One way to achieve personal sovereignty is by cultivating financial freedom. That means developing a diversified portfolio of jobs, investments, and businesses to support a lifestyle of your choosing. But we are living in challenging times with Covid, war, supply chain shocks, and high inflation. It can be hard to allocate more cash towards wealth building investments. That’s why it’s important to learn and use this simple way to generate income with Crypto.
Like many people, I’m on the hunt for ways to put my investments to work for me. And this is true recently because inflation has weakened the purchasing power of my cash. The good news is that tools for building wealth are expanding, and it’s never been easier to get started.
That’s why I’ve been learning how to take advantage of my Proof of Stake crypto investments to earn income. The goal: earn income denominated in assets of an exponential industry without investing new money.
This article covers how to leverage Proof of Stake assets (like Ethereum & Solana) to generate income without investing more money. It’s perfect for someone that wants to grow their investments but is feeling the pinch of inflation.
Read on to learn more.
What To Expect From This Article
This article will cover the following topics:
- Setting expectations for these strategies by addressing volatility & time horizons
- Defining what Proof of Stake is vs Liquid staking
- How to use staking and liquidity tokens to generate yield on your long-term holdings.
- Two different strategies for what to do with liquidity tokens.
- Risks and caveats to these strategies.
- Some of the costs of pursuing these strategies.
- Concluding thoughts on these strategies matter
This article is long and sets context for beginners. If you’re more experienced with crypto, feel free to skip down to the how to guide if you want to jump right in.
Getting Started – Volatility & Time Horizons
Before jumping into the “how-to” section it’s important to recognize that crypto asset markets are volatile in dollar terms.
For example, we know that 1 bitcoin will always equal 1 bitcoin. And we know that it will have a max supply of 21 million bitcoins. But when compared to the value of the dollar, the price of bitcoin swings significantly in short periods of time.
In reality, this means that the money you invest into crypto should be viewed on a long time horizon. Ie: don’t expect to be able to use this money to pay for your living expenses in the near future. Crypto is an asset class that can require an extended investment time horizon of 2 to 3-year range. With a long-time horizon, it’s easier to navigate the volatility of this asset class and achieving greater returns.
But with volatility and a longer time horizon in mind, it can be intimidating to invest money, time, and energy into this emerging market. This is especially true in the Covid, global war, and supply chain disrupted financial environment of the early 2020s. Many people don’t feel good about locking more money up in a volatile asset class. The risk profile just doesn’t make equal sense for everyone at the moment. And that’s ok!
The good news is that the crypto industry has come a long way in the past few years and you can now use many of your preexisting crypto assets to generate income (in both dollars and in more crypto). There are new tools that provide a great way to grow your total holdings without the need of investing more money. And you don’t have to be a sophisticated user messing around with liquidity pools and impermanent loss.
There are now simple savings tools and automated investment vehicles that can help you earn a significant yield on your holdings.
The point: In order to generate income with crypto, you need a longer time horizon and an understanding that you’ll be exploiting the asset classes volatility.
Staking vs Liquid Staking
This is a non-technical guide for non-technical people. It’s intended to provide a simple to use strategy to generate yield on your holdings. As such, I won’t provide a technically nuanced definition for proof of stake or cover the mechanics of staking. You can get those elsewhere.
For our purposes, I’ll provide some simple, need-to-know definitions that will act as a baseline for further research if you’re interested.
Proof of Work vs Proof of Stake?
Rather than reinvent the wheel, let’s look at how Coinbase defines Proof of Work and Proof of Stake networks.
Proof Of Work
In a Proof of Work system, “the network throws a huge amount of processing power at solving problems like validating transactions between strangers on opposite sides of the planet and making sure nobody is trying to spend the same money twice. Part of the process involves “miners” all over the world competing to be the first to solve a cryptographic puzzle. The winner earns the right to add the latest “block” of verified transactions onto the blockchain — and receives some crypto in return.“
Proof Of Stake
In a Proof of Stake system, “Cryptocurrencies that allow staking use a “consensus mechanism” called Proof of Stake, which is the way they ensure that all transactions are verified and secured without a bank or payment processor in the middle. Your crypto, if you choose to stake it, becomes part of that process.”
“A major way Proof of Stake reduces costs is by not requiring all those miners to churn through math problems, which is an energy-intensive process. Instead, transactions are validated by people who are literally invested in the blockchain via staking.”
“The exact implementations vary from project to project, but in essence, users put their tokens on the line for a chance to add a new block onto the blockchain in exchange for a reward. Their staked tokens act as a guarantee of the legitimacy of any new transaction they add to the blockchain.”
