This post was last updated on June 14th, 2019 at 08:36 pm
Welcome to this two-part deep dive on institutional cryptoasset staking, staking-as-a-service, and using staking to generate returns. My guest today is Joe Buttram, founder and CEO of EON Staking.
This two-part deep dive is divided into four chapters:
- Chapter One: What staking is and a step-by-step process for doing it with tokens you may be holding
- Chapter Two: The ins and outs of “staking-as-a-service” as a practice and business model
- Chapter Three: The regulatory landscape around staking and how the IRS, FINRA, the SEC, and the CFTC view staking
- Chapter Four: What the future of staking and staking based block chains might look like
In part 1 (episode 0046), we explore chapters one and two. In part 2 (episode 0047), we finish up chapter two and cover chapters three and four.
Topics Discussed In These Two Episodes
- What led Joe to start a service like EON
- Whether Joe was more drawn to Ethereum or Bitcoin
- How EON Staking is funded
- What staking is and how it exists as an alternative model to proof of work
- Criticisms of proof of stake
- Popular stake-based blockchains
- The difference between proof of stake and delegated proof of stake systems
- The economic models around staking
- What a validator does
- Whether staking’s history predates blockchain
- The risk profile of proof of work versus proof of stake
- The algorithmically dictated returns that occur with proof of stake
- The reliability and the consistency of returns with a proof of stake system
- Which crypto networks began using staking first
- The value-add users get from staking as a service and a platform like EON
- How staking relates to custody
- What else EON does beyond validating blocks
- Corollaries to staking as a service in the pre-blockchain financial world
- Which areas EON needs users to trust them on
- Whether voting is required to earn a reward
- How EON communicates its philosophy and actions to its users
- Whether or not EON functions as a B2C platform
- The threshold for someone to work with EON
- How EON makes money
- How the legal agreements that EON has with its customers work and who is protected by those agreements
- How customers are protected from slashing
- Who is at risk from slashing
- How EON developed their legal model
- EON’s in-house legal counsel
- What makes clients choose EON, rather than a competitor
- Which laws and agencies EON’s services are regulated by
- The tax situation for EON’s business model
- How SEC, FinCEN, and CFTC regulations apply to EON
- What the future looks like in the space that EON is operating in
- Big shifts that EON may need to adapt to in the future
- Cryptoinvestor Weekly Newsletter
- Clay Collins
- Joe Buttram
- EON Staking
- EON Staking on LinkedIn
- EON Staking on Twitter
- DLx Law
“I thought most of the magic of this stuff was on the open source side, and so basically got my start on the community level, helping my good friend, Grant Hummer, throw the first Ethereum meet in San Francisco.”
“Instead of using that electricity and that infrastructure and those machines, instead, you’re backing that proposal or that ability to go and capture those rewards with the tokens, themselves, the native assets.”
“In proof of stake, you’re essentially ensuring the integrity of your voting of new transactions and new blocks by putting up stake, which is the native token.”
“And so, with our B2C platform, essentially, that whole entire chain is going to be just on our web app and our mobile app, so they never have to leave.”
“You have validators that are in the cloud where they’re anonymous and people are delegating to them with no sort of counterparty contracts. For us, we’re public. We’re based in the US.”
“Now, we’re able to basically chop up the inflation curve and potentially, hypothecate more and more assets to create more and more value with an ecosystem.”
Part 1 Transcript
Welcome to Flippening, the first and original podcast for full time, professional, and institutional crypto investors. I’m your host, Clay Collins. Each week we discuss the cryptocurrency economy, new investment strategies for maximizing returns, and stories from the frontlines of financial disruptions. Go to flippening.com to join our newsletter for cryptocurrency investors and find out just why this podcast is called Flippening.
Clay Collins is the CEO of Nomics. All opinions expressed by Clay and podcast guests are solely their own opinion and [00:00:30] do not reflect the opinion of Nomics or any other company. This podcast is for informational and entertainment purposes only and should not be relied upon as the basis for investment decisions.
Clay: Welcome to this two-part deepdive on crypto assets staking as a service, and on the topic of how to use staking to generate returns for your portfolio. My guest today is Joe Buttram, founder and CEO of EON Staking. I was introduced to Joe through a previous [00:01:00] guest, Katya Kovelenko and you can learn more about her in episode 36.
During a pre-interview with Joe, I was blown away at just how deep the staking rabbit hole went. I was expecting for this interview to take anywhere between 45 minutes and an hour, and we went almost two entire hours. In this episode, we explore staking as a service and how proof of stake consensus mechanisms offer a completely different paradigm for operating blockchains and also [00:01:30] generating returns.
This two-part deep dive on staking is broken up into four chapters. In chapter one, we explore what staking is and we discuss a step by step process for how doing it with tokens that you might be holding. In chapter two, we discuss the ins and outs of “staking-as-a-service” and what that looks like. Also, what that looks like as a business model. In chapter three, we consider the regulatory landscape around staking and consider how the IRS [00:02:00], the SEC, and the CFTC view staking. As a side note, I should tell you that this is the most extensive review on the regulation around staking available anywhere online that I’ve personally seen. Finally in chapter four, our last chapter, we peer into the distance and see what the future of staking and staking based block chains looks like.
We’ll get right to this episode in just a second, but before we get [00:02:30] started, I’d like to pause for a moment to tell you that this episode is brought to you by Nexo. Here’s a word from them:
Nexo is the world’s largest and most trusted crypto lender offering automated instant crypto credit lines, which allow you to use your crypto, for example Bitcoin, Ether, XRP, etc., as collateral to get cash in over 45 fiat currencies and stablecoins and you can do this without having to sell your crypto assets.
Nexo also offers [00:03:00] interest earning accounts yielding up to 6.5% per year for stablecoins and Euros. Interest is paid out daily, and you can add or withdraw funds at any time.
Nexo is also a strategic partner of exchanges, OTC desks, traditional and crypto funds helping them earn interest on idle stablecoins and fiat. The company’s growing portfolio of structured institutional products includes fully collateralized, continuously rebalanced swap agreements allowing counterparties to effectively [00:03:30] manage their balance sheets. Check them out at Nexo.io. Thanks to them for sponsoring this content, and making this content possible so that you can consume it for free.
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Okay, back to our regularly scheduled program. Here’s part one of my conversation with Joe Buttram from EON Staking. Enjoy. [00:05:00]
What was the journey that you took to go from someone who heard of Blockchain, and Ethereum, and Bitcoin at some point to starting a service like EON. What was that path like?
Joe: I first heard about Bitcoin in 2011. I was just kind of [00:05:30] going and surfing the web, and reading about a lot of interesting different things, and ran across the silk road at that time. It was obviously very intriguing that there was this marketplace where people can buy and sell pretty much anything. As I kind of looked into that, I saw that they were using Bitcoin as the payment solution. It was very interesting to me, but it didn’t necessarily click as how big and powerful sort of blockchain was and could be.
With that said, in 2012, a year later, I worked for the [00:06:00] Ron Paul campaign, and so I basically got indoctrinated into the whole end of fence sort of thing that he was proposing and just generally learned a lot more about monetary policy. Coming of age, during that time, QE was in full force, and it was very obvious to me at that particular time how it was changing the economy.
Clay: Hey, this is Clay cutting in from the editor’s booth to define QE. QE stands for quantitative easing which is a monetary policy whereby [00:06:30] a central bank buys predetermined amounts of government bonds or other financial assets in order to inject money directly into the economy. This, of course, creates inflation. Okay, back to Joe.
Joe: With that added life experience, when the big, first bubble of Bitcoin happened in 2013-2014, I saw it again at a much higher price. I was like okay, what’s going on? With that knowledge, during my time at the Ron Paul campaign when I dove deeper into Bitcoin, I was like, wow, [00:07:00] this is super important and potentially really big.
From there, I was just trying to figure out the best way to get involved. At that time, it was a lot of the narrative was like Blockchain, not Bitcoin. I thought most of the magic of this stuff was on the open source side, and so basically got my start on the community level, helping my good friend, Grant Hummer, throw the first Ethereum meet in San Francisco. From there, just got to know the teams, and know the different projects, and see what sort of technologies were promising in the space.
As the market started taking off [00:07:30] in 2016-2017, I was actively doing a lot of investing in these projects that I identified early on as something that could be very interesting, and so that transitioned me into EON in that I was doing a lot of deals and stuff, trying to get in on these good projects.
The climate was in 2017, and I was really taken aback. I mean, that was the environment, but basically, there were large syndicates that were just on [00:08:00] chat rooms sending around tens of millions of dollars. I very much realized that this is probably not the safest and best way to do things from a legal perspective, and obviously now during the bare market, we’re seeing a lot of the blow back from that. As I was searching for a way to do these sort of deals, I ran into my current partner and co-founder of EON, Santiago Roel Santos, early on in the business deal. He did a great job putting together the SPV that I was going to go into [00:08:30], and from there, we started going back and forth on a lot of different investment opportunities.
As we started investing more and more, over the course of a year, we realized wow, all these projects we’re very enthusiastic about have proof of stake coming, and there needs to be a solution on the market that is really buttoned up to potentially manage billions of dollars.
We decided that we wanted to do that after we really took a deep dive into what the market could look like, and that’s how we came here to EON [00:09:00]. It’s going in full force now, and it’s been a very interesting experience in this brand new market that’s emerging.
Colin: What year were the first Ethereum meetups in San Francisco?
