# Decentralized Basic Income: Creating Wealth with On-Chain Staking and Fixed-
Rate Protocols

Hakwan Lau  Center for Brain Science, Riken Institute, Japan  Correspondence
to<EMAIL_ADDRESS>Stephen Tse  Harmony.ONE

###### Abstract

In this review, we evaluate the mechanisms behind the decentralized finance
protocols for generating stable, passive income. Currently, some savings
interest rates can be as high as 20% annually, payable in traditional currency
values such as US dollars. Therefore, one can benefit from the growth of the
cryptocurrency markets, with minimal exposure to their volatility risks. We
aim to explain the rationale behind these savings products in simple terms.
The key here is that asset deposits in cryptocurrency ecosystems are of
intrinsic economic value, as they facilitate network consensus mechanisms and
automated marketplaces. Therefore, savings in cryptocurrency are associated
with some unique advantages unavailable in traditional financial systems. We
will go through the implementations of how savings can be channeled into the
staking deposits in Proof-of-Stake (PoS) protocols, through fixed-rate lending
protocols, and staking derivative tokens. We will discuss potential pitfalls,
assess how these protocols may behave in market cycles, as well as suggest
areas for further research and development. We end by discussing the notion of
decentralized basic income – analogous to universal basic income but
guaranteed by financial products on blockchains instead of public policies.

##  1 Background

As of year 2021, the interest rates for savings in traditional ‘fiat’
currencies such as the US dollar and the Japanese yen are at historic lows, at
around 0.07% and 0.01% respectively[1]. Because of the large national debts
held by these major economies, some may anticipate that interest rates may
remain relatively low for the near future. At low interest rates, the
traditionally lauded act of regular household savings becomes less rewarding.
This may have a particularly strong impact on aging populations which rely on
saved money as pension income, for the long-term sustenance of quality of life
after retirement[2].

Meanwhile, during the pandemic triggered by COVID-19, major governments have
printed large amounts of money to support their economic stimulation efforts
[3]. This has led some to worry that inflation, i.e. the rising of nominal
prices of goods, will eventually become inevitable. Although modern economists
have disputed the basis of this worry [4, 5, 6], historically this has been
the consequences of excessive increases in circulating currency, such as in
the cases of Germany in 1923 [7] and Argentina in 1989 [8]. To many, these
dramatic cases likely reinforces the pessimistic narrative about inflation as
a source of potential concern. As of 2021 May, the US inflation rate for
consumer goods was reported to be 5% for the past annual period, considerably
higher than anticipated [9].

These may be some of the reasons why, somewhat paradoxically, despite the
obviously negative economic impact of COVID-19, stocks and real estate prices
have generally gone up since March 2020 [10, 11]. As investors lose confidence
in the future value of savings in fiat currencies, they look for options that
would give higher expected returns. Accordingly, the cryptocurrency market has
also flourished during this time [12, 13, 14].

However, this puts the common household savers into an unfavorable position.
To the socio-economic groups who may have the most need to hedge against
possible inflation, fixed-term saving and government bonds have historically
been the major go-to options for the steady accumulation of wealth. To the
average saver, the stock market may seem like a rather complex and potentially
risky place. While real estate may be perceived as a relatively stable asset,
the threshold for investment entry is higher. Above all, cryptocurrency
remains very far from a mainstream investment option. Importantly, the
perceived risk is in fact supported by the evidently high volatility of the
market.

But what if one can benefit from the staggering growth of the cryptocurrency
market without ever ‘investing’ into it? That is, what if one can sidestep the
financial risks directly associated with the acknowledged volatility of the
market, and yet generate stable income via interest rates on the order of
several hundred times higher (i.e. 20% annual rate) than what the current
traditional financial market can offer? What if this can happen even when the
market is contracting instead of growing, at least to some extent?

