Change is Constant at Coinbase

“We’re proud to be the first full-service, regulated, comprehensively insured, and 100% offline staking provider in crypto” Sam McIngvale, Head of Product at Coinbase Custody

Coinbase is one of the longest operating and most well-known exchanges in the cryptocurrency business. Starting in 2012, the company has progressed to be among the leading exchanges.

While initially starting out offering exchange services, the company has since ventured into multiple areas of business. Their latest venture is into providing staking as a service to institutions using their custody services.

Coinbase has been changing rapidly in the last two quarters with an accelerated listing of crypto assets to Coinbase Pro taking place since the final quarter of 2019. In this post, we analyse Coinbase’s latest venture into the world of staking and the impact this decision may have.

 

What is staking?

 

Scalability with blockchain technology has been a topic of discussion and debate as far back as 2010. Blockchain technology may be revolutionary but it is slow and many solutions have been proposed to tackle this.

 

We discussed the issue to scalability in blockchain in more detail in a previous post here. One of the solutions proposed to tackling the scalability problem is to change the consensus algorithm which is responsible for facilitating trust in the system.

 

The top two networks by market cap, Bitcoin and Ethereum, use proof-of-work (PoW) as their consensus algorithm. This requires all block validators to check every transaction and keep a copy of the ledger, a computationally expensive and slow process.

There are many consensus algorithms which are being considered as alternatives to PoW but the leading alternative is proof-of-stake (PoS). PoS involves block validators effectively depositing assets to the network to act as block validators.

 

This puts their crypto assets at risk and if they process invalid transactions, their deposited assets will be slashed thus incentivising the block validators to act for the good of the network. The block validators also get rewarded for doing their job correctly, receiving a share of block rewards and transactions.

 

In some versions of this, it is also responsible for holders of the network’s cryptocurrency to delegate their holdings to a block validator and receive a share of the rewards in return. This also involves added risk as the cryptocurrency has to be kept in a hot wallet, one which is connected to the internet, and run a higher risk of being hacked.

 

How does Coinbase fit into this?

 

Coinbase launched Coinbase Custody in mid-2018. The service provides custody solutions for institutions, mainly to institutions with a fiduciary responsibility to their clients.

 

The new staking service will be for Coinbase Custody clients and facilitate the delegation of stored funds to block validators so to receive a share of the rewards. The service will be starting with the Tezos network and is planning shortly to extend this service to facilitating governance on MakerDAO. Ethereum also plans to eventually transition to PoS which will likely serve to make this service attractive to even more Coinbase Custody clients.

 

The increased risk of delegating funds to a hot wallet would an attractive proposition to custody clients who owe the utmost security to their clients. Coinbase will be using their own funds for delegation, taking on the increased risk of storing funds in a wallet connected to the internet.

 

Coinbase will take a handsome fee for providing this service and assuming the risk of using its own funds for delegation. Coinbase will take a 20 to 25% variable fee of all earnings but estimate that custody clients using the service can expect to earn approximately 6.6% annually after fees are deducted.

 

Does this move make sense for Coinbase?

 

Coinbase has already noted that it is not in competition with public staking-as-a-service providers such as Battlestar. Its services will only be available to institutions in Coinbase Custody and the funds will remain fully regulated and comprehensively insured.

Even in the case that the funds staked do get hacked, the custody clients funds will remain in a cold storage wallet meaning that the institutions can fulfil their fiduciary responsibility to their clients.

 

This move by Coinbase is the latest part of what has been an accelerated launching of new products since mid-2018. Coinbase was once one of the most conservative exchanges for listing new cryptocurrencies but it has started streamlining its listing of assets since late 2018.

 

The launch of staking as a service seems to be well thought out and pose little to no risks to Coinbase as a business. It may be turn out to have been an extremely lucrative move once Ethereum transition to PoS.

 

The streamlined listing of assets such as Ripple’s XRP likely poses a far greater risk to Coinbase in the future. These cryptocurrencies still have questionable legal status and there may be future repercussions to exchanges that list them.

 

For the moment, Coinbase continues to operate at the frontier of the cryptocurrency industry. It continues to innovate and try new products while shutting down those that do not work.