Does lock-up lead to stability?

Stakers invest capital to facilitate transactions under Proof-of-Stake (PoS), which is replacing the energy-intensive Proof-of-Work protocol for most crypto assets. Because stakers put capital at risk with PoS, there is a higher risk of runs–stakers coordinating an exit. A run on a major PoS blockchain, like Ethereum, could undermine security for the crypto asset and disrupt broader crypto markets that rely on that blockchain (Working Paper no. 24-08).

Abstract

Blockchains increasingly rely on the capital-intensive Proof-of-Stake protocol over the energy-intensive Proof-of-Work protocol to propose blocks, putting those block-chains at risk of capital withdrawal that could undermine consensus and security. We model a population of investors who decide to stake, reaping staking rewards, or exit, liquidating their crypto-asset holdings. Runs on staking are more common for weak protocols, when price impacts of protocol failure are high, or when rewards to staking are low. We extend the model to leveraged staking, where margin calls exacerbate run dynamics. In examining staking lock-up periods, we fnd that a longer lock-up period can reduce runs but does not eliminate them. Previous work demonstrates that consensus and security of a crypto-asset depend on low staking rewards, but our results highlight that low rewards induce runs. If a run were to occur on a major Proof-of-Stake backed blockchain, such as Ethereum, this would undermine security, potentially disrupting crypto markets dependent on that blockchain and the Decentralized Finance networks that depend on it.

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