This possibility is obviously of strategic concern for those who are already
invested into cryptocurrency technology, who see mass adoption as a desirable
and necessary next step for the development of the industry. But more
importantly, there is also a moral argument behind this consideration, even
for the technologically uninitiated. Given the current economic context, the
widening gap between the rich and the poor may increasingly turn into a gap
between savvy investors and traditional savers. The former group can afford
taking higher risks due to larger initial capital, while the latter may lack
the means and the know-how to truly benefit from anything other than the
anemic fiat saving rates.

Fortunately, certain existing cryptocurrency protocols may be able to help us
bridge this gap. To anticipate, the general rationale behind is simple: in
many modern blockchain systems the integrity of the ledger is supported by the
Proof-of-Stake (PoS) consensus mechanism [15, 16], rather than the Proof of
Work (PoW) protocol used in e.g. Bitcoin. This means that to validate a
transaction, one does not need to dedicate an excessive amount of energy and
computational power to solve a cryptographic puzzle, to ‘mine’ a coin.
Instead, in PoS networks, a validator needs to show that one holds a
sufficient amount of the currency (i.e. stake) within the system such that it
would be against one’s interest to act maliciously. By lending money to
validators, one is allowing them to qualify to do their jobs. This process,
sometimes called ‘staking’, means that putting money down for a fixed term can
be of intrinsic economic value, as staking is key to the financial efficiency,
security, and guaranteed integrity of the blockchain bookkeeping system. As
long as a PoS ecosystem is able to derive utility and value with decentralized
finance applications, e.g. for trading, there will be demand for staking. As
such, savers can be rewarded in a sustainable way, as they support the
generation of financial services and products provided by the PoS network -
not entirely unlike why bankers and corporate lawyers are paid good salaries
in the traditional financial system, even during downturns.

##  2 Stablecoins and Lending Markets

Besides the existence of PoS blockchain systems, the protocols for the
generation of stable interest assumes the availability of several instruments
and decentralized finance (DeFi) products [17]. The most basic of these
include stable currencies (sometimes called stable coins) pegged to real-world
fiat currencies. Examples include Tether (USDT) [18], MakerDAO’s DAI [19],
Binance’s BUSD [20], Terra’s UST [21]. These are all pegged to the US dollar.
There are also stablecoins for other currencies, such as Korean won [22],
British pound [23], etc. The different mechanisms for how the peg is achieved
have been reviewed elsewhere [24, 25]. One interesting fact is that they do
not necessarily have to be backed by real-world fiat assets. Some are backed
by other cryptocurrencies, yet others maintain their value by algorithmically
adjusting the supply. Accordingly, they come with varying degrees of absolute
stability. Nevertheless, overall, for the major stablecoins including the ones
mentioned above, the stabilization mechanisms have been shown to be generally
effective over the past couple of years, withstanding considerable market
volatility. Also, insurance options are now available to mitigate the risks of
unpegging [26, 27].

Stablecoins are important for our purposes; for the stable interest rates to
be meaningful to the typical household savers, both the savings and the
interest have to be in terms of everyday currencies. With them, one can
already earn savings interest without exposing oneself directly to the
volatility of the cryptocurrency market. Protocols like COMPOUND [28], Maker
[19], and AAVE [29] allow loans to be provided to borrowers who put down
cryptocurrencies as collateral. Savers can deposit money into these protocols
to form a pool for the loans. Because borrowers have to pay interest on their
loans, part of that translates into the interest to be paid back to the savers
in return. These interest rates are determined by market mechanisms [30],
reflecting the expected values of future assets.

In part due to the semi-anonymized nature of financial engagement with
cryptocurrency, with few exceptions [31], long-term loans tend to be
overcollateralized, meaning that one has to put down a higher amount of
‘collateral’ in order to borrow. This overcollateralization ratio is typically
up to 150% to 200%, meaning that for every $1 borrowed one has to put down as
collateralization something worth up to $1.5 or $2. This way, if a borrower
defaults, the lender would be protected. Also, the collateral itself is
typically in a cryptocurrency that fluctuates in price. Should the worth of
the collateral diminishes so that the expected overcollateralization ratio
cannot be maintained, the lender can seize the collateral (in accordance with
prior agreement) and sell it immediately to avoid a loss. With
overcollateralization, even slippage during a flash crash should not lead to a
loss on the lender’s part. If the process of liquidation is achieved more
efficiently and quickly, some lenders can even afford to offer a lower
overcollateralization rate e.g. at just 110% [32]. Accordingly, ‘bad debt’ as
we traditionally understand it does not really occur as such in decentralized
finance. Given the nature of contracts in advanced blockchain systems (known
as Smart Contracts [33, 34]), theoretically they are completely binding and
frictionless to execute.