Joe: I believe in 2014-2015, most of the meetups were happening in Silicon Valley by Chris Peel. I used to go to those a lot, and me living in San Francisco, I would commute down. We talked about the opportunity to do it in SF, and Grant beat me to the punch a little bit by setting everything up [00:09:30] first. I immediately was ready to help them, and so the first meetups were, I believe, December 2015 in San Francisco.
Clay: You also mentioned an SPV.
Hey, this is Clay cutting in here again to explain what an SPV is. SPV stands for Special Purpose Vehicle. It is an entity that allows for making very focused investments without compromising investment restrictions that a parent entity might be beholden to, or creating liabilities [00:10:00] for the parent entity. Usually, SPVs are used for securitization purposes and they’re allowed to finance, buy, and sell assets. Okay, back to the show.
Was that an SPV for raising capital for EON?
Joe: It was just to syndicate investments into ICOs that were coming off the marketplace. A lot of the deals that I was seeing on chat rooms and stuff were pretty much just here’s my address, send me money. The SPV was a very nice way of covering our [00:10:30] bases, legally.
Clay: Oh, got it. That was during the ICO craze of, like, 2017-2016. Is that right?
Clay: Oh, those were the days.
Clay: I am not surprised that—you heard about Bitcoin, but it sounds like really sunk your teeth in the space through Ethereum. It does seem like there’s a kind of person that’s drawn more to Bitcoin, and there’s another kind of person [00:11:00] who really wants to get involved. They want to write some code, they want to get their hands dirty, and sometimes it could help them take their mind off price movements. Did you find yourself drawn more to Ethereum in that community than more of the Bitcoin community?
Joe: I’m not necessarily a maximus one way or another. I would just say that Bitcoin, the magic of it is that the parameters are very hard set, right? Everyone knows what Bitcoin is. You don’t bury it [00:11:30] too far off from the core features of it, and while that is very important to this ecosystem in the world, I gravitated towards Ethereum and some of these other projects because of potential venture style plays that it could enable with all the cool things, like global computer and that sort of stuff.
Clay: We’ve learned a little bit about your background and how you came into the space. What was the transition from being involved in the Ethereum community to saying, [00:11:30] “Hey, we’re going to start EON Staking.” Was there a spark? Were you staking on your own and seeing nice returns? What made you decide that you were going to throw everything into this and make this a full-time endeavor?
Joe: I wouldn’t necessarily say there was one particular thing. I would say it’s a combination. One is just, as I mentioned, I just held assets that needed to be staked because I wasn’t necessarily short-term on any of these projects. I was like, okay, I don’t want to get too in the way [00:12:30], so I’ll need a solution. Just for my own personal needs and my own problems, that was the first thing that got me thinking about it.
On top of that, I really liked being able to contribute to the networks and help and everything like that. Generally, just by the nature of doing the deals and communicating with them and trying to be a value add partner, we had close communication with a lot of these folks, and they were immediately telling me that, “Hey, we need help here. Would you be able to stake your assets?” [00:13:00] They were reaching out for us to do that, and so I identified that need, as well.
The next thing that really kind of solidified it in my head, as well as the other two, is the block producer debate that happened for EOS when they launched. It wasn’t necessarily a debate, but it was highly competitive. You can see that there was a real powerful market movement and concentration of focus on that particular feature of the network, which I thought was extremely interesting and kind of validated [00:13:30] sort of my thesis that, okay, this could be a big thing.
Clay: Are you bootstrapped, or have you raised some venture capital money? What’s funding you right now?
Joe: Today, we’re completely founder-funded. The nice thing about staking is that it’s an operating margin, and the upfront cost… They’re pretty efficient. It’s not like there just work where the more hash power you need to aggregate to mine more blocks. You need more electricity, more hardware. There’s not necessarily those economies of scale, so we’re able to keep the operation [00:14:00] pretty neat at that stake.
Clay: Let’s kick off chapter one which is a primer on staking. For those who have heard of staking or maybe they’ve done a little staking on their own, but really haven’t gotten the 360 on what staking is, how would you describe what is staking, how it exists as sort of a competing or alternative model to proof of work?
Joe: I usually tell people that are not [00:14:30] intimate with crypto or brand new to that part of the space is just it’s the new form of cryptocurrency mining that’s coming on to the scene, and to dive a little deeper into that, essentially, the main difference is that instead of in proof of work, having to solve an arbitrary algorithm with hash power to hopefully win the lottery of sorts to be the highest and best output of hash power to obtain the rewards and the ability to mine a block. [00:15:00] Instead of using that electricity and that infrastructure and those machines, instead, you’re backing that proposal or that ability to go and capture those rewards with the tokens, themselves, the native assets. There’s a process involved with that, called validating, in which you have to sign transactions. That, at its core, I think, is sort of how I split the two.
Clay: I, personally, have heard a lot of criticisms of proof of work. It’s expensive. You have to purchase [00:15:30] a lot of hardware that isn’t put to very good use. There’s environmental cases against it, and on, and on, and on. I think we’ve heard criticisms of proof of work, and some of them are good, and some of them are not. What do you think are some of the best criticisms of proof of stake?
Joe: I think the best criticism of proof of stake is the centralization of voting power to large token holders. [00:16:00] While I do think that is better than exogenous players in proof of work, when governance comes into play, that could add some complexity and some trickiness to the system. That one, I think, is very true, but that being said, we’re seeing interesting workarounds and proposals people are putting out there to sort of solve that problem. That’s the biggest one, I think.
Clay: For people who are kind of new to this space, what are some of the more popular stake-based [00:16:30] block chains where staking is securing the network versus proof of work?
Joe: Well, there’s many different flavors of proof of stake, but the ones that are just like pure-proven stake and the model that we’ll probably get into at some point, we’re finding that Tezos is probably the leader because they were the first on the scene to really implement it in a big way. In a big way, I mean by large market capital awareness via their ICO. Decred is also very, very good. They have a hybrid proof of work stake model. They’ve been working very well, [00:17:00] and that one is very popular in the community. Now, Cosmos is live, and that one is definitely getting a lot of traction and really bringing staking to light.
Clay: You mentioned EOS before and block producers. Is EOS not a proof of stake-based blockchain?
Joe: It’s DPOS. It is a proof of stake sort of system, but instead of users depositing their tokens to obtain rewards, they use their tokens to vote for a block producer [00:17:30] and rewards payouts are kind of done in a fashion that they decide at the end of the day. It’s just a different type of proof of stake.
Clay: You said DPOS. For the uninitiated, that’s Delegated Proof Of Stake. Is that correct?
Clay: Yeah, okay. That’s a little bit more like maybe more analogous to a representative democracy, like we have the United States where you vote for a congressperson, and that person votes on your behalf, versus a direct democracy [00:18:00] where you’re voting on specific issues yourself, maybe like the California state proposal system. Is that an accurate characterization?
Joe: There’s obviously not a lot of nuances between the two, but we see that comparison brought up a lot, yeah. There’s a lot of similarities, for sure.
Clay: What other popular proof of stake block chains might exist? Is Cardano a proof of stake-based blockchain?
Joe: Yeah. They are planning to migrate to their proof of stake system, called Ouroboros pretty soon [00:18:30], I think. They currently aren’t running live on proof of stake, but it’s definitely within their plans, and they’ve done, actually, a lot of work on it. It’s a very interesting sort of skim of it they’ve put together for it.
Clay: Right, and then potentially Ethereum, as well, maybe 20 years from now.
Joe: They just launched their test net phase zero validator system, so we’ll see. I mean, that was one thing I was thinking about Cosmos for a bit, but people were upset that Cosmos was taking a long time to launch their blockchain, [00:19:00] but these are really hard problems with lots of value in them, so it makes sense to take their time, but Cosmos eventually did it. I can totally see Eth shocking everyone, too, and delivering early, as well.
Clay: What are some of the economic models around staking? Can you pick one or two block chains and talk about what someone might do end-to-end to begin staking, starting with buying the currency and then what comes next? [00:19:30] How do you get up and running if you want to participate in this security model and earn some revenue doing this?
Joe: I’ll use Tezos as an example. How do token holders earn rewards? Essentially, you obtain the token, whether you participated in the ICO or you bought it on an exchange, you, at some point, need to basically regain custody of that asset. If you bought at an exchange, if the exchange doesn’t offer a staking service, [00:20:00] you’ll have to basically repatriate the assets back to yourself in the wallet. Then from there, you use, generally, a native wallet that has a delegation feature in it. A common one that people use is Ledger or a web wallet is TezBox. They have this function in their UI which basically allows you to send a message to the blockchain, called the delegation transaction, which essentially gives your rights to vote for blocks to a validator of your choice.
7In order to do that, you have to [00:20:30] pick a validator. That’s one of the big things, I think, that goes into the thought process of a token holder looking to delegate and participate in proof of stake, is finding a validator that fits their profile. There’s a lot of different methodologies that people are using to date. A lot of it is price-based, so some people, all they care about is just what’s the lowest fee of the validator? Some of them are very into the security and the technical operations and [00:21:00] excellence of that validator. Are their up times sufficient? Have they ever had a flashing event? Those type of things.
Then we’re seeing more and more, there is, especially with these governance protocols and we’re seeing this in Tezos, as well, but there is sort of an alignment between the validator and the delegator that needs to happen, in terms of a constitution or some sort of thought process they use in how to vote and the integrity that the validator has to go [00:21:30] and vote on proposals to upgrade the network.
