What is crypto staking? In simple terms, it’s like putting your money into the bank, but in this case it’s a blockchain network. You lockup your digital assets to support its operations and earn “interests” in terms of rewards. This guide will explain what crypto staking is, how it works, the benefits, and how to get started.
Disclaimer: The following information is not financial advice or recommendation and should not be considered as such. We are not regulated by the Financial Conduct Authority (FCA), we are not financial advisors and it is therefore not authorized to offer financial advice. This is just our explanation and/or an overview of the current technology.
What is Crypto Staking?
Crypto staking is a process where token holders participate in the Proof of Stake (PoS) consensus mechanism by locking their tokens into a staking contract and running the associated validator software program.
This process comes with benefits by earning interests on your account because you are contributing to the security and operation of a blockchain network. Validators have a greater chance of being randomly selected to verify and process a new block if they stake more crypto. This means that the amount of crypto staked directly impacts a validator’s likelihood of being chosen. Validators can also sell pooled security to protocols, creating a competitive marketplace for pooled security.
The primary purpose of on-chain staking is to passively generate rewards from cryptocurrency holdings while contributing to protocol security. Staking ensures the stability and security of a PoS blockchain as validators risk losing their staked crypto if they validate false transactions. This symbiotic relationship between earning rewards and enhancing network security makes staking an attractive option for many crypto users.
A comprehensive understanding of crypto staking requires knowledge of the PoS (Proof of Stake) mechanism and the roles of validators and delegators. We’ll examine these components in the following subsections.
Proof of Stake (PoS)
There are generally two main types of validation, PoS (Proof of Stake) and PoW (Proof of Work), both are consensus mechanisms verify and secure blockchain transactions without intermediaries, but they achieve this differently.
In Proof-of-Work (PoW), mining new blocks requires solving complex cryptographic puzzles, and as a reward to the ones who is the first to solve the puzzle, they’re rewarded with the token such as Bitcoin or Ethereum. However, the downside of PoW is that it requires computational hardware, and consume a lot of energy, so much that it became a concern that might contribute to Global Warming and Environmental issue.
Proof-of-stake (POS) was created as an alternative to proof-of-work (POW). PoS is also a consensus mechanism, validators stake their crypto in a smart contract and are randomly selected to create new blocks. This selection process considers various factors determined by the protocol, such as the amount of staked tokens and the validator’s past behavior. When a node is selected, its role is to ensure the validity of transactions within the block, sign it, and propose the block for network validation. This process provides a more eco-friendly alternative to traditional proof-of-work mining.
Validators and Delegators
Validators are simply those who is participating in a Proof of Stake (PoS) by ‘staking’ their tokens into the pool. They stake their crypto as collateral to perform these tasks and earn rewards in return. Validators are incentivized to ensure the blockchain’s accuracy to avoid losing their staked tokens, thus contributing to the network’s security and stability. Validators can also sell pooled security to protocols, creating a competitive marketplace and enhancing the efficiency of the staking process.
On the other hand, delegators are participants who lock up their crypto and delegate it to validators to secure and record new transactions on the blockchain. By doing so, delegators earn a portion of the validator’s reward without needing to run the validator software themselves. This system allows more crypto users to participate in staking and earn rewards, even if they lack the technical expertise to run their own validator.
Benefits of Crypto Staking
The multiple advantages of crypto staking render it an appealing alternative for cryptocurrency holders. Participants benefit by earning rewards and passive income, similar to dividends or interest on a savings account, but with much greater risk. Staking allows cryptocurrency holders to earn additional income without needing to sell their assets, thereby putting their digital assets to work.
Moreover, staking encourages hodling and can potentially lead to an increase in a token’s value when fewer coins are in circulation, contributing to the overall health and stability of the network. We’ll further examine these benefits.
Earning Staking Rewards
Validators earn rewards for their role in maintaining the integrity and consistency of the blockchain. These rewards come in the form of newly created cryptocurrency and transaction fees. The staking rewards can vary widely depending on the cryptocurrency and the platform used.
Popular staking cryptocurrencies like Ethereum and Cardano offer rewards ranging from 5% to 20%. The amount of crypto staking rewards is proportionate to the amount staked, and some platforms may take a cut of the rewards while others pass the full reward to users, allowing them to earn staking rewards.
Enhancing Network Security
Staking helps ensure only legitimate data and transactions are added to a blockchain, enhancing the network’s integrity. By locking up tokens for staking, users contribute to network security and stability, which promotes decentralization. More staked tokens in the network mean a higher cost for potential attacks, enhancing overall security. Selling pooled security can further contribute to network security by creating a competitive marketplace for validators.
