3 Things to Consider when Staking Cryptocurrencies
With the crypto market going off the boil in recent months, I have recently seen a lot of interest in high yield APY’s with DeFi tokens. A lot of investors are looking to stake their investments to try and mitigate the losses they may have taken since the top of the last cycle. Some of the comments I have seen have caused me concern, specifically in relation to chasing high yield rates for low cap projects.
I thought I would share some of my concerns in this article to hopefully educate the community around a couple of potential issues with staking. This is not going to go into the technology behind decentralized finance, but more so address the economic considerations that could cause you to lose money in these projects.
1. Impermanent Loss
Impermanent loss is when you purchase a cryptocurrency and it goes down in value.
Hypothetically, when you are staking for a yearly yield. Let’s say 10% per year. If you invested say $10,000 into that project and stake it for a year, you would have $11,000 at the end of the year, if that token stays at the same value you paid for it.
But what if it goes down in value???
Let’s say that token goes down 10% in value. You would now have $9,000 and after a year at a 10% yield, you would only have $9,900. So you would have actually lost $100.
What if it goes down in value by 50%?
You would have $5,000 and after a year you would have $5,500 at a 10% yield. If it does not go up in value you have to wait 4.55 years to get back to your initial investment of $10,000.
Be careful to consider impermanent loss. Make sure you do your research and don’t go out and buy some scam coin that is promising 3000% yields. If the project goes to zero. Then you make a 30x profit on zero. Which if you aren’t the best at maths, comes out at $0.
2. Consider the Total Coin Supply
Similar to my last point, when you have a 3000% yield. You have an increase in supply of coins.
For example:
Say you purchase a DeFi token that has a 3000% annual yield. If there is a circulating supply at the time of purchase of 1 million tokens. At the end of the year there will now be 30 million tokens if every owner was staking their tokens.
This has now multiplied the supply of tokens by 30x.
If you don’t have a 30x multiple of demand. Be it that you don't have another 30 million people interested in purchasing that token.
You can guarantee that the price of that token will go down in value.
This is basic supply demand principles. If the supply outweighs the demand the price will go down. Alternatively, if the demand increases and the supply does not increase, then the price will go up in value.
A great example of this is the AXS token for AXIE Infinity.
If you were to stake AXS you would get a yearly gain in the ballpark of somewhere around 70% at time of writing this article.
But if you look at how the price action trends on AXS it has been trending downwards consistently over the last 6 months.
Now you could put this down to the crypto bear market. But it also has something to do with an increase in supply of the token.
Much like the inflationary nature of the US dollar. There is a temporary inflationary nature to the AXS token. This will at a time in the future scale back. But you would hope that there is still demand for the AXS token at that time.
This is something you should consider when staking tokens!!!
This brings me on to my final point.
3. Utility is the key when staking or investing in cryptocurrency.
If there is a high benefit to owning that coin, plus you can stake that coin on top of it being incredibly useful to own. Then that is one of the key ingredients for success.
SPS token is a great example of this!
You can stake SPS for around 20% APY in the Splinterlands blockchain game economy.
SPS gives you the ability to vote on key decisions within the game.
It also gives you daily rewards in vouchers that allow you to purchase in-game assets. These vouchers will also be burned when assets are purchased, causing the supply to drastically reduce over time. Even if demand stays the same, it will increase in price.
It can be used to purchase rare in-game assets, like validator nodes and the SPS used to purchase those assets are burned causing SPS to reduce in supply.
There is a team working on developing this game and its underling assets to be one of the most innovative blockchain games, with SPS being developed to be a highly innovative DeFi token used in supporting this economy.
So, the moral of this story is don’t just look at the APY when it comes to investing in DeFi and staking through a bear market. Lower APY can be a better sign around the belief in the project.
Thanks for reading!
I would love to hear your thoughts on what are the best tokens for staking?