Clay: So, step one, buy the cryptocurrency. We’re talking about Tezos. Ledger is… You can move it to Ledger or what was the name of the web wallet that you mentioned? Was it TezBox, did you say?
Joe: Yeah. TezBox is, I think, the most popular for Tezos.
Clay: Maybe this is the next kind of thing to unpack here, is who are all the players? You’ve got the token holder. You mentioned a validator, what is a validator? [00:22:00]
Joe: A validator is somebody like us at EON that essentially votes on blocks and aggregates voting rights from delegators to earn rewards for the delegators, as well as to add new transactions to the Ledger.
Clay: What is the role of a validator in a non-delegated proof of stake system? If the corollary here is direct democracy, why are votes being aggregated?
Joe: Votes are being aggregated because stake needs to be [00:22:30] put into the voting of new blocks, right? Basically, in proof of work, you’re using a bunch of hash power, and the whole thing is proof of work, in which you’re proving that you’re doing all this work, which means you value that chain and that asset, right? In proof of stake, you’re essentially ensuring the integrity of your voting of new transactions and new blocks by putting up stake, which is the native token.
Clay: The validator is backed by the tokens, [00:23:00] which are associated with it by virtue of staking, and that is sort of equivalent to hash power in a staking system. How does a block get created with a proof of stake system?
Joe: It depends on the proof of stake system, but generally, people are transacting on chain. Let’s just say they’re moving tokens around, and they have to send a signed message from their wallet to a mempool, which is sort of like the queuing period for all these transactions. [00:23:30] Generally, in proof of work, and this is similar in the majority of proof of stake networks, as well, the validators or the minors in proof of work, they sift through that mempool and pick which transactions to be included into the blockchain.
Clay: How is it determined which validator gets compensated for creating the block? Is it somewhat similar to proof of work?
Joe: There are some similarities. Probably the biggest thing is how much stake you have. Again, it varies on network to network [00:24:00] and all the different flavors of proof of stake, but essentially, the more stake you have delegated to you, the higher chances you have of validating a block. Often times, at least the majority of the large proof of stake protocols currently out in the wild, there is a lottery system, which sort of picks all the different validators, and you have a higher chance of being selected, the more stake you have.
Clay: The number of tokens that back a validator is [00:24:30] somewhat analogous to the amount of hashing power behind mining in a proof of work system, and the more tokens backing a validator, the more likely it is that that validator is going to mine a block, and that it can return tokens to the people who are backing that validator. It’s kind of like a mining pool, it sounds like. You have some tokens, you have some Tezos. You’re using something like Ledger or you’re using something like TezBox, or maybe you’re using EON Staking, and [00:25:00] what happens from there? Is there any way to sort of approximate what your return is going to be? Do you have calculators for that kind of thing? I guess for someone who doesn’t have a lot of bandwidth for calculating things, are there any kind of rules of thumb? Should you get returns that are roughly the same as inflation over the course of a year? How do you think about returns? And explain it to the layperson.
Joe: Overall, it’s pretty straightforward, [00:25:30] but one of the interesting dynamic factors to take into account when you are modeling those things is the inflation rate on these proof of stake networks changes, depending on how much of the entire supply is staked at any one point in time.
Clay: Hey! I wanted to pause for a second to let you know that this episode of the Flippening podcast is sponsored and brought to you by Nexo who believes in the value of making this kind of education possible. If you enjoy this content, [00:26:00] you can thank Nexo for their generous support of the work that we do here. Here’s a word from Nexo:
Nexo is the world’s largest and most trusted crypto lender offering automated instant crypto credit lines, which allow you to use your crypto, for example Bitcoin, Etherium, XRP, etc., as collateral to get cash in over 45 fiat currencies & stablecoins without having to sell your crypto assets.
Nexo also offers interest earning accounts [00:26:30] yielding up to 6.5% per year for stablecoins and Euros. Interest is paid out daily and you can add or withdraw funds at any time.
Nexo is also a strategic partner of exchanges, OTC desks, traditional and crypto funds helping them earn interest on idle stablecoins and fiat. The company’s growing portfolio of structured institutional products includes fully collateralized, continuously rebalanced swap agreements allowing counterparties to effectively manage their balance sheets. [00:27:00] Check them out at Nexo.io. Thanks to them from the entire Flippening team and from our audience for making this education and this content possible.
In addition to Nexo, this episode is also brought to you by the NomicsAPI and the Nomics CSV Data Export Service. The Nomics Market Data API offers squeaky clean and normalized primary source trade data offered through fast and modern endpoints. If you’re a professional [00:27:30] investor or developer, you need accurate prices, and I can tell you that our competitors prices are not accurate—we’re actually going to come out with a report about this soon. I should also note that the NomicsAPI is used by many of the largest and most influential companies in the space, including top exchanges, $100+ AUM funds, and prop shops. Hit us up if you’d like more details or go to NomicsAPI.com. Furthermore, if you’d like to order historical cryptocurrency market data as CSV exports [00:28:01] from top exchanges, email us at firstname.lastname@example.org. Okay, back to the show.
Joe: There’s general consensus that two thirds of the assets staked, so of all the tokens, that number roughly is the best to ensure the highest level of security in most of these networks. I’ll take Cosmos as an example. Their inflation rate fluctuates anywhere from 7-20%, depending on how much is staked [00:28:30] at any one time. If a full two thirds of the entire network is staking, it would reach the optimal rate of 7%, but the lesser of two thirds, the higher the inflation goes.
There are calculators and models out there, there’s a lot of open source tooling for that that people can just simply Google and pop up a lot of different validators also provided. We do, as well, but that’s the only thing I would have to say that takes a little bit of extra math. From there, you basically are looking at how much tokens you have, and based upon that [00:29:00] fluctuating inflation rate, they can then deduce how much rewards they should expect over the lifecycle of their staking.
Clay: There are very few financial products or paradigms in finance that are truly net new. Do you think there is a corollary to staking in sort of the pre-blockchain financial world or not? [00:29:30] Does staking have a history that predates block chain?
Joe: I think it definitely is an extremely novel and new economic experiment. There are some corollaries between different sort of assets that are pre-blockchain. There’s potentially some crossovers between fixed income, potentially structured products, potentially just looking at a reserved currency of a sovereign nation and the inflation that is created by the central bank. [00:30:00] I think there’s obviously a whole bunch of new features in proof of stake that are dedicated to the blockchain realm, but it’s definitely taking a lot of these economic theories and models from traditional finance, as well.
Clay: Is there a specific fixed income product that you think this looks most like, or not?
Joe: It’s not a one up for one example in anything particularly, but I do think there are some similarities to treasury bills [00:30:30] and bonds, and also loans. Basically, if you’re going long on a currency in some sort of emerging economy and you decide to buy a bunch of that native fiat, the central bank is most likely going to be printing money to do various central banking. With that, you’re probably going to have to figure out a way to hedge the inflation and potentially being able to acquire a T-bill or a bond, [00:31:00] something that could be sort of similar, but obviously this is something that’s native and automated to the network, but that’s something that comes to mind as I think about stake.
Clay: How would you compare the risk profile of proof of work versus proof of stake? Let’s say you have $100,000, and you’re looking to invest in proof of stake versus proof of work. How do you think they compare?
Joe: I think there’s a lot of really interesting nuances when you compare investing in proof of stake versus proof of work. [00:31:30] The immediate things that come to mind when it comes to the risk profile proof of stake, and what a lot of our clients, particularly hedge funds communicate with us, is the risk of slashing. Most of these groups stake networks, because you are essentially using your tokens as collateral to be able to sign blocks and to be doing it honestly. If you do it dishonestly or you make a mistake, the protocol slashes or reduces your principle. That is something that a lot of our clients think deeply about [00:32:00] when they think about just purely staking for one, or two, investing proof of stake networks. Each network has a different sort of structure for that, but that is certainly a clear distinction between proof of stake and proof of work.
To be more positive on proof of stake, I think one of the cool things about proof of stake if you’re thinking about investing in that specific infrastructure is for proof of work, there’s a significant amount of upfront costs. If you don’t mine a block, that electricity that you spent on, you can’t recover. But with proof of stake, [00:32:30] the assets that you’re acquiring to participate in that consensus mechanism and earn rewards is liquid. You’ll be able to efficiently use your upfront capital and trade it out if you ever decide to change the course of your strategy. There’s a lot of cool things in proof of work and proof of stake as a difference or profiles for investors and users to think about, but those are some of the two that I think about a lot.
Clay: One of the things that you said to me during our pre-interview [00:33:00] that really stuck out or struck home was that there has never been before algorithmically dictated returns that are programmatic and somewhat guaranteed, like with proof of stake. Can you go into that a little bit more?
Joe: I would say that proof of work definitely… Every block, you expect someone is going to trade a reward, but in proof of stake, now this is more accessible to the individual token holder. [00:33:30] What I was kind of leaning towards is if you’re trying to get involved and you want to buy $100 of tokens, now you have the certainty around the rewards, and your efforts, and inflation. Something that is seen in other markets, like fixed income and other things, but it’s never been programmatic, right? While with fixed income and real estate and these other things, it’s always overtime, a lot of the risk gets hedged out via different [00:34:00] operational efficiencies and what not. At the end of the day, this is a protocol that’s running on code, and so it really reduces sort of that risk profile when you’re thinking about consistency of rewards and payouts.