Validators are incentivized to behave correctly through mechanisms like ‘slashing,’ which penalizes improper validations by destroying part of their stake. This system makes the blockchain network more secure and resistant to attacks by validating transactions.
Passive Income
Staking allows users to earn passive income by simply holding and staking their tokens over time. Income can be earned through cryptocurrency staking by:
- Helping regulate and validate a cryptocurrency’s transactions
- Participating in the consensus mechanism of the blockchain network
- Locking up a certain amount of tokens as collateral
The passive income from staking can provide a steady stream of additional tokens, contributing to one’s overall crypto portfolio.
Staking can serve as a way to generate staking yields on long-term crypto investments. This steady stream of income enhances the capital efficiency of your crypto holdings.
How to Start Staking Crypto
Embarking on your crypto staking adventure entails a series of important steps, which include:
- Selecting an appropriate platform that supports the cryptocurrency you wish to stake. Options include exchanges, staking-as-a-service platforms, and DeFi lending platforms.
- Establishing a secure staking wallet.
- Transferring your cryptocurrency to the staking platform or using it directly from your wallet if the platform supports wallet staking.
Now that we’ve covered the basics, we’ll dive deeper into each step to bolster your confidence as you commence staking.
Choosing a Staking Platform
The selection of a staking platform should be based on various considerations, including the coins supported, required technical expertise, and security features. Popular platforms like Gemini, KuCoin, Coinbase, and Binance.US offer different cryptocurrencies and varying annual percentage yields (APYs). For instance, KuCoin supports staking for a range of cryptocurrencies, including stablecoins such as Tether (USDT) and USD Coin (USDC). Some platforms may also offer the ability to sell pooled security, creating a competitive marketplace for validators.
Coinbase, for example, requires a minimum balance for staking certain cryptocurrencies, like a minimum of $1 of SOL to stake Solana. The rewards on these platforms can range from 2.0% APY to 13% APY.
Selecting the Right Cryptocurrency
The choice of cryptocurrency for staking is pivotal to optimize your rewards while reducing risks. It’s essential to evaluate the expected rewards and the stability of the underlying cryptocurrency. For instance, staking major coins like Ethereum (ETH), Solana (SOL), and Cardano (ADA) typically yields an annual return of around 4% to 5%.
Considering the reward rates along with the stability and future potential of the project can guide you to make a well-informed choice. It’s not just about high returns; the project’s overall health and potential for growth are equally important.
Setting Up a Staking Wallet
Establishing a staking wallet is a vital step in safeguarding your staked assets and ensuring their compatibility with your selected platform. Choose a wallet that supports staking and ensure it’s compatible with the staking platform you have selected. Wallets like MetaMask, Trust Wallet, and Ledger are popular choices for staking.
It’s also important to ensure that the chosen staking wallet is aligned with the requirements and features of the staking platform you plan to use. This alignment will help prevent any technical issues and ensure a smooth staking experience.
Risks and Challenges of Staking
Despite the numerous benefits of crypto staking, it also bears inherent risks and challenges. Some of these risks and challenges include:
- Staking rewards come with higher risks due to the potential for losing investment by approving fraudulent transactions.
- Smaller cryptocurrencies often offer higher rewards but may end up being hyperinflationary or failing.
- Network vulnerabilities like attacks or bugs can disrupt the staking process, leading to potential loss of staked funds.
It is important to carefully consider these risks and challenges before engaging in crypto staking.
We’ll further probe into the specific risks tied to staking.
Volatility of Underlying Cryptocurrency
One of the biggest risks in staking is the price movement of the staked cryptocurrency. Even if you earn a 20% yield from staking, a 50% drop in the value of the staked asset can wipe out those gains and more. This price volatility is a significant concern because it can lead to substantial losses if the value doesn’t recover by the end of the staking period.
Price fluctuations are particularly significant because even the most attractive staking rewards can be outweighed by considerable declines in the value of the staked cryptocurrency. Therefore, it’s essential to consider the stability and long-term potential of the underlying cryptocurrency before staking.
Lockup Periods
Locking up your cryptocurrency for staking means that it is unavailable for selling or unstaking for a certain period, which can be as long as 180 days. During this lockup period, you cannot access your staked assets, which might prevent you from taking advantage of other financial opportunities.
These lockup periods can range from 30 to 120 days, depending on the platform and the cryptocurrency. For instance, rewards from staking on the Ethereum network are typically locked up until the Ethereum 2.0 network is complete. This restriction can pose financial difficulties or missed economic opportunities due to illiquidity.