In terms of economic incentives, some borrowers may be willing to put down
collateral because they expect the value of them to go up in the future. So
they do not want to sell the collateral at the current price. And yet, while
‘holding’ the cryptocurrency for the longer term, if the asset is deposited as
collateral, the loan gives them instant liquidity, which may allow them to
reinvest further into the market via leverage. This is part of the reason why
they are willing to pay for the loan interest. In this sense, at least part of
the savings interest ultimately comes from the expected growth of the
cryptocurrency market, even though the savers do not have to partake into the
market speculation directly in order to enjoy the interest as income.

However, as of the time of writing, the interest rate for borrowing and
lending tends not to exceed 10% annual rate [35]. This is already far higher
than current fiat interest rates. In fact, this is on par with, or just
outperforms in some cases, most other major forms of low-risk investments,
like national bonds, pension accounts, etc. And if one is to be paid back in
stablecoins, the risks involved are likewise relatively small. However, one
caveat is that it is unclear if borrowers would be willing to pay high
interest during a bear market. Importantly, as we will discuss below, it may
also be possible to generate stable interests at as high as 20% annual rate,
by capitalizing on other sources of revenue besides anticipated market growth.

##  3 Fixed-Rate Lending Protocols and Derivatives

One other issue in treating lending interest as stable income is that until
recently, in decentralized finance, borrowing and lending interest rates
tended to fluctuate flexibly according to market conditions. However, fixed-
rate lending protocols are now available [36]. The key idea here is that we
can trade the value of a loan on the market. That is, if a token is to give
its holder the right to be paid $100, as a settlement of a loan, at a certain
future date, then the token itself could be traded at a certain price.
Assuming one generally prefers money right now over money in the future, one
could probably only be willing to buy this token at a discount. How deep that
discount is, in turn, should depend on when the loan matures. For loans that
are to be settled further in the future, buyers may be willing to buy such a
token only at a deeper discount. That is to say, the interest for longer-term
loans should be higher. By setting up automated markets for these tokens [37],
one can work out the general interest rates for loans for different durations
- what is sometimes called a yield curve [38]. This curve is not entirely
fixed in the long run. But it can allow relatively stable predictions to be
made within a certain timeframe.

The token described above is essentially a bond. Specifically, it is what is
called a zero-coupon bond, meaning that the bond itself generates no interests
or other additional benefits; the attractiveness is just that it may be bought
at a current price lower than the eventual loan settlement.

In traditional financial terms, bonds are a kind of derivatives, which are
simply contracts that ‘derive’ their value based on some other asset. Some
other types of derivatives include options for buying a certain asset at a
certain price X at a certain future date. The holder may exercise the option
only if the price turns out to be favorable. This could be useful, for
example, for hedging purposes. That is, given that a party is obligated to
fulfil a transaction in the future in a particular currency, such as to pay up
for some consumed services. The party could end up suffering an unexpected
loss if the price of the currency goes up. By holding the option token
mentioned above, the party can be sure that the actual total cost would not
exceed a certain point; if the price of the currency goes up above
expectation, one can then exercise the option to buy the currency at the
agreed price X, making a profit that would exactly compensate for the loss.

Notably, the derivatives market in the traditional financial world is large,
in which the most traded type of derivatives are interest rate swaps. The
trade volume for these alone are on the order of 10 times larger than the
stock market [39]. These instruments allow two parties to trade on the future
yield of an underlying asset. This can be useful for turning floating interest
rate incomes into a fixed-rate income, or vice versa. For example, if I have
lent out money to someone who is to pay me back at whatever current fiat
interest rate is, I may be able to find a third party to swap my interest
income into a fixed rate. The third party may demand a lump sum, or may only
offer a relatively low fixed rate. But if the deal is made, the third party
will absorb the variability in future changes in fiat interest rates.

