Should you bet crypto? Here’s what the data says

Double digit stake returns may seem good, but after taking into account the inflation rates of most Layer 1 coins, the real returns are not always as attractive as they appear.

What is cryptocurrency betting?

With Ethereum’s transition to Proof-of-Stake fast approaching, staking has emerged at the top of many investors’ minds as a method of earning passive income. Staking refers to the practice of unlocking cryptocurrency tokens for a specific period of time to secure and support the operation of blockchain networks that use a Proof-of-Stake consensus mechanism.

Unlike in Proof-of-Work-based cryptocurrencies like Bitcoin, where miners use massive amounts of electricity to validate transactions and secure the network, validators in Proof-of-Stake systems lock coins as collateral to perform the same functions. In return, both Proof-of-Work miners and Proof-of-Stake actors receive coins as a reward for their services.

While both mining and staking can be profitable, many investors consider staking a more desirable way to allocate capital as it allows them to earn a steady income without having to purchase, operate and maintain mining equipment. However, when deciding which cryptocurrencies to bet, many investors make the mistake of only considering the nominal stake instead of digging deeper. Specifically, investors often forget to check the inflation rates of cryptocurrency tokens they plan to stake, which impacts the real rates of return for the asset. In other words, if the issuance of a token yields double-digit returns per year, but the token has an emission schedule that results in a high inflation rate, the real return may be lower than expected, or even negative.

ETH returns after the Ethereum merger

Using current and historical data from cryptocurrency prices and staking reward aggregators CoinMarketCap and Staking Rewards, investors can estimate the exact annual inflation rate of the 10 largest Proof-of-Stake cryptocurrencies and find current staking returns. Using these calculations, it is possible to calculate the real return on investment for each asset by

For example, according to CoinMarketCap data, Ethereum’s circulating supply on September 7, 2021 and September 7, 2022 was 117,431,297 and 122,274,059, respectively, putting the network’s inflation rate at about 4.12%. Staking Rewards data shows that the annual reward rate for indirect staking of Ethereum through staking pools is 4.04%, which puts the real return on staking at -0.08%. This means that anyone who thought they were getting a 4.04% return through staking had their return diluted by the network’s token emissions over the past year.

While Ethereum’s negative real return looks bad on the surface, holders of most other Layer 1 Proof-of-Stake coins are worse off. Additionally, when Ethereum completes the “merger”, ETH issuance is set to drop from approximately 13,000 ETH to 1,600 ETH per day. This will reduce Ethereum’s inflation rate from around 4.12% to around 0.49%, not taking into account EIP-1559’s fee burn.

Based on data from ultrasound.money, if Ethereum’s gas price remains the same as last year’s average, ETH will become deflationary after the merger, shrinking its total supply by around 1.5% a year. In addition, Ethereum’s nominal return is expected to grow to around 7%, which – assuming the informed estimates are correct – would put the real annual return after the merger at around 8.5%.

Is it always worth it?

Besides the soon-to-be largest Proof-of-Stake cryptocurrency, seven of the nine largest Proof-of-Stake coins have generated negative real returns for investors over the past year. Cardano, Solana, Polygon, TRON, Avalanche, Cosmos, and NEAR all had negative real returns when factoring in their circulating supply growth over the past year.

The worst in the group is NEAR, which has an inflation of 73.34% and a nominal return of 9.75%. That puts the real yield at -63.59%. TRON’s real yield comes in at -25.34% (inflation rate of 28.9% and reward of 3.56%), followed by Avalanche at -25.23% (inflation rate of 33.78% and reward of 8.55%), and Polygon at -17.75% (inflation rate of 31.36% and reward of 13.61%). Solana’s real return is currently -14.38% (inflation rate of 19.7% and reward of 5.32%), Cosmos is -11.7% (inflation rate of 29.57% and reward of 17.87%), and Cardanos is at -3.09% (inflation) rate of 6.73% and reward of 3.64%).

Based on the data, instead of earning passive income, most Proof-of-Stake cryptocurrency players lost income in real terms over the past year due to aggressive token emission plans.

The most profitable cryptocurrencies to bet

Based on the same methodology, only two of the 10 largest Proof-of-Stake cryptocurrencies (including Ethereum) have generated positive real returns for stakers in the past year.

BNB, which implements a similar transaction fee burning mechanism to Ethereum’s EIP-1559 in addition to a standard coin burning mechanism based on Binance’s profits, generates by far the highest real return for stakers. BNB currently has a negative inflation rate of -4.04% – meaning that the circulating supply has shrunk over the past year – and offers nominal yields of around 4.24%. That puts the real return for BNB players at around 8.28%, roughly the same as Ethereum’s projected post-merger return.

Polkadot also generates real returns for stakers. Its circulating supply grew by 12.83% over the past year, while its annualized return currently stands at around 13.9%. That puts its real yield at 1.07%.

Taking into account token emission schedules, the real rates of return for the top 10 Proof-of-Stake cryptocurrencies (including Ethereum) came in as follows over the past year:

BNB (BNB): 8.28%

Polka Dot (DOT): 1.07%

Ethereum (ETH): -0.08% (estimated at about 8.5% post-merger)

Cardano (ADA): -3.09%

Cosmos (ATOM): -11.07%

Solana (SOL): -14.38%

Polygon (MATIC): -17.75%

Avalanche (AVAX): -25.23%

TRON (TRX): -25.34%

NEAR (NEAR): -63.59%

Final thoughts

The data above shows that high nominal investment rates do not necessarily translate into high real returns. That is why investment interest rates should not be the only consideration for investors looking to own an asset. Equally important, volatility in the crypto market can affect real returns – even if an asset generates returns through effort, it may not be favorable if it falls 70% in a bear market. As a final note, readers should be aware that cryptocurrency prices are a factor of supply and demand, meaning that if the supply of a cryptocurrency grows by 30% a year, then the demand for it must also grow at the same rate for the price to remain so same.

Disclosure: At the time of writing, the author of this piece owned ETH and several other cryptocurrencies.