Crypto Staking: Passive Income Generator or Scam?

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Wanderer

The Wanderer retired from his engineering job at a major Silicon Valley semiconductor company at the age of 33. He now travels the world, seeking out knowledge from other wealthy people, so that he can teach people how to become Financially Independent themselves.

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You’d think that after Bitcoin’s stunning fall from grace, plummeting from $50,000 USD per BTC all the way down to $16,000 USD at the beginning of the year, we’d stop getting questions about cryptocurrencies. But as the price of BTC has recovered somewhat ($23,884 USD right now), interest is starting to return to the beleaguered crypto space. And with it, the questions.

I’ve been reading about crypto staking, and apparently I can make 10%+ in interest just by holding my money in crypto, like a savings account! Why would I invest when I can make this much guaranteed?

Anonymous reader

Now, you might be thinking “Oh, great. Here he goes with his anti-crypto ranting again.” But the thing is, I’m not anti-crypto. I’ve actually been following the crypto space for years. Personally, I think it’s really interesting technology and the technical details of it are endlessly fascinating to the computer nerd part of my brain. But the finance part of my brain then looks at it from an investing perspective, and it doesn’t even come close to passing the smell test.

Depending on who you ask, crypto is simultaneously a) a stable store of wealth, b) an inflation hedging asset akin to physical gold, and c) a high-flying tech stock that will rocket to the moon. It’s impossible for any single investment to be all 3 things, and as we’ve seen over the past year, crypto has done an abysmal job at doing any of these things.

In short, it’s cool code, but I don’t trust it with a nickel of my money.

But will that change when it comes to staking crypto? Is this a new way of earning passive income, or is just another scam? Well, let’s find out!

What is Staking?

First of all, let’s get one very important thing out of the way. “Staking” is not the same as a dividend or interest. A dividend is a redistribution of profit from a business, which crypto can’t do since it’s not attached to a business like a stock. It’s also not the same as interest, which is a redistribution of income that comes from lending the underlying asset out.

Instead, staking is an entirely new business model that the crypto world, essentially, recently made up.

Here’s how it works.

How “traditional” blockchains work is that lots of computers attempt to solve a very complex math problem. Successfully solving this problem allows new blocks, and therefore transactions, to be validated and added to the blockchain. This also grants the winner a reward, in the form of newly minted coins. The point of this is that because of the enormous amount of computing power necessary to solve this math problem, it’s very difficult for a bad actor to create fake transactions and steal everyone’s crypto. The downside is that it consumes a LOT of electricity. In 2022, the total energy consumed by crypto miners was more than the entire country of Australia.

In an attempt to fix this, some cryptocurrencies such as Ethereum changed over to a system of verifying transactions known as “staking.” In this system, instead of computers competing to see who can solve a complex math problem, users vote on which transactions are valid and put money down on the result, a process known as “staking” crypto. If the block turns out to be valid, they get a piece of the newly minted coins, and if the block turns out to be fraudulent, they could lose their stake.

This system, known as “Proof of Stake,” has the advantage of using way less electricity. After the switchover, known in crypto circles as “The Merge,” Ethereum energy consumption dropped by 99.99%.

For that reason alone, I am a huge proponent of Proof-of-Stake blockchains vs. the old Proof-of-Work system. Why we were wasting so much electricity and warming the globe to solve complex math problems with no purpose was the height of stupidity.

It also presents an interesting opportunity to make a yield on your crypto.

Not Your Keys, Not Your Coins

However, just like seemingly everything else in the crypto space, staking is rife with scam artists trying to steal your shit.

Here’s a simple way to tell if you’re about to be scammed: Do you have to deposit your coins into another wallet? Then it’s a scam.

There’s a saying in the crypto space: Not Your Keys, Not Your Coins. Because blockchain transactions aren’t regulated by any bank or government agency, if a transaction gets validated onto the chain, it’s irreversible. There’s no way to retrieve coins that have been stolen. That’s why the first step of every scam in the crypto space is to trick the victim into depositing (and keeping) their crypto in a wallet that the scammers control.