“The network chooses validators (as they’re usually known) based on the size of their stake and the length of time they’ve held it. So the most invested participants are rewarded. If transactions in a new block are discovered to be invalid, users can have a certain amount of their stake burned by the network, in what is known as a slashing event.“
But with PoS systems, you can’t just decide to be a network validator. There are specific minimum staking requirements across the variety of PoS chains.
Staking services emerged as a popular workaround for everyday people that wanted to stake their assets. Ie: Staking as a Service is when a validator service pools assets from individuals, uses those assets to conduct validator functions, and then splits the rewards among the pool of investors.
The bottom line is that staking as a service provides access to the financial benefits of staking to the non-technical masses. The upside is that these services provide access to a variable rate income, but the downside is that it requires that capital be locked up.
Liquid staking was developed in response to the locked-up capital requirements of staking.
According to Messari, “Since staking is a commitment to the security of the network, assets need to be locked up in order to prevent a “bank run” scenario where all the stake is quickly withdrawn and the network’s security collapses. The lockup period is unique to each network. Unstaking for Solana only takes two days, whereas stake in Eth2 is locked indefinitely until it completes its transition to PoS.
Liquid staking provides depositors with a derivative asset that represents their staked position, accrues staking rewards, and can be traded and potentially used as collateral for DeFi activities. While liquid staking is a feature that both custodial and non-custodial STaaS providers may offer customers, it’s most commonly used in decentralized staking pools. These protocols don’t run validators themselves. Instead, they accumulate staking deposits and distribute them to validators already operating in a given network. For this reason, rewards and penalties are generally shared by all depositors in a staking pool.”
So the value proposition of liquid staking then is that it permits a person to stake their crypto to earn network rewards while also being able to have access to liquidity. Ie: some staking services provide IOUs in the form of liquid tokens that can then be traded and invested in unique ways.
Now, we can finally get to the part you care about. The steps you can take to stake, receive liquid IOUs, and use those IOUs to earn some income.
The HOW-TO GUIDE:
The Steps You Can Take To Earn Income
We are going to use liquid Proof of Stake assets to earn income.
That means identifying liquid staking services that provide staking yield and provide us with the IOU liquid stake tokens. We’ll then explore options to put those IOUs to work generating income.
To begin with, you’ll need to own proof of stake assets like Ethereum or Solana. In the following example, I’ll be using Solana and Solana ecosystem assets but this practice is becoming widely available for most PoS assets.
Start by taking the asset off exchange into your preferred self-custody wallet. I use Phantom for my Solana assets which can integrate with a Ledger hardware wallet.
Identify The Platforms That Provide Liquid Staking
Here are three examples from the Solana Ecosystem.
“Stake and grow your SOL holdings with Lido for Solana. Get instant liquidity and participate in DeFi with stSOL.”
Lido is unique in that it provides a wider set of services beyond the Solana chain.
“Stake SOL and use mSOL while earning rewards.”
“The best risk-free yields on Solana.”
As you can see, each of these services provides around 6% APY for staking Solana. This amount varies by asset type and service but generally doesn’t fluctuate too much. You could think of staking alone as placing your asset in a money market fund. It will work best with a “set it and forget it” attitude.
What To Focus On When Comparing Options:
Total Value Locked or Staked
Total Value Locked or Staked shows the amount of the token and their corresponding value in dollars staked with the service provider. This can be used as a comparative metric to assess the relative popularity of the platform as it relates to the assets you’re interested in staking.
It’s sometimes ok to follow the herd. Ie: there’s a behavioral economics concept that we often make decisions by following the herd. In this case, if it seems like a lot of people are using one staking service versus another, that’s a good decision-making data point to keep track of.
Value of The Liquid Token vs The Underlying Asset
You can also see the value of the liquid stake token vs staked asset. The liquid token is what is provided in exchange for the staked asset. This will not have a 1:1 price ratio because the liquid token corresponds to the value of the staked asset plus a percentage of the platform staking rewards. So, if I deposit 1 SOL, I can expect to receive slightly less than 1 liquid token in return.
This ratio will make more sense when you consider the reward APY you can expect in return for staking your assets.
The Staking Yield
As you can see from comparing Lido, Marinade, and Socean, each platform has different total amounts of staked Solana, different corresponding values of their liquid tokens when compared to Solana, and each provides a slightly different APY for staking Solana.
These rates are variable based on supply, demand, and rate of rewards won by the pool. But typically, the rates stay in a narrow range.
Before comparing the three platforms and deciding which to use, it’s important to understand what you can do with the IOU token you receive from each platform.
