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Does lock-up lead to stability?

Authors: Thomas Ruchti

A new OFR Working Paper by Tom Ruchti and co-authors Samuel Hempel and Gregory Phelan examines the capital-intensive nature of Proof of Stake (PoS) which has come to replace energy-intensive Proof of Work (PoW) among cryptocurrencies. Protocols like PoS have a higher risk of runs because capital is at stake. During a run on crypto assets, investors rapidly exit their holdings in a fire sale, which can undermine security for that blockchain and disrupt broader crypto markets dependent on that protocol. In theory, low rewards improve security of PoS by reducing the incentive for neutral parties to participate in co-opting the blockchain by nefarious actors. However, low rewards exacerbate run risk. Lock-up periods can reduce the risk of runs, but they do not eliminate them completely. If an event occurs during a lock-up period, investors cannot sell their crypto asset until the end of the period.