Regulatory and Security Risks
The regulatory status of staking remains unclear in many countries, which adds to the uncertainty and potential legal risks. Regulatory crackdowns, such as the SEC’s actions against exchanges offering staking without proper registration, can impact the services offered by large exchanges.
Security is another significant concern. Even platforms trusted by millions are prone to hacking or cybersecurity threats. Therefore, it’s crucial to ensure your crypto wallet has robust security features, including cryptoeconomic security, to protect your staked assets. Additionally, some platforms may not be trustworthy, leading to potential loss of funds and rewards.
Popular Cryptocurrencies for Staking
A number of cryptocurrencies are favored for staking, owing to their lucrative rewards and sturdy ecosystems. Chainlink (LINK), Polkadot (DOT), and Cardano (ADA) are among the common cryptocurrencies staked for passive income. Each of these cryptocurrencies offers different staking rewards and benefits, making them suitable for various staking strategies.
We’ll delve into some of the most favored cryptocurrencies for staking, such as Ethereum, Cardano, and Polkadot.
Ethereum (ETH)
Ethereum is a popular choice for staking due to its robust ecosystem and various staking options. Centralized exchanges offer roughly 4% APY for staking ETH.
Additionally, platforms like Crypto.com provide liquid staking options for Ethereum, allowing users to maintain liquidity while earning rewards.
Cardano (ADA)
The staking process for ADA involves using non-custodial wallets such as Daedalus or Yoroi. Staking Cardano can yield around 4.6% APR for delegators.
This process not only provides financial benefits but also contributes to the network’s pooled security by utilizing a bank or payment processor and implementing data availability layers.
Polkadot (DOT)
Polkadot (DOT) is a popular cryptocurrency for staking, known for its unique features and attractive rewards. Staking returns for validators are estimated at 15.31% APR, while delegating DOT can yield an estimated 14.34% APR. These high returns make Polkadot an attractive option for both new and experienced stakers.
Advanced Staking Strategies
For those seeking to enhance their staking rewards, sophisticated staking strategies can offer a competitive advantage. These strategies often involve the use of multiple platforms or mechanisms to enhance returns. Diversification in staking helps mitigate risk and maximize returns by spreading investments across various assets and protocols.
We’ll inspect some advanced staking strategies, encompassing liquid staking, pooled staking, and restaking across various protocols.
Liquid Staking
Liquid staking allows users to maintain liquidity while earning rewards by wrapping their staked assets for a tradeable receipt token. This process provides the benefit of maintaining liquidity while earning staking rewards.
LSTs can be utilized within the DeFi ecosystem to generate additional returns.
Pooled Staking
Pooled staking involves combining resources from multiple investors to increase staking rewards. For example, using platforms like Lido, pooled staking of ETH offers an estimated APR between 4.05% and 7.09%. Staking pools allow users to stake less than 32 ETH and receive liquidity tokens representing their staked ETH.
Restaking Across Multiple Protocols
Restaking allows users to:
- Stake the same cryptocurrency on multiple networks simultaneously
- Increase trust and security across those networks
- Enhance capital efficiency by allowing stakers to earn rewards from multiple protocols with the same capital.
However, restakers are exposed to an increased slashing risk when they opt-in to restake their ETH.
Future of Crypto Staking
The future of crypto staking appears bright, as trends like cross-chain staking and interoperability are poised to have a substantial impact. Interoperability will become crucial, allowing assets to be staked across various blockchain networks seamlessly.
Staking in Web 3.0 will likely integrate staking into various decentralized applications and services. We’ll examine some of the pivotal trends that will mold the future of crypto staking.
Increased Decentralization
Increased decentralization will distribute network control among more participants, making it harder for any single entity to dominate. Staking-as-a-Service enhances decentralization by enabling more users to participate in staking through a staking service.
The use of cross-chain staking will further decentralize power by enabling staking across different blockchain platforms.
New Governance Models
Staking can incentivize user engagement, potentially leading to new governance models driven by active participation. These governance models can offer more inclusive voting structures, allowing a broader range of participants to have a say in network decisions.
Enhanced Rewards and Incentives
Future staking mechanisms might offer dynamic reward structures that adapt based on network conditions. These dynamic reward structures could improve staking incentives by making reward rates flexible according to the specific needs and conditions of the network at any given time.
Summary
Crypto staking offers an exciting opportunity to earn rewards while contributing to the security and stability of blockchain networks. From understanding the basics of staking and how to start, to exploring advanced strategies and envisioning the future, this guide has covered all you need to know to embark on your staking journey. As the crypto ecosystem continues to evolve, staking will undoubtedly play a pivotal role in its growth and development.