The low-risk and simple option is to find lending platforms that have a demand for liquid stake collateral. Ie: The lending platform has users that want to borrow the liquid stake token. You can think of this opportunity as a high yield savings account that will lend out your liquid stake in exchange for yield. The difference is some lending platforms are more in line with wildcat banks than they are with modern banking. That means more risk of default.
Here is a comparison of two lending platforms that provide interest for liquid stake collateral.
As you can see from the image, Tulip accepts deposits of mSol (Marinades liquid stake token) and stSol (Lido’s liquid stake token). They do not currently accept deposits for Socean’s liquid stake token.
It’s worth observing that there is a considerable difference in yield when comparing mSol’s 1.87% APY vs stSol’s 8.81%.
From this first comparison, we can already start to get a sense of the value proposition of each liquid staking platform. Marinade and Lido provide almost the same staking yield, but Lido’s liquid stake token is considerably more valuable than Marinade’s and Socean’s tokens.
But we still have more research to perform. This is only one platform and one strategy.
Let’s now look at Apricot.
On this platform, we can see that each of the three liquid staking tokens can be deposited for varying yields.
A key distinction is that with Apricot, they provide an APR vs Tulips APY. ie: Apricot does not compound the interest rewards while Tulip does. This is a significant distinction if you plan to use this strategy for a long period of time.
A further distinction is that Apricot provides some of the interest payments split among a number of governance tokens and the underlying liquid stake token. For example, with mSol, you’d receive a small amount of Marinade’s governance token, a small amount of Apricot’s governance token, and a remaining amount of the payment yield in mSol. The same is true for the other liquid stake deposits on Apricot.
This is very important to understand when comparing and contrasting the value propositions of which staking platform you use. You may ultimately decide you don’t see value in receiving a governance token and would prefer to receive yield in the form of more liquid staking tokens. The question you have to ask is whether you want more Solana or you’re willing to make a bet on the future value of these governance tokens.
Ie: based on the current information we have in these examples, if you wanted to maximize your Solana holdings, you’d opt to stake Solana with Lido to earn 6% APY, then deposit your liquid stake token (stSol) into Tulip for an additional 8.81% APY. A caveat here is that these yields are not fixed rates. They change based on market borrowing demand for stSol.
Or, perhaps you decide you really like Lido, you like the fact that they facilitate liquid staking for a variety of crypto assets, and you can see value in owning their governance token. So you opt to deposit stSol into Apricot to earn some yield in governance tokens.
Options Vault Strategies
But there’s more to the value proposition of liquid staking than lending liquid tokens out for yield. In fact, it’s one of the reason’s there is demand for borrowing liquid staked tokens in the first place.
You can take on more risk by trading the liquid stake tokens. One way to do this is by taking advantage of options selling strategies. (covered call options writing)
I’m not going to go into detail on these strategies beyond saying that they allow you to earn income by making directional bets on the future value of the underlying assets. (That being both the market value of the particular liquid stake token and the value of SOL).
Selling call options to generate income is not a beginner strategy. But over the past few years, the crypto industry has developed some very useful tools for individuals that want to generate income from their long-term holdings but don’t have the skills to write their own options strategies.
There are now several automated/algorithmic trading strategies that productize the skills needed to conduct the trades that generate yield. Put another way, these apps democratize access to earning yield on long-term holdings.
To be clear, these strategies have considerably more risk than simply depositing into lending platforms. But with greater risk comes the potential for more yield as we’ll see below.
Here’s one example of an option vault.
As you can see from the image, all three liquid stake tokens have covered call strategies that provide different expected yields. These strategies typically focus on writing weekly call options. You deposit your liquid tokens into the vault where they are locked for the duration of the weekly strategy. If you decide to roll your funds into the following week’s strategy, the vault will automatically compound the income you earned from the previous week’s options.
Based on the above projected APY’s, you’d yield about 0.5%of profit each week. But that of course assumes that the weekly options expired without being called.
When reviewing these vaults, you can see a greater breakdown of the projected returns on a daily, weekly, monthly, and yearly basis. But to be clear, covered call strategies can lose value if they are overly aggressive and the market value of the underlying assets increases, and the options are called.
Ribbon Finance is another platform that provides options vaults for a variety of assets.
They don’t offer any strategies for Solana liquid stake tokens yet but I suspect that in time, they will offer more strategies across a variety of assets.
So let’s bring things all back together now for comparative analysis.
You want to earn income on the assets you plan to hold for the long term. In our example, that asset was Solana. Now that we’ve done some research on options, we have decisions to make that can potentially take us further down the risk curve.
We need to decide, are we willing to chase more yield in exchange for more risk?
