What is staking in crypto?
Crypto staking is a concept an investor can often hear in the cryptocurrency world. It can be a great way to maximize your earnings, as some cryptocurrencies offer relatively high-interest rates. But it’s crucial to understand how staking works before you get started.
What does staking mean in crypto?
In simple terms, staking coins is the act of locking your cryptocurrency to earn interest. The concept of staking is closely related to the Proof of Stake (PoS) mechanism. Cryptocurrencies based on PoS consensus protocols allow participants to earn additional coins by locking up assets in the network as a form of collateral.
Why can you stake only particular cryptocurrencies?
This is where it comes to the technical aspect. Bitcoin, for example, does not allow staking. Cryptocurrencies are typically decentralized, meaning a central authority does not manage them. How do all the computers in a particular decentralized network agree on which transactions should be added to the chain? Consensus mechanisms determine how the miners in the network reach an agreement.
Many cryptocurrencies — including Bitcoin and Ethereum 1.0 — use a consensus mechanism called Proof of Work (PoW). In the PoW model, the network requires a huge amount of computing power to perform the so-called “mining.”This involves verifying transactions between nodes worldwide to ensure that no one tries to spend the same money twice. This process involves “miners” competing to be the first to solve a cryptographic task. The winner receives the right to add the latest “block” and verify transactions on the blockchain, thus receiving some cryptocurrency as a reward.
For a relatively simple blockchain like Bitcoin’s, Proof of Work works well. But for something more complex like Ethereum-which has a variety of applications, including the whole world of cryptocurrency-related decentralized finance (DeFi) running on the Proof of Work blockchain can cause bottlenecks if there is too much activity. As a result, transaction times could be longer and fees higher.
How does crypto staking work? While PoW blockchains rely on miners to validate and confirm new blocks, PoS chains involve stakers. So instead of competing to mine the next block at a high computational cost, PoS validators are chosen according to the number of coins in the system, the stake. This allows the system to develop and validate new blocks without specialized hardware, such as CPU or ASIC miners.
What is Proof of Stake?
Sunny King and Scott Nadal were most likely the first to introduce the Proof of Stake concept back in 2012. This consensus model was used as a basis for Peercoin cryptocurrency. Originally it relied on the hybrid PoW / PoS algorithm, but gradually the project moved away from Proof of Work (PoW).
In 2014, Daniel Larimer developed the delegated Proof of Stake (DPoS) consensus model. Larimer’s model was first implemented on the Bitshares network, and later other cryptocurrencies adopted it. Larimer was notably involved in creating Steem and EOS, also based on a DPoS-based model. Nowadays, several blockchains, including Cardano, EOS, and TRON, use Delegated Proof of Stake (DPoS).
Proponents of DPoS believe that it is a more democratic way to verify the next block, as it allows more people to participate based on their reputation rather than the size of their stake. Since the number of validators is limited, DPoS enables the network to reach consensus faster.
This model aims to reduce latency — the delay between transactions — and increase bandwidth — the number of transactions per second. In essence, the algorithm allows consensus to be reached using fewer validation nodes. Nevertheless, this mainly leads to a lower degree of decentralization, as users rely only on a selected node group.
Technically, staking is when the blockchain platform selects a network participant to add the latest batch of transactions to the blockchain and receive rewards in return. Users are required to put their tokens on the line to create new blocks and earn a reward. Their stakes serve as a guarantee of legitimacy for each new transaction they add to the blockchain.
Nodes in a network with a PoS system can be either validators or users. Validators are chosen based on the size of their stake and the amount of time they hold it. When invalid transactions are detected in a new block, a portion of the validator’s stake is lost.
How much can you earn with staking?
Several cryptocurrencies offer staking rewards. In our list below, you can see the estimated APY an investor would receive based on their initial investment:
The full list of staking options can be found here. There is always the risk of a significant price drop that could result in the loss of your initial investment.
You can use the Staking Rewards calculator to compare different Staking Rewards options.
What are the advantages of staking coins?