We will return to interest rate swaps in section 8. For now, what is important
is that this sets the context for a type of derivative that is unique to
decentralized finance, and is key to the problem of generating stable income.

##  4 Staking Derivatives

In a PoS network, staking derivatives are tokens that can be generated when
one lends money to validators to allow them to qualify for the job of
approving transactions [40, 41]. Without such tokens, there will be a number
of risks involved in staking. The first is due to the fact that staking
generally requires locking in the staked currency for a fixed period,
typically up to a few weeks, during which the validators are considered
qualified for the role (by demonstrating that they have enough stake). If the
currency drops in value over this time, the lender may not be able to
‘unstake’ fast enough, i.e. to extract the money back from the validator, to
stop the losses. The second is that if the validator fails to do the job
correctly, such as not being present frequently enough to approve new
transactions on time, there will be penalties, i.e. part of the staked
currency will be ‘slashed’.

By having staking derivatives, it addresses the first problem by making the
staked value essentially liquid. The staking derivative can be the contract
allowing whomever holding the token to claim the staked currency, as the time
matures. Therefore, by trading the staking derivative, one is essentially
selling off the loan to the validator to someone else, in exchange for instant
liquidity. As different people may have different speculations on the future
value of the staked currency, general market mechanisms will determine its
current price. Depending on the nature of the contract, the risk of slashing
can also be taken into account.

Currently, not all PoS networks offer staking derivatives, at least not
natively. However, the concept behind is straightforward and attractive, and
we expect implementation and adoption to occur widely in the near future. As
we will see in the next section, most relevant to the protocols for the
generation of high stable interest is the fact that these staking derivatives
can be used as collaterals for borrowing money.

##  5 Staking Fees as Stable Interest

Because staking is essential for a PoS ledger system to maintain its
integrity, staking fees on the order of 10% annual rate or higher are
typically offered to incentivize stakers [42]. Importantly, these fees are
relatively stable. Depending on how the derivative contract is set up, the fee
can go entirely towards the holder of the relevant staking derivative. In the
Anchor protocol [43], one can put down staking derivatives as collateral, for
borrowing money in a stable currency. Instead of forfeiting all the staking
fees, the borrower can continue to earn a portion of it. The exact percentage
of this split is not a constant, as we will explain in the next section. But
for illustration we can assume that this split will be 1:5, meaning the
borrower gets to retain 1/6 of the staking fees earned. That means they give
up 5/6 of the staking fees yield, in exchange of the instant liquidity
provided by having the loan. (Nominally, the ‘splitting’ is more complex in
the Anchor protocol, in that the borrower pays an interest, and receives
certain tokens of value, ANC, in return. But the sum total of the transaction
is equivalent to losing part but not all of the staking fees earned, and for
simplicity we will continue to conceptualize and present it this way.)

Like other lending protocols discussed in section 2, the Anchor protocol
thereby also functions a bit like a bank in a traditional financial system. To
accumulate a pool of deposited money for lending to borrowers, it accepts
savings in a stable currency from savers. Because it takes a split of the
staking fees from the borrower’s collaterals, that can be used to contribute
towards the interests to be paid to the savers. Using the example above of a
1:5 split of the staking fees between the borrowers and the protocol, at an
overcollateralization ratio of 200%, the maximum affordable interest rate can
be as high as 167% the staking fee itself; each dollar borrowed attract twice
as much worth of collateral, which in turn attracts 5/6 of the staking fees
per collateral unit (5/6 x 2 = 167%). This is why the Anchor protocol can
offer such competitive interest rates, currently at about 20% annual rate,
given that the staking yield is at 12% on the native LUNA network [22] for
staking (12% x 167% ≈ 20%). In other words, it exploits a source of income
that is not available in traditional financial systems, and is unique to PoS
networks: staking fees.