This is where the companies out there offering crypto staking really start ringing alarm bells. In order to stake your crypto, they claim, all you have to do is deposit your crypto with us! By just keeping your coins in an account, you can earn a return on your investment just like a savings account!

It’s all lies.

First of all, convincing customers to deposit their coins on an exchange is always the first step of an exit scam. Once the company accumulates enough money under their control, they execute what’s known as a “rug pull,” and disappear into the night, cackling. This is what happened to BitConnect.

Secondly, sometimes an attractive staking offer is used to lure people into a new coin that the exchange itself has created (or has a controlling stake in). The hope is to get people to buy and hold this new fancy coin, pumping up its value from all the buying activity. Once the value gets high enough, the scammers sell off their holdings, leaving everyone else holding the bag. This is a traditional pump-and-dump scheme, and I can easily find examples of it being perpetrated today. Here’s the current staking offers from a major crypto exchange that I won’t name since I don’t want to give them traffic.

I mean, a 65% APR for a coin named APE?!? They’re not even trying anymore. They even named it after that stupid Bored Ape NFT, which famously collapsed as a giant scam last year. Why don’t they just name the next coin SCAM? At least nobody will have to pretend that it’s anything else. And they’ll still find rubes to invest in it, I bet.

And finally, if you want to stake coins, you don’t actually need to give up control of your coins at all! Cryptocurrencies such as Ethereum and Solana were designed so that you can stake directly from your wallet. If you have the minimum balance (in Ethereum’s case, it’s 32 ETH) you can configure your wallet to stake however much you want, allowing you to earn staking rewards, all without the coins ever leaving your control.

And if you have less than that, the protocol allows you to join pools of other smaller investors to validate blocks together. Generally, any rewards earned are split proportionally depending on how much you staked, minus a pool fee, but this setup doesn’t require you to give up control over your coins either.

In other words, there’s never a good reason to stake your coins through a centralized exchange, yet this is how the vast majority of people do it. And then they wonder why they keep getting scammed.

Regulators Are Taking Notice

If you haven’t guessed already, everything to do in the crypto space is crawling with scams. I literally can’t read anything about crypto without seeing news of people who have been scammed, bad actors arrested for scamming, or seeing giant indicators of scams about to happen.

It’s a big reason why regulators are starting to step in. Just this month, the SEC fined one of the biggest crypto exchanges into the US, Kraken, for failing to properly disclose the risks of staking.

Crypto exchange Kraken agreed to shut down its U.S. cryptocurrency staking service and pay $30 million in penalties to settle U.S. Securities and Exchange Commission charges that it failed to register the program, the agency said on Thursday, in a move that could cause headaches for platforms with similar offerings.

U.S. SEC targets crypto ‘staking’ with Kraken crackdown, Reuters

Other exchanges like Coinbase and Binance reacted to the news by crying government overreach, of course, but here’s the thing. You don’t need exchanges to stake coins. So why were they so upset at the prospect of having securities regulators taking an interest in their activities? What were they planning on doing with those coins?

Conclusion

Watching the crypto space evolve over the past few years has been fascinating, to say the least. When I first heard about staking, especially the positive environmental impact, I was pretty excited. But when I started researching into how staking was being used by bad actors to separate people from their money, I had to throw up my hands and say “Again?!?”

Why is it that this space attracts so many scammers? Is it the promises of easy riches? Is it the nerdy futuristic appeal of money that only exists as code?

Who knows. But if you feel like you have the luck, smarts, and technical know-how to dive into this den of vipers and emerge with your shirt intact, be my guest. For everyone else, stick with ETFs.

Speaking of ETFs, we will be doing a Livestream on March 15, 2023 8pm EST with our friends at Passiv, where we will chat about how we use their tool to make investing easier, manage our dividends, and basically live our kick-ass nomadic retired life!

Here’s the link to the FB event page.

Be sure to go there and mark it as “Interested” so we know how many people will be attending. If you do, you will automatically be entered into a draw to win 5 t-shirts from Passiv, which is exactly the kind of nerd cred that you need in your life 🙂

Click here to add it to your calendars:

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Hope to see you there!

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