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The Nasdaq billboard at Times Square in New York welcomes Coinbase on April 14, 2021, ahead of its stock market debut.GABBY JONES/The New York Times News Service

A number of prominent venture capital firms have started pouring millions of dollars into a niche, early-stage technology within the cryptocurrency sector that generates yield for investors and professes to make crypto mining more energy efficient.

Traditional mining of cryptocurrencies such as bitcoin involves using sophisticated computers to solve complex mathematical puzzles. New bitcoins are entered into circulation when those problems are solved and bitcoin miners receive a reward in the form of bitcoin tokens. That process is known as proof-of-work.

The latest development in the crypto sector is called “proof-of-stake” or “staking.” Staking allows an individual or an entity to create new digital tokens and verify the legitimacy of cryptocurrency transactions on a blockchain, or digital ledger, while getting rewarded with additional digital currency – a yield on their existing investments for participating in the process.

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Unlike proof-of-work, proof-of-stake does not require massive computing hardware and large facilities that consume an immense amount of electricity. Instead, cryptocurrency developers have developed a way to create digital currency in a more decentralized fashion, involving more crypto users, but less hardware.

“It’s a new idea that has really accelerated in the past 12 months,” explained Brian Mosoff, chief executive officer of Toronto-based crypto company Ether Capital . “With proof-of-stake, you don’t need to go out and make deals with chip manufacturers on the other side of the world [to power computers]. You don’t need to build a business based on burning a crazy amount of electricity. So it is way more efficient and less intensive than bitcoin mining,” Mr. Mosoff told The Globe and Mail.

Figment, a Toronto-based cryptocurrency firm which provides staking services, recently raised US$50-million in a round of financing led by New York VC firms Senator Investment Group and Liberty City Ventures. Galaxy Digital, a digital-asset merchant bank founded by prominent crypto investor Mike Novogratz, also participated in the round.

Months earlier, New York-based Blockdaemon, another blockchain company and staking service provider received US$28-million in funding from Greenspring Associates, a VC firm that has traditionally invested in biotech and healthcare companies. Goldman Sachs was also part of the funding round.

Figment essentially runs staking infrastructure on behalf of clients and generates revenue by charging a fee. According to Lorien Gabel, co-founder and chief executive officer of Figment, his company’s early clients were crypto exchanges as well as a handful of VC firms. Eventually, traditional asset managers, family offices and consumer brokerage platforms started enquiring about staking, and were particularly enthused by the energy efficiency of the technology as well as the idea of receiving yield on their crypto investments.

“Crypto has become a pretty speculative asset. What’s happening with proof-of-stake is that there’s an income stream or interest being provided to token holders who participate in the process of validating the blockchain,” Mr. Gabel said.

He used the analogy of a social-media platform to explain staking. “When you use Twitter or Facebook, you don’t benefit at all from the advertising revenue that the platform receives. Here, as a token holder of say, ether, you can benefit from the revenue generated when crypto transactions are being processed. That’s the big change investors need to wrap their heads around,” Mr. Gabel said.

There are still only a handful of companies that provide staking services, such as New York-based Staked and the France’s Stake Capital, partly because the technology is new and complicated. In January, Coinbase , one of the largest cryptocurrency exchanges in the world, purchased a small U.S. staking service startup called Bison Trails for US$80-million – that purchase would allow Coinbase to participate in staking and earn yield using its existing holdings.

Emil Woods, a partner at Liberty City Ventures who has been involved in the crypto sector since 2009, said that proof-of-stake technology had begun to be developed back in 2015, but investor sentiment and understanding toward cryptocurrency at the time was still weak, and it was much too complex to explain staking to the average investor.

“It was not the right time to pull the trigger. But in 2017 everything changed because of the initial coin offering boom, and people started understanding the difference between bitcoin, and blockchain technology,” he added.

Only certain digital currencies can be staked. Bitcoin, for example, still has to be created using proof-of-work technology, but ether has begun a process of migrating from proof-of-work to proof-of-stake, a process that insiders refer to as “Ethereum 2.0.” Right now, only US$26-billion of US$434-billion of ether has been staked, meaning there is plenty of opportunity for existing investors of the digital currency to earn a yield on their investment by participating in the staking process.

“The challenge to date for everyone interested in staking is that there have been very few currencies that you can actually stake. So Ethereum 2.0 is significant, because the market cap of that currency is very big,” said Boris Wertz, founding partner of Vancouver-based VC firm Version One Ventures.

Mr. Wertz also told The Globe that beyond the ESG advantage of staking versus traditional crypto mining, many holders of crypto assets want to not just hold them passively, but would like to earn a yield or reward on them.

“It’s like getting interest on money you have in your bank account. I eventually see a world where everyone will participate in staking, as we become more and more comfortable with digital currency,” he added.

Mr. Mosoff calls staking the “birth of a digital bond” and believes that ether will be the most lucrative digital currency in the future precisely because of staking technology. “If you can generate a return of say 5 or 6 per cent on a commodity you believe is hedging inflation, this becomes a very interesting asset for investors.”

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