But if the interest ultimately comes from staking fees, why do savers not
stake the money themselves and earn the staking fees directly? Or, assuming
some savers may lack the technical knowhow and familiarity with
cryptocurrencies to engage in such activity, why does the savings protocol
(such as Anchor) not directly stake the savers’ money on their behalf, and use
the generated staking fees to pay the interest? Why do we need to involve the
borrowers at all?

There are several advantages in doing so. The first is that staking is
inherently risky, as explained briefly in the last section. During the period
of staking, the value of the staked currency may fluctuate. Also, if the
savings protocol collects money from many savers, and proceeds to stake the
entire pool of money, this may also create an unhealthy situation for the
staked network. Ultimately, the PoS consensus mechanisms work well when there
are many different independent stakeholders, all incentivized to make honest
and reliable decisions, none of whom are ‘too big to fail’. If all the
validators are chosen and supported by a single source of money, the security
of the network could be compromised [41]. By having borrowers who
independently make their staking decisions, and contribute staking derivatives
voluntarily as collaterals, the risks and control are both diluted over many
individuals. Because the loans are overcollateralized, the protocol itself is
protected against the risks of defaults or unexpected falls in the value of
the staked currency.

Importantly, another key advantage is that because loans are
overcollateralized, if the split of staking fees mostly go towards the
protocol rather than the borrower, this leads to higher staking yield than
would have been achievable via direct staking (167% in the example above).

##  6 Stabilization Mechanisms

But the scenario of always being able to offer savings interest rates as high
as staking fees yield is an unrealistic ideal. It assumes that all of the
savings deposited by savers will be successfully loaned to borrowers. In
reality, borrower demands fluctuate. If the terms of the loans are
sufficiently favorable, enough borrowing should happen. It is understandable
that borrowers will find a lower overcollateralization ratio attractive, as it
allows them to borrow a higher amount with the same collateral size. But not
maintaining a high overcollateralization ratio would mean that the protocol is
exposed to a higher level of risks, so the room for maneuver in this regard is
not unlimited.

This leaves the other parameter, the ratio for the split of the staking fees,
as the primary leverage for regulatory control. In the Anchor protocol, when
there is insufficient borrowing, the split changes so that the borrower can
keep a relatively higher portion of the staking fee; when enough of the
savings are successfully loaned out, this split changes in the other direction
so that an increased amount of the staking fee goes towards the savers.

It is possible that depending on the availability of other borrowing
opportunities in the market, even at a very favorable split of the staking
fees there may not be enough borrowing demand. Some other lenders may offer a
lower interest rate; some are already offering 0% [32]. Others may also be
able to offer a lower overcollateralization ratio. We will discuss more about
these possible competitions in the next section.

As such, borrower demand will necessarily fluctuate over different market
conditions. This is why the current Anchor interest rate for savings is set at
a few percentage points below expected staking fees income. This allows the
extra income to go into a reserve. So if future staking fees income is to
fall, the interest rate for savings does not have to change immediately
without sufficient warning to the savers. By using the money from the reserve,
the interest rate can be maintained temporarily even if staking fees income
cannot sustain the rate in the longer run.

##  7 Some Caveats

At the time of writing, the initially offered 20% annual rate Anchor interest
rate has been maintained around the same level successfully since inception
earlier this year (2021). Notably, even during the market crash in May 2021
when the price of Bitcoin dropped by over 50%, the Anchor rate sustained at
around 18% which was within the expected limit. It has been suggested that
this highly competitive rate may become a new industry standard [44].

However, staking derivatives are a relatively new type of financial
instrument. The market is still at an early stage of development, with new
trends emerging rapidly. At the time of writing, Anchor only accepts staking
derivatives from the native Luna network as collaterals. Although there are
plans to accept staking derivatives from other major PoS networks in the near
future, it may be more difficult to fully anticipate what that would entail.
One reason is that staking derivative tokens generated by staking the native
Luna currency are perhaps not so widely accepted as collateral for loans yet.
Therefore, holders of these derivative tokens do not have many other options
for generating immediate liquidity via borrowing.

