Auto-compounded Staking
A summary of the features and benefits of automated staking services available in the Polkadot ecosystem.
Disclaimer: This article is written by Dot.alert() contributors for educational purposes only. This article should not be used as a substitute for competent legal or financial advice from a licensed professional in your country.
What is Auto-compounded Staking?
Auto-compounded staking is a setup in which the rewards earned from collator staking or in DeFi farming are added to the principal/original investment and then automatically re-staked from one staking period to the next. This feature allows users to maximise protocol rewards earned in the medium term.
How-to: Optimising Ecosystem-wide Staking Operations
While nominators staking on Relay chain validators have always had the option to compound their staking rewards over time through a stash-controller setup, this was not the case on other ecosystem protocols. Auto-compounded staking is an additional functionality that some parachains and DeFi projects have deployed as part of their user-facing services.
Accessing auto-compounding facilities from ecosystem dapps is straightforward, as users only need to be actively participating in collator staking or farming pools. The automatic re-staking functionality is often offered as a one-click operation, and users have the option to set the percentage of their reward that they want to reinvest.
Auto-compounded staking has many advantages for ecosystem participants. Aside allowing stakers to automate some of their transactions and save on fees, users can customise their staking based on their own strategies for yield optimisation. For users in countries where crypto assets are subject to taxes, auto-compounded staking can give the option to access Capital gain tax (CGT) discounts after some time.
Risks: Monitoring Markets and Protocols Updates
It is important to note that there are different implementations of auto-compounding functionalities when it comes to collator staking. Native services are integrated at protocol level, accessible to all parachain users, and support a variety of collators. By contrast, services offered by third-party collators or staking facilities often have custodial-like requirements: users must authorise them to re-invest the rewards on their behalf to maximise profits.
An underlying risk of auto-compounding is that the returns for a staked asset can be subject to fluctuations and adjustments, depending on market conditions. This means that it is still possible to be continually earning rewards, but at the same time incur some dramatic losses. Users must therefore keep the following in mind:
The price of staked tokens is often volatile, but unbonding periods tied to staking can make it very challenging to sell an asset on-the-fly during downturns.
As more participants join farming pools, the APY usually decreases, which can affect the viability of auto-compounding strategies after some time.
It is also worth noting that some auto-compounding operations rely on technologies that are continuously revised and updated. There is the risk that the auto-compounding functionality of a given protocol could break due to a faulty runtime upgrade on related parachains. This could significantly affect users' projected returns in the short-term, especially when there are larger than average amounts at stake.
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