I think that’s something that’s going to be leveraged pretty heavily as we see the proof of stake market continue to evolve. The ability for people to have certainty around, yeah, those rewards, it’s really novel and it’s something that I think we’ve only really seen when it comes to the cryptocurrency space, but more particularly [00:34:30] now for the common individual staking.
Clay: I guess I’m trying to get a sense of what is the reliability and the consistency of returns with a proof of stake system? I mean, can you just assume that given a long enough time horizon, if you put up a certain amount of tokens for stake and you are with a validator who is not breaking the rules and going to get your funds slashed, that you can expect a certain rate of [00:35:00] return of the asset? Now, of course, the asset might depreciate in value or increase in value, but if you’re sort of thinking purely of returns in a given asset, can you just come to expect a certain rate of return, or is that not realistic?
Joe: I think there’s a lot of effort to get to that point where you can expect to a high degree of confidence that you’ll be getting those rewards on sort of a fixed schedule. I would preface it to say that [00:35:30] one thing that we can guarantee for sure is that somebody is going to be getting those rewards. From there, I would then extrapolate as to like, okay, are you doing the right diligence? Are you putting in the right efforts to make sure you’re part of that group? But yeah, that’s how I would say it.
Clay: Are there legal reasons why you can’t say more definitive things? I imagine your attorney doesn’t want you saying that a certain amount of return is guaranteed because it’s probably just a lot more complex and nuance than that. [00:36:00]
Joe: There definitely is some legal reasons behind that, but there’s also just very much the truth of the matter. There’s a lot of people that I’m sure are sort of sitting back and it’s like, “Oh, yeah, it’s so easy, I’ll just go ahead and place my tokens over here with this validator, and it’s all hunky-dory,” and then they check a year later and they’re like, “Wait, this is not the reward payouts that I was expecting.” We’re seeing that today. I think it’s just a matter of fact.
Clay: What were the first couple of crypto assets [00:36:30] or networks that used staking? I know you’ve mentioned Tezos, but I’m guessing Tezos was not the very first to pioneer this concept. What were some of the early pioneers of this space?
Joe: The very first cryptocurrency that sort of applied the concept of proof of stake was Pure Coin. I think this was in 2013, around then, but they had a very limited sort of rollout of how staking [00:37:00] would work on their platform, but that was very much the first. From there, we saw different projects, looked into it a little bit more deeply, most notably Ethereum. […] has been thinking about proof of stake for a very long time so that the idea has sort of been floating around and worked on for a good bit.
I would say in production, the one that I think got a lot of traction with a proof of stake model is Decred. There’s a very much dedicated community and a sufficient market cap at this point, [00:37:30] which really validates that, okay, proof of stake is a real thing when it comes to that network. That was sort of the first one to me that really came to prominence, and so we saw many different iterations and variations, as well. I actually credit a lot the Dash team with their master nodes set up. Granted, it’s not pure proof of stake on a consensus layer, but their master nodes basically allow for people to stake or deposit their tokens to perform some sort of on chain function [00:38:00] in order to earn a reward. Those are some of the early ones that I think about when you bring up that question.
Clay: Pure Coin as maybe the first kind of pure proof of stake, but doesn’t have as wide spreaded option in production, and then Decred, and maybe Dash as examples of hybrid proof of work, proof of stake. Is that a fair characterization?
Joe: Yeah, yeah. I would say so.
Clay: Moving on to chapter two, staking as a service. Maybe a good place [00:38:30] to start here is the value propositions. You mentioned with Tezos that if you have a ledger, you can stake your tokens, and you could also use something like TezBox. What is the value-add to staking as a service and a platform like EON?
Joe: If you’re a token holder and you don’t necessarily have the technical capabilities to run the processes yourself, that’s immediately the first thing that I think people lean towards as to why they use staking as a service [00:39:00] provider. With that, even if you were to run it yourself, there’s also high degrees of technical complexities that essentially revolve around slashing uptimes that even if you were to run it yourself, do you feel confident enough in your abilities to make sure that you don’t screw that up? Even if you can just spin up nodes, and we see a lot of people do, at a certain level, you’re going to have to think about, okay, is my setup secure enough? That’s another reason people move towards staking as a service [00:39:30].
But there’s a lot of different reasons for it, another one is tax. A lot of people, particularly hedge funds, aren’t necessarily structured to do it themselves due to unrelated business taxable income. They essentially have to use a service provider because it’s not necessarily within their original structuring. I would say that the first two I mentioned were the most pertinent, which is technical complexities and the high risks of doing it yourself. Another thing to add, as well, is a lot of these block chains, they have minimum capital requirements to become a validator [00:40:00].
In EON, in order to become a block producer, you have to be a top 21 block producer, which means at least, I think at these levels, this market capital, it’s $120 million. For Dash, for instance, in their master nodes, you need at least 1,000 Dash. In Cosmos, it’s 100 validators. In Tezos, there are actually quite a bit on that platform, but there is a rule requirement where you need 10,000 Tezos. If you’re a small-ish sort of token holder, you may want to leverage the economies of scale of a third party service provider, like us.
Clay: Is another reason why someone might go to you is because maybe there are custody requirements that a hedge fund might have or a family office, in order to show that they’re doing things correctly, that sort of sending things to a value-added custodian is probably a good way to go since they do custody most of their assets, anyway, to kind of have this as sort of an additional thing that a custodian provides? Is that another reason why someone might use [00:41:00] you guys? Are you guys officially a custodian?
Joe: I think an important thing to note is particularly when it comes to staking, there is a paradigm shift in regards to custody. In most of the proof of stake networks that are out there, you actually don’t have to give up custody of your tokens to a service provider or validator. The delegation transaction that I was mentioning is just a signed message from your own wallet with your assets, just basically giving the voting rights to a particular validator of your choice. We don’t take custody. We’re delegation only at the moment [00:41:30].
We’ve been talking to a lot of the big custody providers out there, and it is becoming clear that this is going to have to be a value-added service that they implement in-house because I would say back to your fund question or your family office question, with staking, it brings up a lot of interesting fiduciary responsibility questions. If there is a 20% inflation rate on the asset that you’re holding, are your LPs going to be okay with you not going out and ensuring that you’re able [00:42:00] to hedge and not reduce your positions? All those kind of things kind of fit into your question.
Clay: I didn’t know that you guys didn’t take custody, I just assumed that was part of the deal. Let’s take the example of Tezos which we’ve been using. What would you do to give your voting rights over to EON? Is there a smart contract you have to execute? Is it something that’s just in every single wallet that’s pretty easy to do [00:42:30] out of the box and the UX is good? How complicated is it to actually do that?
Joe: It sort of depends on the client that you’re using, but the majority of wallets that are out there have that delegation feature within that wallet. A ledger, you can go and delegate on TezBox. Once you basically take custody of your assets, it is a pretty seamless process to have your rights be delegated somewhere else for them.
Clay: What else is part of what you guys do? You validate blocks. Do you provide interfaces around voting on particular proposals and such?
Joe: In our rollout of our B2C platform, basically, yeah. There will be a very easy way when it comes to a new proposal that people need to vote on that they can go and interact deeply with that decision and let us know what they’d like to vote for. A lot of the different proof of stake networks out there, [00:43:30] if the token holders are passive and don’t vote on anything, we end up becoming a proxy. Basically, any votes that the token holder doesn’t use to vote on new proposals, we have to make that decision on our own. That’s another service that if a token holder doesn’t want to necessarily constantly be looking at the upgrades and all the different sort of proposals that are out there, they can outsource that to us, potentially.
Clay: Does voting versus [00:44:00] not voting affect the return profile? Are you required to vote in order to earn a certain amount, or at least to delegate your voting to someone else in order to earn rewards?
Joe: Not particularly, but there could be a scenario where there’s a proposal in which they’re interested in either increasing or decreasing the inflation rates of that network, which would adjust the expected rewards that a token holder would accrue. [00:44:30] On its surface, no, but there could be instances in the future where it does cross over.
Clay: In most of those instances, I imagine it would be whoever is staking to vote for more inflation. Is that correct?
Joe: Potentially. I mean, a lot of people are very adverse to too high of inflation, which totally makes sense. It’s a community vote, at the end of the day. It just depends on what the constituents want.
Clay: Governance and proof of stake, although they are related, [00:45:00] voting is not required in most instances to generate a return. It’s simply enough that you’re staking the tokens and using that to validate blocks.
Clay: What is the history behind staking as a service? Are there any corollaries, again, in the pre-blockchain financial world to what you do?
Joe: There are some analogies out there that we can potentially point to. [00:45:30] I think a very interesting one is a proxy firm for equities. Same thing if you’re a shareholder and you have voting rights or if you’re just a small shareholder and you want to join a bigger class, that’s something that we see in traditional markets that look sort of similar. In terms of the history, in terms of staking in the early days, a lot of it was just people spinning up nodes. It had been interesting to see over time how it’s become more professional and also with the stakes, [00:46:00] no pun intended, getting larger and larger. There definitely is a lot of focus that’s been happening on using these service providers.
Clay: It was news to me that you did not have to take custody of these assets. I guess that brings me to think a little bit more about trust, and where your customers need to trust you and where they don’t. We’ve established that they don’t have to trust that you won’t run off with their assets or that you won’t be hacked. Where do your users need to trust you? [00:46:30]
Joe: I think what every delegator should think about when they pick a validator is once their technical excellence, like are their up times sufficient? I’d say 95% plus, 96%, 97%. Have they ever had a slashing event? I think at the very minimum, that’s what people are really going to have to look towards, is this technical competency. In terms of the other trust verticals, especially if you’re relying on a validator for voting, you’re going to have to see if you’re in line [00:47:00] with their values. That’s a big one, but as a whole, because yeah, you don’t have to take custody for a lot of these networks, it does sort of change dynamic of the attacks. That being said, it’s not to say that a validator isn’t at risk, either.