But if this general protocol design is to scale up, and to accept other
staking derivatives as collaterals, one has to face the market competition
offered by other lenders. As mentioned in the last section, some other lenders
may be able to afford taking a higher level of risk, by requiring a relatively
marginal overcollateralization ratio as low as just 110% [32]. At such a tight
margin, should the value of the staked currency suddenly drop substantially
during a flash crash, one would have to seize the collateral and sell it very
quickly to avoid a loss. The Liquity protocol [32], for instance, is able to
do so because of a more efficient and automated liquidation process supported
by an internal liquidity pool. Furthermore, they are also able to offer zero
interest rate for the borrowers. Currently Liquity only accepts Ethereum (not
its staked derivatives) as collateral. But it is conceivable that similar
forms of competition may soon come into play for other major cryptocurrencies,
as well as their staking derivatives.

According to one analysis [45], the Anchor protocol may do particularly well
during a bear market. On the savings side, this seems intuitive; saving
demands should increase as riskier investment opportunities do not look
promising. However, the borrower demands are again more difficult to predict.
In a mild downturn, it is possible that some ‘HODLers’ may be more inclined to
stake their cryptocurrencies, to wait for the expected market recovery. But if
the market is perceived to be in a strong downward trend, or if it is highly
volatile, fewer people may be willing to stake.

Importantly, the main motivation for borrowing may be to create leverage for
further investment. In a downturn, the risk of liquidation (as one fails to
maintain the overcollateralization ratio, such as during a flash crash) may
render this rather unappealing. Accordingly, since May 2021, the Anchor
Protocol have had to offer extremely generous staking fee splits to attract
borrowing. At such splits, even if borrowing demand is high, the earned fees
cannot fully support the high interests paid out to savers. That is because
the income of the protocol is just a multiplicative product of total staking
derivative deposited as collateral and the fees split earned per collateral
unit. As such, in July 2021, external funds had to be injected into the
reserve in order to sustain the high savings interest rate [46].

Despite these caveats, like many others [44, 45], we agree that Anchor is a
very timely product, with elegant protocol design and stimulating foresight.
Below we outline some areas of further development, for achieving similar
goals.

##  8 Diversification, Interest Rates
Swaps, and Tranching

As reviewed so far, the key idea behind the generation of highly competitive
interest rates in decentralized finance is to make use of the staking fees as
a source of income for savings. In section 4 we mentioned some advantages of
not directly staking the savings, and only receiving staking yield via the
lending market. However, there may also be advantages in directly engaging
with generating income with the deposited savings, rather than lending the
money out to borrowers. One such advantage is the economy of scale.

For example, the Yearn protocol [47] systematically searches for maximal gain
with a combination of lending interest rates, staking fees, leveraged
reinvestments of the borrowed money, etc , and can achieve much higher return
than simple staking strategies. It takes considerable effort to keep track of
the changing fee rates, availability of new yield-earning products, etc. But
for a decentralized organization at the scale of a bank, the overhead cost
incurred is more likely to be worthwhile.

One lucrative way of generating passive income is liquidity pool yield farming
[48]. In decentralized finance, in order to create a market to exchange,
rather than relying on a traditional central market maker, one needs to create
a pool of funds to allow trades to happen instantly and smoothly. By
contributing to such a liquidity pool, one earns fees in return, when
transactions take place. In other words, for an automated market to be able to
allow trades between two currencies X and Y, that mechanism needs to have
enough flowing infantry of both currencies. But merely putting down these
currencies into the mechanism, one is thereby facilitating trades. So, in a
way not unlike staking, one earns the deserved reward through the process;
accordingly this kind of ‘investment ‘ is sometimes called liquidity pool
‘staking’, even though it is distinct from the type staking in PoS networks
mentioned earlier.

