Figment started in 2018, and we started with a thesis that proof of stake would become relevant, if not the dominant consensus mechanism or operating system for blockchains.
This is not a negative statement about Bitcoin in any way or proof of work. I love Bitcoin and own bitcoin, but at that time, various crypto protocols, communities, and individuals were thinking that maybe there's a different way to organize the incentives around maintaining a distributed ledger and security in producing blocks. Right around the time we were looking to do something in the space, some white papers were floating around about proof of stake.
Considering our background in infrastructure, internet infrastructure, distributed databases, and security, we thought, “If this works out, we would probably be pretty good at doing that.” Every successful startup has a combination of skill and luck. And the luck was there because, over the last two or three years, the most significant new L1 and L2 protocols launched have been proof of stake based.
I think that the transition of Ethereum from proof of work to proof of stake demonstrates a market trend towards proof of stake. So, we got a little bit lucky there. It could have failed early on or couldn't have scaled, or might not have worked. I think for the interim, proof of stake appears to be how blockchains are going to be organized at the infrastructure level, and we run that infrastructure at Figment.
Staking, unfortunately, is not a clearly defined term currently, so it can take on many meanings. For example, staking can be used to describe Figment's validator management activities or other staking-based reward-generating activity. We are, with some success, defining staking to focus on protocol staking, and I'll mention why that matters versus staking your Bored Apes or engaging in lending or other defi activities. So, staking right now means a lot of things.
What we're talking about here is the type of staking where you as a token holder can essentially run the protocol of that token and then share in the rewards and governance. Or, you can have someone run that infrastructure on your behalf. What we're really talking about here is essentially participating in consensus, (i.e., if you have 32 ETH or more, you can run your own Ethereum proof of stake node) or you can outsource it to Figment to do that on your behalf. Essentially that's it.
You can think of staking as participating in the actual functioning of the protocol (i.e. processing transactions, maintaining the ledger, etc.) As I mentioned, we saw that there was a need among our channel partners who are custodians, exchanges, wallets, our institutional clients, and large holders for an enterprise-grade solution around staking.
There are lots of consumer solutions out there that are fantastic and are all important parts of the ecosystem. But, we're very much focused on that institutional layer and on our channel partners.
If you're a long-term holder of a protocol's tokens, there are, broadly speaking, two or three activities that you can engage in. One is to do nothing, just hold the token or use it on the protocol if it's a utility-type token.
Two, if you're a long-term holder, you could (depending on the protocol) engage in lending, and borrowing, and other defi activities. In theory, those activities should have some form of higher rewards but are also actively managed. As we've seen recently, option two can be pretty risky.
Your third option is to help maintain the security of the network and help govern the network. To do that, you stake your tokens, either on your own via an infrastructure provider such as Figment. With this option, you're essentially maintaining the security of the network and being rewarded for it, along with any value generated when people are using that network.
If you're a long-term holder, you may want to contribute to the growth of a given blockchain. Staking is the best way to do it in my opinion. It also allows you to participate in governance.
Governance either gets people really excited or puts people to sleep. It's a tricky subject. Blockchain governance is pretty chaotic right now. But I think over time, it's determinative: it's important and it will determine which blockchains will succeed and which will fail. So, if you have the time and inclination it may be worth participating in the governance of your preferred blockchain. It's more than just staking, it's also about being involved and influencing the direction of the chain.
Governance allows you to have an opportunity to contribute your time, thoughts, and views, and help grow the network. So those are the reasons to stake. Generally speaking, there are two risks associated with staking. One is that if we don't do our job properly and, for example, we go down for a significant amount of time, you would miss some of your rewards so your return would be lower.
And that's generally called missed rewards. We have asset SLAs and insurance which cover you for that risk. On the other hand, there's another side. There are also opportunities and ways for us to optimize your stake (i.e., increase rewards) as opposed to using other infrastructure providers.
So we call that reward optimization. And essentially, we have a bunch of activities in the background that help us maximize the rewards you're entitled to, which requires doing a whole set of activities on the infrastructure and software layer. There's a risk and reward with this. The risk here is known as slashing.