It’s pretty interesting because what are situations in which a validator would get attacked? One that comes to mind is other competing validators, as well. If you’re validator number 10 and you want to be validator number 1, instead of going to market and essentially [00:47:30] campaigning for your delegates to trust you and to build all this PD and all these value-add products, doesn’t make sense for some validators to go and try to get others slashed, and we think that’s going to happen at some point at a high level. There’s that, and then also if there’s a big slashing event, that could potentially affect the market, and people may want to use margin or something like that. It’s not necessarily risk-free to be a validator in the security aspect of things, [00:48:00] but those are some of the aspects that we think about when it comes to our operational excellence and some things that delegates need to think about when they choose and trust their validator.
Clay: That wraps up part one of my conversation with Joe Buttram from EON Staking. I hope you’ll join us next week for part 2 where we discuss the regulatory landscape for staking and hear Joe’s take on the future of staking.
Before you go, however, I want to mention that since we’ve started producing episodes at a much higher rate, we now have room for a few more sponsors. If you like the work we do and would like to support the show, then a sponsorship might be a good fit for you. I can say from our own experience that Flippening sponsorships absolutely work. Each and every time we put out an episode of the podcast, we mention our own API. And to date, every single one of these advertisements have resulted in at least one customer. In fact, we would do these shows even if nobody else sponsored because of the business it brings to us. Over 80% of paying customers mention that they heard of our through our podcast.
If you’re interested in sponsoring the show, please hit us up at email@example.com. Alright, that wraps up things for this week. Stay tuned for next week’s episode which is part two with Joe on staking, staking as a service, and generating income with staking. Until then, take care.
Part 2 Transcript
Welcome to Flippening, the first and original podcast for full time, professional, and institutional crypto investors. I’m your host, Clay Collins. Each week we discuss the cryptocurrency economy, new investment strategies for maximizing returns, and stories from the frontlines of financial disruption. Go to flippening.com to join our newsletter for cryptocurrency investors and find out just why this podcast is called Flippening.
Clay Collins is the CEO of Nomics. All opinions expressed by Clay and podcast guests are solely their own opinion [00:00:30] and do not reflect the opinion of Nomics or any other company. This podcast is for informational and entertainment purposes only and should not be relied upon as the basis for investment decisions.
Welcome to the second and final installment of this deep-dive on staking-as-a-service and generating returns for your portfolio with staking. I’m joined by Joe Buttram, founder and CEO of EON Staking. If you didn’t catch our previous episode, I encourage you to listen to that first. [00:01:00] In the previous episode, we discussed proof of stake consensus mechanisms, how this differs from proof of work, the best blockchains for generating staking returns, and the staking-as-a-service provider business model.
The previous episode provides the necessary context for understanding today’s conversation which is around regulation and the future of staking. As I mentioned in the previous episode, I’ve been blown away by how deep the staking and staking-as-a-service rabbit hole goes. I believe this is the [00:01:30] best content in existence on the internet about staking from an institutional investor’s perspective.
This two-part deep dive is broken up into four chapters. Chapters one and two were covered in the previous episode. In Chapter one, we explored what staking is and also shared a step by step process for participating and generating staking rewards. In Chapter two, we discussed the ins and outs of staking, taking-as-a-service, the best blockchains for staking, [00:02:00] and the staking-as-a-service business model. In this episode, we finish up chapter two and dive into chapters three and four which are about the regulatory landscape in the future of staking and staking services.
We’ll get right to this episode in just a second, but before we get started, I’d like to pause for a moment to tell you that this episode is brought to you by Nexo who is making this content available for you to consume for free and who believes in education about the space. Here’s a word from them. [00:02:30] Nexo is the world’s largest and most trusted crypto lender offering automated instant crypto credit lines, which allow you to use your crypto, for example, Bitcoin, Ethereum, or XRP as collateral to get cash in over 45 fiat currencies and stablecoins without selling your crypto assets.
Nexo also offers interest earning accounts yielding up to 6.5% per year for stablecoins and Euros. Interest is paid out daily and you can add or withdraw funds at any time. [00:03:00] Nexo is also a strategic partner of exchanges, OTC desks, traditional and crypto funds helping them earn interest on idle stablecoins and fiat. The company’s growing portfolio of structured institutional products includes fully collateralized continuously rebalanced swap agreements allowing counterparties to effectively manage their balance sheets. Check them out at nexo.io. Thanks to them for making this episode available to you.
This episode is also brought to you by the Nomics API and CSV Data Export Service. [00:03:30] If you need an enterprise-grade crypto market data API for your fund, smart contract, or app, or if you need historical CSV dumps of trading data from top exchanges or even obscure ones then consider trying out the Nomics API or our historical data export service. Our API enables programmatic access to clean, normalized, and gapless primary source trade data across a number of cryptocurrency exchanges. Instead of having to integrate with multiple exchange APIs of varying quality, you can get everything [00:04:00] through one screaming fast fire hose. If you found that you or your developer have to spend too much time cleaning up and maintaining datasets, instead of identifying opportunities, or if you’re tired of interpolated data and want raw primary source trades delivered simply and consistently with top-notch support and SLAs, then check us out at nomicsapi.com. Or if you’d like to order historical cryptocurrency market data as CSV exports from top exchanges, email us at firstname.lastname@example.org.
Okay, [00:04:30] back to our regularly scheduled program. Here’s part two of my conversation with Joe Buttram from Eon Staking. Enjoy.
Clay: Do you always vote on behalf of the tokens that back you when your end users don’t vote?
Joe: For some networks, yes. [00:05:00] It’s required.
Clay: Okay. Oh, so voting is required in order to earn a reward.
Joe: Not particularly, no, but for some networks, it’s potentially going to be a thing, yeah. They might upgrade to implement this feature, but it’s not necessarily required, but if we want to vote, then it will be required that we vote on behalf of our constituents if they don’t vote.
Clay: Right now, at least, one of your users can’t say, “I don’t want to vote, and I don’t want you to vote for me, either.”
Joe: [00:05:30] Yeah, yeah, exactly.
Clay: Do you put out position statements? How do you communicate to your users what your general philosophy is and how you are going to vote on their behalf? Is there platform or positioning kind of documents that sum these things up or disclosures around that?
Joe: This is a very interesting question that comes to, I think, the crypto space, in general, but also validators, [00:06:00] but in an extremely decentralized environment, how do you communicate effectively, right? We see this as a big challenge, generally, but also as a validator. I could just tell you the way we go about it. Right now, most of our clients are private placement, so we just have direct lines of communication with them. But that being said, as these partner […] are rolling out that really reach out to a large group of people, our B2C platform is going to have direct governance portal, which sort of details these things. Today, what we do, and a lot of others do as well, is essentially use [00:06:30] blog posts and medium to sort of put these, as you said, position statements out there for the world to see.
Clay: You mentioned the B2C platform. In what way is your current platform not B2C? If I come by and I’ve got one grand worth of Tezos, can I be your customer? Or is there a certain threshold that I have to surpass in order to work with you guys?
Joe: Most of these systems are permission less. The nuance [00:07:00] for us when we talk about a B2C platform is basically, we streamline the process from start to finish all in one place. Currently, today, we didn’t have a B2C platform out there and a token holder wanted to delegate to us, anyway, they could. They would just have to go through the hoops of obtaining the tokens and setting up their own wallet, and then going and finding our address, essentially delegating to us from their wallet, and then doing the accounting on their own on a block explorer, and the communications would probably be [00:07:30] sort of difficult because they could ping us directly on a forum post, or something like that, but what we’re referring to as our B2C platform is that whole entire value chain is going to be a one stop shop. That’s what we’re […].
Clay: Got it. Right now, are you saying it is a somewhat complex process, or it’s just more of a manual process where they need to contact you, and you send them instructions, and you go from there?
Joe: Yeah, I think you said it well. It’s quite manual at the moment. If you’re a delegator, [00:08:00] you have to go and pull up your own native wallet. Then you have to delegate to your validator. To find your validator, you have to go […] page and obtain his address, and then you delegate. Then if you want to communicate, it’s not necessarily a streamlined process, and then if you want to do your accounting, you go to a block explorer, right? As you said, it is manual, and it has the friction. And so, with our B2C platform, essentially, that whole entire chain is going to be just on our web app and our mobile app, so they never have to leave.
Clay: So just providing good UI and an end-to-end experience. That’s great. [00:08:30] Is there a threshold right now for someone to work with you? Is someone kind of on their own if they’re under a certain dollar amount, or are you just kind of taking inquiries as they come in?
Joe: Yeah. At the moment, we take inquiries as they come in, but the other interesting thing too is, if the delegator is savvy enough, and we do have those clients, they can just find us on their own and just delegate to us. We have probably a good amount of clients that are doing that today.
Clay: How are you guys paid? [00:09:00] How do you make money from doing this?
