Defi Staking is a Ponzi Scheme

Why defi staking rewards is unsustainable.

Before I go into the reasons why Staking is the hottest trend in the crypto world and why it will eventually go like the “Tulipmania,” I will explain what Crypto Staking is.

In PoS, holders of the crypto coins delegate their coins to Validators. These validators combine to make up the validator pool. This pool is responsible for validating and adding new blocks to the blockchain; in other words, keep the blockchain transactions chugging along.

As such, there need to be incentives for the validators to be performing this work. This reward is given in the form of more crypto coins. Since users have delegated their tokens to the validators, they also get a cut of the proceeds.

So, for example, hypothetically, if you had staked 1000 ADA (Cardano), you will receive 5% returns annually for staking. So, after a year of staking, your ADA bag will contain 1050 ADA coins.

This is a layman explanation of how Proof of Staking works.

So far, so good. Investors of the crypto coin are staking, and the company behind the coin is promising rewards. The company has a legit business to run, and as long as they are producing goods, all is well in this bright sunny world.

Due to the decentralized personality of the crypto industry, when various tokens/coins moved to PoS, they created their versions and rules for staking. Some kept it as simple as getting interested through saving’s account in a bank, while others made it closer to CD’s etc. There were also many more who made it look like subprime mortgages. No one even what those meant. The variance in definition quickly became way too much convoluted for the non-technical folks.

If you are a crypto investor and do not fully understand the technical details, you are always behind a step on everything. It’s much more difficult for you to understand the risks or even evaluate the risk if you know it.

Given a world flush with cash due to the bull run in the stock market for the last ten years and the COVID stimulus pumped by the central banks, and, investors who didn’t have the technical or financial chops to understand the product, a lot of companies smelled an opportunity in creating what is called today “Defi Staking” or “Staking as a service.”

These companies popped up in the last couple of years, promising to act as the middleman in this staking transaction. They promise to remove the complexity and assure dependable returns as “passive income” to investors who staked their coins.

So, you now have a situation where a separate company is acting as a middle man between the blockchain company and the investors. This company does not own the blockchain, or the product features that the parent company is introducing.

This company, which only does the role of a validator, is promising interest for the coins staked. These interests can range anywhere between 5.47% to 26.63%, as you see in the above chart.

To give you the correct perspective on interest rate climate, USA currently has an interest rate close to ZERO. Europe is in a negative interest rate, meaning you don’t get any returns for the money invested in banks. You pay money to banks to hold your money. Technically if this continues forever, your bank balance will at some point become, you guessed it, a big walloping ZERO.

So now that we have established the massive variance between the interest rate promised by these De-fi companies who promote staking-as-a-service and the prevailing interest rate environment, let’s look at the most critical question.

Usually, a Ponzi scheme has three distinct characters,

a. It promises “High Investment returns with no or little risk.”

b. It promises “dependable returns irrespective of market conditions.”

I am also going to add my trait.

Do you see how the companies promising crazy interest rates for defi staking ticks all of the checkboxes above?

I am not suggesting that all the companies are fraud. I am merely connecting the dots where these companies who have nothing to lose, except their investor confidence, are misleading their investments as passive income. People associate passive income to dividends, CDs, savings rates, etc. These are dependable, and in most cases, like in the US, are FDIC insured, so even if the company that promises these returns to go bust, they are backed up by a government entity so that the investor capital is secure.

Staking is nowhere near as dependable as passive income. These defi staking companies will have to resort to some financial wizardry to keep giving these high returns to future investors. If these companies go under, what is the mechanism by which investors get back their original investment? There seems to be no consensus or any binding agreement or any government-backed insurance.

If my hunch is correct, they will most likely reduce the interest rates after locking in significant capital in their books and pocketing the difference. When the market conditions don’t allow them to continue paying out these crazy interest rates, they will quickly close their company as they do not produce any goods.

There will undoubtedly be some unpleasant episodes of losses after this current bull run in crypto fades, and the 2nd crypto winter starts!!

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