Cryptocurrency exchanges could use staking to effectively pay their customers interest at more competitive rates than is on offer at traditional banks and blur the lines between what is a bank and what is not.

Having launched staking rewards on Tezos for US customers in November, Coinbase is now rolling out the offer to the UK, France, Spain and the Netherlands.

Zeeshan Feroz, Coinbase’s UK CEO, explains to Finextra Research that “fundamentally, as a consumer you have the ability to own a coin and earn a reward on top of it, while folks like Coinbase do the work behind the scenes to participate and support the network.”

What is Tezos and what is staking?

Tezos is one the newer crop of cryptocurrencies, having launched in September 2018 after raising $232 million via an ICO.

Its network is based on ‘proof of staking’ protocol, meaning it does not involve the mining work and the huge electricity output involved that other cryptos like Bitcoin are built on.

Staking is a process where users hold funds in a cryptocurrency wallet to support a blockchain network’s operation.

Where most cryptocurrencies networks are supported by “proof of work”, staking relies on “proof of stake”, allowing blocks to continue to be added without the energy-intensive mining.

Instead of users of the network competing to add the next block by solving complex mathematical problems, they are chosen as validator of the next block based on their current stake in the network.

Some commentators therefore suggest that PoS is a more scalable and sustainable model for a blockchain than PoW, because it lacks the burden of excessive electricity use.

“Proof of stake serves the same purpose as mining, but it uses no energy,” Feroz says.

“In mining, you show your commitment to the network by using a lot of energy, but in staking you’re saying, ‘I’ll wager what I own in order to secure this network’.”

Feroz sees reward programmes such as this as “the building blocks that mirror some of the structures and incentives in the traditional financial system.”

Banks and non-banks

Earning rewards for holding an asset bears similarity to earning interest on a savings account, which will raise questions over whether Coinbase is attempting the trick of becoming a bank in all but name.

By giving its customers around 5% reward for holding cryptocurrency on its exchange, Coinbase is offering a rate of return above and beyond anything like to be found in a savings account at high street banks.

“I think this is loosely comparable to interest,” Feroz says. “Yes, you have some sort of earning based on the amount you hold.

“However, it is fundamentally different from interest because there’s risk in it, and you are earning those rewards by participation in the Tezos network.”

With customers' participation in the network handled by Coinbase, it is unlikely they will see any difference between rewards of this nature and earning interest on their savings.

Feroz believes however that rather than companies like Coinbase finding ways to offer banking services without being a bank, this is part of a broader change in the notion of what a bank actually is.

“You could look at the collaboration between fintechs at the front end and aggregate bank accounts at the back end, which become the go-to place for all your financial services.

“So, if you look at what somebody needs and how that can be procured, the underlying rails may be a traditional bank or may even be a crypto ecosystem.

“I sincerely believe that in the next five years, what we think of as ‘a bank’ today will be very different. The definition will broaden quite a lot.”

How successful Coinbase or any other company attempting this will be in attracting interest in its offering will depend on the user experience that can be offered and the trust that can be garnered from consumers.

The way forward

Coinbase state that its estimated annual return of around 5% derives from the rewards generated over the past 90 days and is set by the underlying Tezos network based on the number of users who stake.

Any return could of course be effectively wiped out by negative swings in the cryptocurrency’s price. While the price of Tezos has seen a 66% increase in the last three months, it of course is prone to the volatility that afflicts most cryptocurrencies.

Tezos may not necessarily be the network to make this practice widely used but other more prominent cryptocurrencies could be harnessed in a similar way.

Ethereum, the world’s second largest blockchain network by market capitalisation, is planning to relaunch later in 2020 under a staking model, which co-founder, Vitalik Buterin, believes will make it more secure and stable than bitcoin.

“I think this will potentially bring a much broader user base into contact with staking,” Feroz says.

“So, watch this space, as there’s plenty more coming.”