Joe: We operate on a commission model. Basically, any rewards that we make for our users or our delegates, we take a 5% commission on that. That is the main model that pretty much the majority of validators are using currently in the space. There are some other interesting models, as well. We support sort of a SaaS model for some of the smaller networks that don’t necessarily have this liquid of a market, so we just basically […], and then run the nodes for them, [00:09:30] but there also is nodes-as-a-service where people are, for individual clients, running their nodes for them, and they have their own agreements. But as a whole, the commission model is what’s sort of the standard practice.
Clay: Is the commission model instantiated on chain? Or is there some amount of trust that if funds are flowing to you, that you’re not going to take 8%, or 10%, or 15%? [00:10:00] Is it sort of hardened on the block chain or is that another area where folks have to trust you?
Joe: It depends on the network. For Cosmos, for instance, it is hard coded in your award on the block chain, but in models like Tezos, for instance, the rewards are paid out to the validator, and the validator then distributes the rewards to their delegates. From there, then you have to trust the validator as to how they’re going to basically split up those rewards, [00:10:30] and then take a commission, and such.
Clay: I like the Cosmos model. With Tezos, someone could conceivably find out if you were doing something other than what you said you’d do. It would just probably involve a lot of complicated math and be a pain. Is that right?
Joe: No. I mean, they would just basically go on to the block explorer and see if, “Did we take our 5% commission?” We’ll be honest about it. No. It’s pretty transparent.
Clay: It is, okay, got it. Yeah, I was thinking about, you’d have to figure out what the lump sum was [00:11:00] and then how many people is it divided between, but certainly, they could do an easy calculation and see how much you took, but in terms of the distribution among everyone else and how much precisely they should get. That would be more complicated or still that’s pretty simple?
Joe: I’d say it would be slightly more complicated, but as a whole, it’s at least straightforward. There may be a couple hoops and a couple different calculations you’ll have to make, but it’s not like hard to find.
Clay: I’m thinking through the legal agreements [00:11:30] you have with your customers. If someone comes to your homepage, fills out the form, get something from you, maybe you sign some contracts. Then, those contracts, protect the end user, but if someone finds you and just on their own creates an agreement with you or says that you’re going to be their validator, do you legally owe them anything? Are they protected by documents that you have in place to protect other customers, [00:12:00] or is it just kind of a trust-base system there, as well? I’m trying to find the places of where trust needs to be versus not.
Joe: For us, we actually focused on this a good bit and was one of the early things that we really worked on pretty deeply. But to answer your question, it’s pretty much the entire spectrum. You have validators that are in the cloud where they’re anonymous and people are delegating to them with no sort of counterparty contracts. For us, we’re public. We’re based in the US. [00:12:30] We also have the thesis that if you’re a token holder with hundreds of millions of dollars, you’re probably going to want some sort of agreement, right? We […] have a very robust delegation agreement/terms of service, which pretty much details sort of all the backstops and all the situations that we’ve thought through that could potentially happen and guarantees. You’re also seeing too SLAs sort of become more and more common in the space. So, yeah. It just depends on the delegate, but the entire spectrum is [00:13:00] available currently on the market.
Clay: Are there guarantees, or insurance, or measures in place to protect your customers in the event of a slashing?
Joe: We get this question a lot. The fact of the matter is, is that we’ve looked into insurance products for staking, and particularly slashing. It’s so new and novel, and the risks are so high that we haven’t necessarily found anyone that’s super keen to take it on just [00:13:30] yet. That being said, it will probably become a standard in our product years from now. But currently, to date, most of these staking as service providers are also startups, as well. There’s essentially limited reserves and what not. For us, depending on the asset and the individual agreement, we will do our best to help users in the slashing events in terms of monetary forfeitures and what not, but as a whole, yeah. I mean, [00:14:00] if we’re successful and managing tens of billions of dollars, and you get slashed for 5%, that’s a lot to cover. Hopefully, by that time, obviously there should be sufficient cash flows in order to do that, like what the finance is doing today, but it’s still very early. So, those products aren’t necessarily really on the market yet.
Clay: Just to dig into slashing a little bit, are there instances in which your users could get slashed due to no fault of yours [00:14:30] with regards to execution? Can you be doing everything perfectly and have your customers’ funds still get slashed?
Joe: By doing things perfectly, that sort of has to fit within the context of what the consensus of the crowd on Blockchain looks like after a fatal event. If there’s […] and for some reason, we think we’re doing the right thing, and people migrate to another chain, it’s not necessarily [00:15:00] who is right or wrong, it’s what the consensus was, right? But that being said, we fully intend to go along with that crowd decision, and so it shouldn’t be an issue.
I think the other thing to note, too, though is these different proof of stake mechanisms have different sort of slashing requirements. In Tezos, for instance, the validator has to put up a self-custody bond, right? Basically, the company, EON or any validator, has to put up at least 12% of the entire [00:15:30] pool of assets we’re managing as sort of the slashed collateral. If validator wants to do something that enforces or requires a slashing event, the delegates aren’t affected, but the bond, which is at 12% of the validators’ holding, would be subject to slashing. It really just depends on the network.
Clay: As the validator, it’s only your funds that are at risk, and the delegates are not at risk?
Joe: [00:16:00] On Tezos, yeah, but on networks like Cosmos, everyone is at risk.
Clay: It definitely does seem like Tezos has thought a lot of this through pretty well. I like the Reitmans.
Clay: You mentioned some of the legal agreements that you’ve had developed. That’s interesting. Where do you go to find an attorney who is going to work with you on this? Can you speak a little bit to who your legal counsel was, the precedence that they drew upon? Were there any existing models out there, or is a lot of this is [00:16:30] kind of custom stuff that you’ve developed on your own?
Joe: In terms of how we find information, our first hire was actually are general counsel, Evan Weiss, former corporate attorney at Holland & Knight, and so he obviously is in the weeds everyday thinking about staking. He does a great job sort of working on that side of the shop for us. We basically, with his help and some of the connections we had previously, the main firm that we have obtained is called [00:17:00] DLx Law. Basically, they were a firm, or a firm, that pioneered the 2014 FinCEN mining decision. They had a lot of really good in-depth knowledge on how sort of transactions work on a blockchain, and so we worked closely with them to work out the nuances and proof of stake, and they’ve been extremely helpful on that end.
Clay: What are your customers most interested in when it comes to these documents [00:17:30] and coverage?
Joe: I would say the most important thing to them is what happens in the slashing event and what are the resources. We are pretty straightforward about everything there. On top of that, it’s just the certainty of the parameters. Even though it may not necessarily be 100% what they would write, they’re just happy that they’re like, “Okay, there’s something here that we can lean on,” and they have a good head around as to what our services are and what we offer. [00:18:00] Then we’re hit a lot now about SLAs. Basically, what are some of the guarantees that we’re giving in terms of operating? Our nodes and our infrastructure, and a big one too is communications. A little hack that we can see happen is if you’re a third party validator with an exchange, and good communications aren’t robust and secure, can somebody just plug in their own validator address for three weeks or an indefinite amount of time, be earning rewards, [00:18:30] and keep it all for themselves. Those are sort of the things that we’re seeing that our clients are really appreciating.
Clay: An example of an SLA might be that your nodes are up for a certain amount of time so that they’re around if they need to validate a block or vote on a measure. Is that right, more or less?
Joe: That’s definitely the biggest one. On top of that, it’s like what are our communication timelines in events of [00:19:00] slashing, or upgrades, or forks, or things that we need to work with them on in a diligent fashion, like responding in six hours, or three hours, or one hour, or something like that.
Clay: Just one point of clarification, you have full-time in-house legal counsel right now that’s like a full-time position. Is that correct?
Joe: Yep, yep.
Clay: That’s crazy for a startup, yeah. [00:19:30] How many people are at EON right now?
Joe: There’s currently seven of us. I mean, Evan was our first hire. He’s a good friend of ours and very educated on this space, but yeah. I mean, our thesis was that as this space becomes bigger and bigger, in regards to staking, that’s more and more of this counterparty of certainties need to be really detailed out. It’s such a new space and all the things with the regulatory stuff, too. It really just helps me sleep better at night having [00:20:00] him on the team.
Clay: My questions don’t come from a place of criticism. I just don’t know of any seven person startups that have full-time in-house, like legal counsel. I think it just speaks to how new the space is, and the importance of regulation, and a whole bunch of stuff that you need to think about that people have never had to really think about before.
Joe: The regulatory overhead in crypto is so high. We just always knew mission critical products. It definitely helps us move a little bit faster and with more certainty. [00:20:30] As you know, a lot of other startups have to think about this thing, or startups in crypto have to think about the legal regulatory at one point or another, right?
Clay: When people come to you guys and let’s say someone comes along and they have a lot of capital crypto assets that they want to stake, and maybe they’re looking at you versus another large competitor. I’m sure there’s a range of options that people [00:21:00] consider, like they’re going to do this, or we could do this ourselves. We could go with you. We could not do anything and we’re slashing, or we could go with this other competitor. What are the points on which you end up differentiating and sort of winning customers? When you do win the deal, what’s usually the reason why?
Joe: That’s a great question and something that comes up a lot when people just talk about validators and staking-as-a-service, generally because there are so many similarities, like how do you differentiate? [00:21:30] For us, our network is pretty strong. Being able to have relationships with these folks, to build that trust, is just something that generally helps out a lot, but on top of that, again, it comes to our legal and regulatory. […] with us and our conversations with all of the regulatory bodies around staking, and all the work that we’ve done, and all the nuances on tax. When they look at our delegation agreement, they really appreciate it because [00:22:00] one of our biggest clients is—the network has yet to launch, but he has many millions of tokens to stake, and it’s a big decision for him who to go with in that regard, and so we knew him ahead of time. We sat him down for days and had many conversations on sort of how it would look structurally, legally, and what he would have to think about from the tax side and also regulatorily because he was such an early investor. All that sort of stuff [00:22:30] gave him a lot of certainty and calm when he decided to go with us.