If yes, then we should consider a combination of option vaults when we believe the market will trade sideways for a while and then deposit in lending platforms when we believe the market may move higher.
Less Risky Strategy:
If we want less risk, we should focus on lending platforms and figure out what type of lending deposit rewards we want. Do we simply want to accumulate more liquid stake tokens or are we interested in the variety of governance tokens available to us? Or a combination.
Finally, we need to understand that in crypto there is also platform and smart contract risk. Each time you opt to provide your assets to another platform or put them into a smart contract, you run the risk that bad actors could steal your assets or that a smart contract could function in an unintended way risking your capital.
One way to address that risk is to split your assets across a variety of liquid stake platforms. Ie: you can opt for slightly less yield and more transactions in exchange for reducing platform and smart contract risk.
General Risks To Consider
If you put your liquid tokens into an aggressive strategy and net a loss, you’re going to have a loss in your corresponding staked holdings as well. The more aggressive you are with your liquid stake tokens, the more damage you can do to your total holdings. More risk means more reward but also more chance of loss.
Always On Vs Sometimes On Sometimes Off Strategies:
When using Options Vaults, you’re using your liquid tokens as collateral in order to sell options contracts and collect the premium as income. The strategies may vary in style and execution, but they all functionally mean the same thing. Ie: you’re making a directional bet on the future value of the underlying asset staked as collateral. Your hope is that the options contracts sold expire “out of the money” or worthless so that the vault doesn’t need to sell the assets.
This means that this strategy is not something you want to do at all times. If you’re unsure of what the market is doing, whether it will rise or fall quickly, this options strategy is risky and can lead to net losses. The lending strategy may at times provide a low yield, but it is one that you can comfortably pursue at all times.
Maxing Out Your Risk With Leverage
What can you do if you don’t own any Proof of Stake assets? You can lever up by using PoW assets as collateral, take loans against them denominated in PoS tokens that can be staked, then use these liquid staking strategies. I’m not really sure why you’d do this because the risk-reward seems off (at least in the examples above). The point is that you could if you wanted to.
Costs & Variable Rates
Most staking services publish variable rates. This is a result of the changing reward incentives created by the supply, demand, and competitive economics of network staking. The bottom line is that the amount you’re paid for staking will change on a regular basis.
On top of the variable rates that staking services provide, they also have fees associated with the staking and unstaking process. It’s really important to understand what the fees are, when the fees are triggered, and whether or not the platform has ways of reducing unstaking fees. For example, some services will provide fee discounts if you opt to unstake over a two-day period instead of an instant unstaking process.
Every time you move money and assets around in crypto there are fees. So moving around your assets from one strategy to another will have a cost. And these costs will add up over time. An asset like Ethereum that has high gas fees can break the economics of the strategy. With an asset like Solana, it can work but the success really depends on the sizing of the underlying assets you put to work.
The bottom line is that you need to actually do the math to understand when you’ll make money and when you’ll lose money from these strategies. And that math must include projected transaction costs.
Another cost to consider is the availability delays associated with each strategy. When using options vaults, you are time locking your assets in the vault. Typically for a week at a time. Even when you initiate a withdrawal, your assets are likely to be locked in the vault for the duration of the options contract period. This requires careful planning and can sometimes mean you miss the ability to take advantage of opportunities happening outside the vault.
You can now earn meaningful yields on crypto-assets you intend to hold for a long period of time. While some strategies have more risks than others, the point is that there are many good ways to generate more of an asset without having to inject more capital into the crypto ecosystem. And there are new strategies being developed all the time.
There’s no right way to do this, you just have to pursue what fits within your risk tolerance.
As an anecdote, I don’t pursue these strategies with my bitcoin holdings because I prefer to maintain self custody of what I think of as self-sovereign money. Bitcoin is my emergency savings account and it’s a core part of my digital bug-out strategy. I sleep better at night without exposing it to platform risk and don’t feel the need to chase incremental yield.
I am less aggressive with my Ethereum holdings simply because the transaction costs eat into a lot of the profits. The constant rotation of assets from one platform to another can add up quickly. And with Ethereum, the costs limit the opportunities. But Solana offers inexpensive transaction costs and nice yields. Solana makes sense if you’re willing to do the math to jump from one platform to another.
I am at peace with treating Solana as a speculative asset and willing to take greater risks with it. The chance to earn higher yields and develop a deeper understanding of crypto’s overall value proposition is worth it to me.
The final point is that crypto has advanced to a point where if you want to earn more from your holdings, you can. It’s worth your time to experiment with these tools to understand where the industry is heading and how it will meaningfully impact global finance.