Slashing sounds like it actually has a name that's kind of appropriate. So depending on the blockchain, you can lose between 1—5% of your amount staked. Not like 100%. Not like 50%. And again, it varies by blockchain, but essentially you have an opportunity to lose 1—5% of the amount staked if we, you, or your provider does something called "double signing," which you can think of as like forking the network or trying to double spend a token. It's not exactly right, but it's a good enough analogy. As a result of the malicious activities or inactivity, a portion of the staked tokens will be “slashed.”
We also have SLAs, and various levels of insurance to guard against slashing. It's never happened to our company. But now I need to knock on wood not to be cursed by the gods of chance. To date we have a 100% perfect operating record in that respect.
We also have insurance on our balance sheet, third-party providers, and supply chain solutions. And the whole orientation of our infrastructure is around avoiding this situation. So we will, in fact, take downtime and some missed rewards to make sure that slashing never happens. We're hyper-focused on that.
Liquid staking is another great name. There are a couple of well-known liquid staking solutions, mostly consumer-focused. Probably the largest and best-known solution is called Lido, of which we're an infrastructure provider in the Lido DAO.
Essentially, liquid staking is when you have a token staked, and you get a receipt token back, which you can think of as a coat check that entitles you to receive the token you staked plus any rewards that have accrued. Sometimes you can use that token as collateral in the defi ecosystem; you can go out, borrow against it, lend it out, and engage in defi activities. You can think of receipt tokens as a liquidity tool while your tokens are staked.
About six weeks ago, we were excited to announce our collaboration with a project called Alluvial. With Alluvial, Coinbase and other industry participants are forming an independent industry consortium focused on liquid staking. Alluvial aims to provide a fully KYC enterprise solution for liquid staking across multiple blockchains.
I think simply that the more chains where this is available, the better. In other words, the markets will be deeper, the pools will be deeper, and there will be more liquidity. So instead of just doing ETH, having a multichain solution across a number of real and significant assets would be better for liquid staking in general. Again, mostly from a liquidity perspective, but you know, it shouldn't just be available to holders of Ethereum, for example.
Right. So we were going to have our own liquid staking solution. We'd been working on it for about a year as a single provider. And, as we looked into it deeper, we felt that a multi-solution protocol would be much more beneficial to the ecosystem than a single provider.
Essentially, you have a whole set of risks dealing with just one provider as a counterparty. We think those risks are really spread out and decreased when it's a multi-provider protocol. So instead of, offering a single-provider protocol, we felt it was better to participate in a multi-provider liquid staking solution and sort of spread it out, you know, we'd be stronger working with many organizations than to just do it ourselves, and the people using liquid staking would have that level of increased confidence.
As a company, we know our core mission is to see the adoption and usage of blockchains grow over time for a host of reasons. We think it would be better for the Internet overall. We think we have too much centralization in the current public Internet stack with a host of negative externalities, such as big, large data monopoly data providers, large financial institutions that are rent-seeking, etc.
We think that at a fundamental level, blockchains offers a counterbalance to some of those centralizing trends that have happened on the Internet over the last ten years. I think that more people using blockchains will be an effective way to counter the trend of centralization and will add several counterbalances.
We just happen to have chosen proof of stake as the consensus mechanism we're going to support. We think it's currently the best way to use and run blockchains. Anything that increases the amount of security locked up in these blockchains, which is what we believe liquid staking would do, should give people greater confidence. The more people using and locking up value within these blockchains will increase their usage. We think it'll be better for the Internet and society in general.
This year, I think probably the most significant event in our part of the industry is around "the merge.” The merge is the term used to describe Ethereum transitioning from proof of work to proof of stake, and so we think that's going to happen, and looks like in the next few months. It's been a long time building that airplane while flying in the air.
So we're super excited about the merge. Generally speaking, if you hold one token, it's usually a bitcoin and if you hold two, it's generally bitcoin and ETH. As a result, the merge and Ethereum's transition to proof of stake, can really increase the number of people we can help participate in consensus. A blockchain of Ethereum's size, significance, and usage transitioning its core operating system while running has never been done before.
That's technically pretty cool. But also, just from a pure business and market opportunity, it's pretty significant for ourselves and other proof of stake providers. In the last six months, there's been a lot of negative narratives and activities in this space. The Ethereum merge, I think, is pretty positive and pretty cool. Keep an eye out for it. It'll be significant. And I think we could use some good news.
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