The fees one can earn in joining liquidity pools are typically on the order of
under 10% annual rate. However, when a new pool is formed, often there are
extra incentives to attract initial endowment, and those can be extremely
lucrative, sometimes reaching over 100% annual rate. The process of earning
these high annual rates is sometimes called yield farming, as one is
essentially investing into a new pool hoping that it would grow as expected,
to allow yields to be ‘harvested’.

As expected, at such high annual rates there are also risks involved. The
incentives in yield farming are typically given in the native currency of the
protocol, which may not turn out to be so valuable in the long run if the
protocol does not turn out to be successful. Besides that, similar to staking,
the value of the assets deposited into the liquidity pool may fluctuate in
time. Besides simple depreciation, when the balance of the two deposited
assets changes (e.g. one increases in value while the other does not), this
can create another kind of deficit known as impermanent loss [49, 50].

Despite these risks, there are arguments to be made that as a bank-like
organization, these are investment opportunities worth pursuing. One reason is
that at a large enough scale, one can methodically and effectively make use of
insurance and hedging instruments. For example, earlier in section 3 we
mentioned the use of interest rate swaps to turn a variable-rate future income
into fixed-rate income. In decentralized finance, protocols like Horizon [51]
are also creating opportunities for doing so. Even in the absence of a fluid
interest rates market, Horizon makes use of game theoretic and auction-like
mechanisms to facilitate the swaps. This way, one can opt to take a smaller
but fixed yield from farming liquidity pools.

To manage risks, protocols like Barnbridge [52] and Saffron [53] also allow
one to break down an investment or loan into ‘tranches’, each representing
different risk levels. For example, a ‘senior’ tranche may lead to a lower
yield overall, but the rate will be more guaranteed. A bank-like organization
can select the appropriate risk level given the reserve level at the moment,
with the guiding principle that higher risks are only affordable when there is
sufficient excess in reserve.

These strategies are not mutually exclusive with extracting staking fees via
borrowers’ collateral, which is admittedly virtually risk-free. That is
because when there is enough borrowing demand, essentially the borrowers
absorb most of the risk involved. However, these riskier and higher yield
strategies can be employed in parallel, especially when borrowing demand is
low. As with competitive banks in the real world, financial institutions
typically participate in various activities including both investment and
lending. If the goal is to give savers the highest stable interest rates at
minimal risks, an algorithm that explicitly optimizes for the ideal
combination of different strategies to achieve this goal should be in
principle more advantageous than fixating onto a single strategy a priori.

##  9 Towards Universal Basic Income

We started by considering the high stable interests of decentralized finance
protocols from the perspective of common household savers. Currently, few of
them have access to investment opportunities with such stable high yield.
However, the availability of these products will naturally also be accessible
by the wealthier, seasoned investors too. Therefore, are they actually going
to help the common household savers, or are they just going to make the rich
richer still?

There are perhaps reasons to be optimistic (from an egalitarian perspective).
The first is that even if these products do allow the wealthier to benefit,
the margin of this benefit is unlikely to be as high as that for the common
savers. That is because currently the savvy and capital-rich investors already
have access to various high return investment options, including high-entry,
actively managed hedge funds.

Secondly, with social and keyless wallets [54], one ultimate goal is to allow
everyday smartphone users to be able to access decentralized finance
applications securely with ease. For many of these new adopters, having access
to such high stable return investment options will likely help level the
playing field.

However, we must also acknowledge that it is not easy to foresee a future
where such high-yield, low-risk products will become commonplace. The impact
of this for traditional financial products will lead to a chain of
consequences that would ultimately depend on relatively unpredictable factors,
including possible governmental intervention. Accordingly, we cannot expect
that the lofty vision of universal basic income will naturally materialize out
of market forces. Rather, we should see the availability of these new
decentralized finance products as providing opportunities for such an agenda.

For example, there are already projects in the cryptocurrency space which aim
at providing universal basic income to those who can prove their identity
[55]. Capitalizing on the high yield generated by the Anchor, the Angel
protocol [56] also allows charity donations to become virtually perceptual (as
supported by the future yields). These may provide the platform for some
universal basic income schemes to be implemented.

