SwissBorg Earn: Understanding DeFi and Different Staking Mechanisms

• What is DeFi? Decentralised finance, usually known as DeFi, is the use of the blockchain to allow individuals to perform financial operations such as lending or borrowing, without the intervention of a third party. DeFi aims at constructing a financial ecosystem that is open-source, fully transparent, and accessible to all. Within this framework, there's no central figure of authority; instead, individuals engage via peer-to-peer connections.
• What is staking? Staking involves locking cryptoassets in a virtual vault (pool) to support a blockchain network or a DeFi protocol in their operations, playing a crucial role in maintaining efficiency and security of blockchain networks. When you stake a sufficient amount of cryptoassets, you can become a “validator” and get rewarded for your support to the network. Staking can be “non-custodial” when you contribute directly to the network, or “custodial” when you are relying on a validator to stake on your behalf.
• Primary purpose of staking: Staking's primary purposes include enhancing network security, validating transactions on the blockchain, providing specific liquidity, and contributing to the network's overall efficiency, integrity, and decentralisation.

• Risks of staking cryptoassets: There are two main risks when staking cryptoassets: Volatility and Slashing.
  • Volatility:A significant risk is the potential decrease in the value of the assets. When you “stake” your crypto assets, they might get locked for a certain period, meaning that you cannot immediately sell them in case of market events.
  • Slashing:The other significant risk is called “slashing”, which is a penalty imposed on a validator in case of fraud or bad behaviour from the validator. In case of custodial staking, slashing of a validator you rely on could have an impact on your assets. This risk highlights the importance of understanding the specific staking mechanisms.
• Risks in decentralised finance (or “DeFi”) Investments: DeFi investments carry the major risk of complete capital loss due to hacks or smart contract flaws. Investors can lose their stake in DeFi projects due to failures or security breaches. This risk underscores the need for thorough due diligence and understanding of the technological and security aspects of DeFi platforms. A good due diligence suggests looking at the team behind the project, the technology used, the documentation available, and whether the project is audited by an established and trustworthy entity.

• Asset-Backed vs Algorithmic Stablecoins: Asset-backed stablecoins are pegged to real-world assets, such as USD or Gold reserves, providing a more tangible value basis compared to algorithmic stablecoins, which rely on mathematical algorithms for stability.

• Regulatory differences in DeFi and traditional finances: DeFi protocols generally operate under less stringent regulatory frameworks compared to traditional finance, highlighting the need for investor awareness and caution.
• Regulation of staking services: Offering staking services is regulated in some jurisdictions. This regulation ensures compliance with financial laws, in particular the safeguarding of clients’ assets from the providers.
• AML laws and staking: Custodial staking platforms, like other financial service providers that enable transactions, must adhere to Anti-Money Laundering (AML) laws, ensuring that these platforms are not used for illicit financial activities.
• Staking pools: Depending on the jurisdiction, regulators may implement guidelines, best practices, and consumer protection measures to be applied in the various decentralised finance applications, such as staking pools. These guidelines play a significant role in ensuring fairness, risk awareness and security. Building and managing a decentralised protocol relying on liquidity pools and smart contracts often requires compliance with local financial regulations, ensuring the pool's operations align with legal standards.

• Portfolio management and loss mitigation: Diversification is key in managing a crypto portfolio, especially given the market's volatility. This approach helps mitigate losses and manage risk more effectively.
• Yield generation: In DeFi, the yield can derive from staking cryptoassets in a blockchain network, ensuring its security and functionality, or it can derive from providing liquidity in a peer-to-peer lending protocol. Unlike in traditional finance, yields from DeFi can be very volatile and are subjects to the usual risks that come with any investment in cryptoassets.
• Investor rights: Rights attached to cryptoassets typically differ from those attached to traditional shares. The rights attached to shares are defined by law, whereas, rights attached to a token are defined solely by the token issuer.

• Protection of investors' assets: Before investing into DeFi, you should verify whether the protocol separates investors' funds from its own operational finances to protect against operational and ins olvency risks. This segregation is vital for ensuring investor security.
• Centralisation risks in staking pools: Centralisation in staking pools can lead to potential manipulation or control by a few large stakeholders, posing risks to network integrity and fairness. You should always check how the governance of a protocol is organised.
• Network participation in staking: The network participation rate in staking influences the security and decentralisation of the network: the more concentration there is, the less secured the network. High participation rates can lead to more robust network security.

• Choosing a staking platform: Selecting a staking platform involves considering factors like platform security, reward rates, and lock-up terms. It's not just about yield percentage but also about reliability, asset lock-up period, and terms of service.

• Staking rewards: Staking rewards are the tokens distributed by the network to those who held and locked up their cryptoassets for a certain amount of time, incentivising participation in network security and operations.

Conclusion: Understanding staking in cryptoassets and the specificities of investing in decentralised finance involves navigating a complex landscape of risks, rewards, and regulations. Investors must be vigilant and informed, balancing potential returns with an understanding of the unique challenges and risks presented by cryptoassets and DeFi projects. This comprehensive awareness is crucial for successful engagement in the evolving world of DeFi.