Clay: Let’s transition to chapter three which is on regulation. What are the laws that you’re regulated by or that you suspect you’re regulated by, but maybe aren’t sure of yet? How do you think about the regulatory landscape?
Joe: One thing we pride ourselves very deeply on is our work in that sort of a space. We put together a trade association [00:23:00] called the Proof of Stake Alliance, in which we’re basically, going out to seek more clarity from all the regulatory bodies when it comes to proof of stake because it’s such a new thing on the marketplace, and it’s going to affect so many people that are holding tokens. We’ve done a lot of work into that. To get a little bit deeper into the specifics of your questions, I’ll just go over, just off the top of my head, some of the ones that probably we put the most amount of effort into based upon sort of the […].
First is tax, right? [00:23:30] That one is such a gnarly thing and that token holders have to consider because there is no sort of precedent at the moment for just proof of stake that you can really have a one-to-one comparison to. If you want to essentially compare it to some of the other things that are out there, it’s not necessarily favorable, and it doesn’t make as much sense. For proof of work mining, miners have to pay ordinary income in the United States, but obviously that would really [00:24:00] affect a token holder’s decision to even stake because if they have to pay denominated in US dollars every block or cycle and they want to compound their rewards over a period of time because they’re along the project, that’s going to throw a wrench into the situation, right? That one, we thought pretty deeply about. There’s again, a lot of different nuances to it, and we’re basically talking to one of the big four at the moment to basically work on a framework for that. We’ll be [00:24:30] open sourcing that within post proof of stake alliance when that is ready.
Clay: I’m playing armchair CPA here, but because it’s a more kind of passive form of income, someone can just delegate to you guys and just kind of sit around. It’s very different from being a miner where you have to purchase equipment, and you have a machine that’s actually doing work, day in and day out. Do you have a stance, or is there consensus around [00:25:00] if this is ordinary income or not?
Joe: It really comes down to each network, in our opinion. Again, not a CPA, but from the work that we’ve done, at the end of the day, if you’re expecting to make income from something, it should outweigh costs and it should be a profitable venture for you, right? If you’re a staker or a delegate and you are wanting to participate in these networks [00:25:30] at call it steady state in which two thirds of the network is staked, and the inflation rate is at optimal, which is the lowest it should be based upon the design decisions. You’re not necessarily making a profit. That sort of changes the whole out of the ordinary income. With some of these networks that have governance, it could be like into a stock split. In stock split, you don’t go and pay on the pro rata shares that you get, [00:26:00] but for some of these networks that have 100% inflation, that could be seen differently in the eyes of the IRS. It’s a discovery process we’ll have to see, but those are some of the early observations we’ve made as we build up our framework.
Clay: It might be somewhat analogous to owning a government bond, whose returns roughly match inflation. Is that ordinary income? The answer is clearly, no, I believe. So, the first theory is tax. What else do we have in terms of regulatory categories?
Joe: [00:26:30] The next thing we’ve thought about a lot is the SEC and any potential […] or investment contract issues. The SEC is pretty approachable. They have an open forum where you can go and just talk to them, and so we’ve set up those meetings and had those conversations. As a whole, we were mostly concerned is the relationship between the delegator and the validator an investment contract, right? Because if you look at the four pillars of Howey Test , first is investment of money, which [00:27:00] you’re aggregating funds to do something, so that could be seen as a common enterprise. Clearly, it’s something that we’re all working towards to earn these rewards.
Next is expectation of profits which again, is just something that is on a case-by-case basis, we believe, and then the managerial efforts of others. That was one thing we looked into pretty deeply, and we think that if presented the right way and structured the right way, and there’s an honest arrangement [00:27:30] between the delegator and the validator, those things can be worked around, we believe. It’s still to be seen. It’s such a new thing, but those were initially our original concerns. Again, to go into these things a little bit more deeply, investment of money. Is there a risk of loss when it comes to that? That’s a big piece of that. For some networks, yes, slashing is subject to everybody, but for some of the networks, no. It’s only maybe the validator or not at all. That’s something that’s important to point out.
In […] of profits, again, if these inflation rates [00:28:00] on some of these networks are out sized, they’re potentially optically could look as though you’re expecting profits. On top of that, it’s also in private marketing, right? If you’re saying to people that, “Hey, you can make a bunch of money with us. Send us your money.” That is more likely to be an investment contractor or some sort of securities issue. But if you’re really just saying, “Hey, we’re providing a service. We’re not trying to necessarily promise you 10 extra turns,” or whatever, that’s obviously going to be more favorable [00:28:30] upon the past examples we’ve seen throughout securities, well, history.
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Okay. Back to the show.
The managerial efforts of others is pretty interesting. You have to think about a couple things, [00:30:30] particularly, what is the primary purpose of sort of the relationship? Are you just handing over your money over to somebody, and then just never doing anything and expecting a whole bunch of money back? There’s an involved process for a delegate when they choose the validator. It’s not a simple thing that they can just do, right? This is why, when you go to different training firms, they have a questionnaire for you to know that you know what you’re doing. Having that clear [00:31:00] understanding with the relationship of your client and customer or delegate is something that needs to be thought about, as well, when it comes to the investment contract issue.
But that being said, we feel much better about that as time has gone on. The thing that I think is sort of the unknown and interesting thing is, does the validator require a BD license to support certain networks that may be deem securities. The SEC has really only publicly said, Bitcoin and Ethereum, but what about these other ones which are the [00:31:30] majority of […] networks out there. If they did their raise in a way that maybe wasn’t as cultured as the SEC would’ve liked or they’re not decentralized enough, they’re clearly, as a network, relying upon managerial efforts of specific parties. That potentially, could run into issues if we decide to support that network and other validators, as well. From a security standpoint, those are the two biggest issues that we’ve identified and that we’ve been working towards. As time goes on, we’ll get more comfortable with the latter, but the investment contract issue, [00:32:00] I think, can be mitigated pretty decently.
Clay: Okay, so there’s the investment of money. Obviously, that’s happening. Into a common enterprise, that’s questionable. Is the cryptocurrency network a common enterprise? I would say no. It’s not really an enterprise. Is TCPIP an enterprise? Then, reasonable expectation of profits derived from the managerial efforts of others. I mean, one might say that that’s what you guys are doing, [00:32:30] but then on the other hand, is a Tezi, or whatever it’s called, does it morph into a security just because you’re handling it for someone. Does it transmute? No, it doesn’t. It’s not like you just invented a security because you’re possessing it and facilitating what they’re doing. You’re not actually managing their money or deciding to allocate it. You’re not moving funds in and out of a staked state, are you, right? [00:33:00] If they’re delegated to you, then they’re permanently being staked, and there isn’t active management happening, other than sometimes you’ll vote on behalf of others. Is that correct?
Joe: I think you touched on it pretty well. One other thing I’ll add to that is, we really do see ourselves as service providers because in Howey Test, this is, a lot of times, focused on equity and some of these other things. We’re just performing a service our delegates [00:33:30] don’t necessarily have rights to EON, or rights to equity, or the shares, or anything like that. Again, each protocol, each instance, each case, each marketing package is all going to be different as it applies to the Howey Test, but I think you hit the nail on the head with a lot of that stuff.
Clay: Is there another regulatory category, in addition to tax and the SEC bucket? Is there a third?
Joe: There are two more, but the next one I’ll touch on is FinCEN, and particularly FinCEN and on the state level, particularly when it comes to [00:34:00] being a money transmitter and a money service business.
Hey, this is Clay cutting in again to define FinCEN which stands for “Financial Crimes Enforcement Network.” FinCEN is a bureau of the United States Department of the Treasury that collects and analyzes information about financial transactions in order to combat domestic and international money laundering, terrorist financing, and other financial crimes. Okay, back to Joe.
That was one thing that FinCEN, in 2014, they deemed that Bitcoin wasn’t necessarily like that for the miners, [00:34:30] but what’s the relationship like now that there are the sort of constituents or delegates that we’re interacting with, right? And so, we feel pretty good about that because we’re not necessarily transmitting money from a person-to-person. We’re just interfacing with the blockchain, and if there is any routing of tokens, it’s just going to go back to the original proprietor that we’re working with. That, we feel pretty comfortable with [00:35:00] when it comes to a money transmission standpoint.
From an MSB license on the federal level, the one big thing we think about a lot, which is probably going to come more to light as time goes on, is KYC/AML […] financing. This, I think, is the biggest question when it comes to the regulatory space with proof of stake, particularly because a lot of these networks and a lot of these protocols are permission less. On some of these networks, you can’t stop [00:35:30] delegations coming to you, and that’s most of them, actually, but I think the key thing is, you can’t stop payouts on some of these networks, as well. Because at that point, you can’t really enforce KYC/AML on some of these networks if that’s happening automated on protocol. It’s outside of our ability to control.