As a longer-term vision, radical markets [57] on blockchain can also help to
enforce overall fairness. Because of the permanent and immutable nature of
transaction records in cryptocurrency ecosystems, taxation will eventually
become automatically enforced, with evasion becoming extremely difficult.
Importantly this can also open up venues for novel and interesting ways of
redistributing wealth. For example, under a Harberger taxation scheme [57],
the value of a property can be self-assessed, i.e. determined by the owner.
The owner may be incentivized to not to overvalue the property, in order to
minimize taxation. At the same time, transaction of the ownership can be made
mandatory if any buyer offers a price above the self-assessed value. Therefore
the owner should also not undervalue the property. With a well-defined true
value to the owner, properties can be fluidly and fairly transferred. Economic
analyses have shown that this can motivate and orchestrate the entire
community into maximizing common good, while maintaining market efficiency.
Similar mechanisms can also be implemented to implement highly progressive and
quadratic wealth redistribution.

Importantly, even in the shorter-term, there is also an argument to be made
that allowing the rich to become richer should not always be a concern, even
for equalitarian purposes. An individual’s fixed or basic income may be
dwarfed by the wealth of others, if such income is paid in a currency that is
subject to inflation. If the rich can offer higher prices for goods, amid
competition there may be a concern that one’s income may lose purchasing
power. However, this would not be an issue if the basic income is to be paid
out in a currency that is truly resistant to inflation. The US dollar is
supposedly (loosely) pegged to the prices of goods. However, there has been
criticism that the consumer price index (CPI) provided by the government is
biased towards goods that do not truly reflect the quality of life of an
average individual [58]. Currently, there are projects such as Frax’s stable
peg and index which aim to rectify this situation [59, 60, 61], to create a
stable currency in decentralized finance pegged not to the inflation-prone US
dollar, but to a more meaningful representation of the true cost of living.

Imagine if a stable yield of as high as over 10% per annum is to be paid out
in this inflation-resistant currency. With such a product, to support the
universal basic income for a person’s lifetime, one would need a few times the
individual’s annual living cost, as a one-time endowment. This is regardless
of the future conditions of the economy, or how the wealthy may become richer
- if the currency truly reflects the cost of living at the moment, in a stable
peg. This could be the basis on which a meaningful universal basic income can
be made feasible.

##  10 Closing Remarks

We have reviewed the logic of how the generation of a stable savings interest
rate at as high as 20% annual rate is possible. In traditional financial
investments, such a high and stable rate is above what even some of the best
investors can achieve these days [62]. The key innovation here is to
capitalize on the unique features of decentralized networks and lending
marketplaces. In particular, ordinary savers can participate in multiple
network stakings and fixed-rate saving products.

It is important to recognize that this is not a technical sleight of hand. The
economics behind it are straightforward. Through staking, one contributes to a
process that allows highly efficient and robust financial services and
products to be delivered, along with other applications [63, 64] of the
blockchain system. Outside of the context of network staking, the same concept
applies for liquidity pools, which allow automated decentralized markets to
take place. To capture the growth of the cryptocurrency market, one can also
turn these into relatively fixed-rate future incomes via interest rate
swapping mechanisms, and thereby use the income to further finance stable
income for the savers.

In the traditional financial world, some bankers may lose part of their
bonuses during economic downturns. But it rarely cuts into their base salary
level, because their services are supposedly still valued. Likewise, even as
the cryptomarket sees adjustments, staking fees in decentralized networks are
here to stay, for staking contributions to the automation of jobs akin to
those done by bankers and corporate lawyers. The very premise of decentralized
finance is that everybody can participate fairly in the market mechanisms.
Unlike in the traditional financial system, in decentralized finance everyone
can be a ‘banker’ – even if only passively, indirectly, on a smaller scale.
This is the economic basis of how we can possibly provide the household savers
with meaningful basic wealth.

##  11 Acknowledgements

We thank Sahil Dewan, Giv Parvaneh, and Boris Polania for helpful discussions
and comments. HL has previously received consulting fees and research funding
from Harmony.

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