, we can account for them as intangible assets similar to other crypto.
There are two methods to account for staking rewards:
Method 1: Accrue the staking rewards monthly.
Method 2: Account for the staking rewards upon receipt.
Generally, Method 2 is more common due to its administrative ease and lower tax burden. However, it may lead to more volatile net profit. It is important to consistently apply the chosen method and avoid cherry-picking for different crypto
About AEM Algorithm
AEM Algorithm (AEM) is an innovative accounting system provider, empowering Web3 businesses and accountants with advanced solutions and applications for accurate cryptocurrency transaction reporting and financial automation. Their flagship product, AEM Journaler, is a cutting-edge SaaS B2B accounting software that seamlessly integrates with Xero and Intuit QuickBooks. We are the only accounting platform offering a complimentary self-custody crypto wallet, AEM+, under active development.
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Winston Chan Winston Chan is a Core Contributor at Launch Factor, a leading web3 professional accounting firm. He specializes in integrating QuickBooks and Xero with crypto sub-ledgers and reconciling Web3 data for OTC exchanges. Winston holds a First Class Honors degree in Accountancy and an MBA from Nanyang Technological University. As a Chartered Accountant (Singapore), he has gained extensive experience working with esteemed institutions, including OKX, DigiFT, and KPMG. Contact: winston.lf@launchfactor.us Website: https://www.launchfactor.xyz/ |
Dino Liu Dino Liu is always eager to engage in discussions on achieving financial compliance within the Web3 industry. Contact: liuqiyuan2@gmail.com |
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