One of the examples that you could come up with is like, okay, what if an OFAC country or someone from an OFAC country is looking to stake assets, [00:36:00] if they can just do it to any validator of their choosing and the rewards that are earned, they can keep and no one can stop it. That’s going to be an interesting thing that the community and the regulators are going to have to start looking into. That’s definitely the toughest aspect of this whole thing. There are some networks that do have some wiggle room for us. Currently, on Tezos, the payouts are sent to the validator. For us, if people don’t KYC with us, we can essentially just [00:36:30] not send the funds to them. We’ll be, hopefully, more in line with the KYC laws if we’re able to essentially be able to have a say in the payout structure. That is the next big thing that we think about when it comes to the regulator space and something that we’ll have to think about more and more as time goes on.
Clay: Do you require KYC/AML from 100% of your users or just ones who come in through the front door?
Joe: [00:37:00] On networks like Tezos, for instance, if they don’t do it at the front door, we can sort of manage the process in the backend of the payout structure that I mentioned. But for some of these networks that are permission less, yeah, we try to enforce it as much as possible, but there are some things that are just out of our hands.
Clay: Let’s say, hypothetically, someone on the Tezos network delegates to you, and it’s just all on the block chain, and you are holding their funds. Well, I guess that’s how they get in contact with [00:37:30] you is, you would be holding…
Joe: Yeah, yeah.
Clay: …and so, in some cases, in most, maybe all, it would be impossible to find them, but people have a way of finding you when you have their money. Then you’d just ask them to fill out the paperwork, and you’d proceed from there. Is that right?
Joe: Right. The CFTC is a big player when it comes to regulating a lot of the stuff. We actually don’t think that proof of stake falls under the CFTC as much. We’re not offering swap products. It’s not a [00:38:00] future’s contract. It doesn’t necessarily fit within the scope of the CFTC. The biggest thing that the CFTC would probably look into when it comes to proof of stake and validators is for basically fraud, right? And so, we should be acting in good faith anyway, and so that should mitigate the CFTC issue. They seem pretty progressive too with a lot of the new stuff that’s coming out, so we feel pretty confident on the CFTC side.
The last bit is back to [00:38:30] securities, but more particularly, FINRA for broker dealer stuff. We have an asset listing framework. Basically, as I sort of discussed, is there potentially an issue supporting security on a platform. We thought deeply about that. FINRA, if you do get a BD, would expect, and so that’s the biggest thing with those guys. That’s kind of it on the regulatory stuff. It’s very in-depth and it’s always changing. I feel good about proof of stake [00:39:00] because we can work through these processes. It’s not a full stop.
Clay: Let’s move on to chapter four, the future. What do you see the future looking like? I’ve heard people speculate about some of the stuff moving to wallets, having voting and maybe communication with stakers or even just users of a given network moving to the wallet as a communication channel. You’ve spoken about custody services or [00:39:30] exchanges, maybe working with you to provide staking services to their users. It’s kind of hard to peer too far in the future in this space, given how new everything is, but what do you see the world looking like? Let’s not get too crazy, like three years from now.
Joe: A lot can happen in three years in crypto right now. I mean, this is one of the things that gets me so excited about this space. I mean, right now, it’s very much focused on aggregating AUM, and clients, and distribution, and that sort of stuff, [00:40:00] but I think proof of stake could potentially be a big unlock for a lot of different applications within the blockchain realm. On that note, we’re obviously seeing governance as a big thing. People now can more effectively have some weight behind a voting structure, which wasn’t necessarily possible for. I mean, on a proof of work system, the votes were kind of happening from clients, and wallet users, and exchanges, running notes, and miners to picking which network to focus on, but now the token holders, themselves, [00:40:30] are now a bigger voice and can now literally vote. That’s something that’s really cool that’s happening. It’s obviously going to have its own host of challenges, but we’re seeing it in the wild now in early stages, and a lot of cool things can be had from that.
On top of that, there’s just the financialization of this yield stream that’s happening with these rewards on networks. We’ve talked a little bit about the pre-interview with fixed income products and structured products. Now, we’re able to [00:41:00] basically chop up the inflation curve and potentially, hypothecate more and more assets to create more and more value with an ecosystem. I’ve thought a lot about this. My friend, Lawson Baker, has a good Twitter presence on some of this stuff. Basically, one of the cool things that can happen with these products is, most of them have maturity dates of call it 6 months to 30 years, but who knows what’s going to happen during that time frame. So, what could [00:41:30] potentially happen is that when these products do come on to the marketplace, the turnover is going to be much shorter. The maturities are going to be much shorter, and more and more trading volume could happen from there, and I think that’s extremely interesting.
Transitioning to the trading stuff, I think that is probably going to be the most immediate thing happens that is just really fascinating when it comes to staking that we’re already seeing right now. One of the big things is circulating supply, right? Is coin market cap and some of these other price feeds going to reflect the price based upon the [00:42:00] circulating supply that’s on the free flow market that’s actually being traded, or are they also going to couple in staked assets that are locked? Or, on the contrary, if people stake assets, does that reduce the circulating supply, and hence, the flow? We’re already seeing interesting trades happen on that side of things.
I think one that’s particularly fascinating right now is with Cosmos. Cosmos, they have their ICO, early 2017. The ICO participants [00:42:30] have been waiting for a long time. When the network launched, it was anywhere from 20X to 100X, right? And so, that’s a lot of gains that people are sitting on. In terms of how the blockchain came on to market, initially, Cosmos unleashed their blockchain onto the world with lopped tokens and transferability. Basically, they wanted to ensure that may net was stable enough before they allowed for trading. And so, what happened was, is that a lot of people [00:43:00] went and staked during a lopped period. The bonding period, which is the period that you can delegate and undelegate from Cosmos is three weeks. If you delegate to someone in Cosmos, you have to stick with that validator for three weeks before you are able to move your tokens around again.
And so, this is really interesting because when they were voting on governance to enable transferability, essentially they had a two-week period in which once they voted for transferability, it would be on lopped, but then they had a vote that [00:43:30] shortened that to two days. Basically, when transferability was enabled, a significant amount of ICO participants were stuck in that bonding. And so now, within the next couple months, we’ll see all of those token holders, un-bond and potentially trade on the marketplace. What does that do for the price of the asset and the liquidity of the marketplace? That is something that is extremely fascinating to see as that sort of changes the dynamic and landscape of probably the biggest use case in crypto right now, [00:44:00] which is trading.
Clay: When you look at your product roadmap, big shifts that might come down the pike that you might have to adapt to or respond to, other than the regulatory stuff, what might they be? It sounds like, first and foremost, you guys are really focused on a B2C model, having a really seamless UX and UI, kind of wrap it around what you’re doing. What comes after that?
Joe: Concurrently, [00:44:30] we have a lot of partnerships right now. Currently, teed up that we’ll be announcing over the next month or plus, but a couple exchanges. Wallet providers are extremely interested in this because a lot of wallets, they don’t necessarily have a monetization model, and so now this clearly gives them a path to revenue that wasn’t there before. It’s a value-add product for their users and not just wallets, but in our opinion, every service provider in the space, that they’ll have to probably implement at some point, at least the majority of them, [00:45:00] so that they can retain their user base over a length of time. That’s particularly interesting as well.
The only other thing I’ll add is a big shift that could potentially happen. We talked about this a little bit in our pre-interview, is this could potentially change the nature of the custody model where now custodians are charging dips on AUM for their clients, but potentially, if a validator were to decide to take custody, now they can actually pay their clients a fee for the right or [00:45:30] the ability to hold their assets. There’s a lot of interesting shifts that staking potentially enable in this space.
Clay: I know that wallet providers, for a bit there, were earning revenue by integrating with services like ShapeShift that would allow for folks to exchange one crypto asset for another, and the AML KYC process kind of created a lot of friction there, and people were less likely to sign up, [00:46:00] just the conversion rate on that went down. I imagine that KYC/AML would still be required of users of a given wallet if they were going to integrate with you and provide your service as a service. Is that correct? There’s no case in which KYC/AML doesn’t have to happen, apart from huge regulations saying otherwise or changing.
Joe: For our wallet partners, that is the case. With exchanges and other users or other partners [00:46:30] that are taking custody, basically within our agreements, we tell them like, “Hey, you should be doing KYC anyway.” We’re essentially able to relinquish our responsibilities there. But yeah, for wallets, yeah, it’s a […].
Clay: One thing that I’ve been contemplating is generalized mining and how that is often a service, more or less, that a VC or an investor might provide to a network that’s [00:47:00] just getting started to, both, secure the network and also to generate a return for the investor above and beyond what they already paid for during a SAFT or something like that. Do you see something similar happening? Is there generalized staking? Is that a thing.
Joe: Yeah, totally. I mean, we’re seeing it with governance, but especially when you need to sort of leverage the wisdom of the crowd and reliable data for many, many users. [00:47:30] Particularly, one that comes to mind is Auger. All the rep users, the rep holders currently that scales, potentially becomes a huge depth that people would want to use, and the market caps becomes efficient enough and large enough, and institutional investors that come in and end up buying it and wanting to participate in that function. I can totally see a service provider that specializes in that, and we definitely plan on it for some of these in-depth staking or generalized mining [00:48:00] services.
Clay: Well, that wraps up this two-part series with Joe Buttram from Eon Staking. I hope you enjoyed it. Before you go, I want to mention that since we’ve started producing episodes at a much higher rate, we now have room for a few more sponsors. If you like the work we do and would like to support this show, [00:48:30] then a sponsorship might be a good fit for you.
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Alright, that wraps up [00:49:00] things for this week. Stay tuned for next week’s episode. Until then, take care.