Many long-term crypto owners see staking coins as a way to make their assets work instead of just holding crypto. Among the key benefits of crypto staking are:
- Staking cryptocurrencies is considered an easy way to earn interest on your holdings, as you do not need any equipment or technical knowledge to earn rewards.
- You contribute to the blockchain of a particular digital asset. By locking your tokens, you help secure the network.
- The Proof of Stake protocol is far less energy-intensive than the Proof of Work protocol. Therefore, you do not need to maintain a supercomputer with adequate energy resources to participate. In this way, PoS saves energy and keeps carbon emissions low.
- PoS protocols offer higher transaction throughput and lower fees, as proven by blockchains like Solana, EOS, Cardano.
- In the PoS protocol, the supply of cryptocurrency is distributed among users in proportion to their holdings of the currency rather than their work. This consensus model is considered more decentralized and secure than Proof of Work because a PoW miner, which controls 51% of the network’s hash rate, can effectively control the blockchain and process transactions to its advantage.
What are the risks associated with staking crypto?
Staking is not entirely risk-free:
- The most significant disadvantage of the Proof of Stake consensus model is that large players can have extraordinary influence over the network. This means that the coins are more concentrated with fewer holders. Therefore, as the stakes increase, a PoS network becomes more centralized. While new mechanisms have been developed to circumvent this problem, your chances of being selected as a validator are proportional to the number of coins you staked. Therefore, this problem can never be avoided entirely.
- Another drawback is that blockchains usually require a minimum stake size to validate transactions. For instance, Ethereum and Dash only allow you to validate transactions if you have staked at least 32 ETH or 1000 DASH, respectively. This discourages many people from running nodes because they have to invest a large amount of money. Instead, they can enter centralized platforms that allow them to stake less than the minimum.
- To earn interest in your cryptocurrency, you need to lock your coins for a certain period. You cannot use your assets during this period of time, such as sell or lend.
- Crypto prices are very volatile. Therefore, you should be aware of the risk that the value of your assets will fall if you use them. So you should be aware that a sharp drop in the price of the digital asset you are staking can “eat up” your interest income. This is especially true for new cryptocurrencies that offer you extremely high returns. However, staking stablecoins can mitigate this risk.
- If you need to unblock your stake for trading cryptocurrencies, you should be aware of a minimum blocking period. So, check these before you lock your assets to avoid any unpleasant surprises.
- Another risk with staking cryptocurrency is becoming a victim of a so-called “rug pull .” These are malicious project teams that artificially inflate a currency’s staking rewards, then dump their holdings once most people have staked.
How do I start staking?
While anyone can participate in staking, it requires a certain amount of deposit, technical knowledge, and hardware that can run 24/7 without downtime to become a validator. Validators take on serious obligations because they can lose a part of their stake if they fail to validate transactions properly.
For most users, there is an easier way to get involved. You do not have to run your validator hardware. Instead, you can join a staking pool. Various centralized providers lower entry barriers and allow investors to earn rewards without running their validator hardware. You only have to transfer your funds to the wallet, such as Ledger or Trust Wallet. This is also known as cold staking.
Among the most popular staking providers are crypto wallets and exchanges:
- Centralized exchanges such as Binance, Coinbase, or PointPay offer staking services for their customers.
- Staking-as-a-service platforms, also known as soft staking, are another option. Unlike wallets, projects like Stake Capital or MyCointainer are designed exclusively for staking. They take a percentage of earned rewards to cover commissions.
The step-by-step process of crypto staking explained
Follow these steps to get started with crypto staking.
- First, choose a PoS cryptocurrency you would like to stake.
PoS coins are popping up everywhere, and it’s hard to decide which one to stake. You should take the time to understand the potential risks and rewards of the coins. Doing research is an essential part of a cryptocurrency investor’s journey.
2. Prepare a separate wallet for non-exchange staking.
To take advantage of staking, you need a software or hardware wallet. However, if you use a centralized service that effectively controls your assets, such as the PointPay platform, you do not need it.
3. Ensure that you can meet the minimum coin staking requirements.
If you want to run a full node, you should know about the minimum stake. Some projects do not have a minimum stake amount, while others require a significant investment (32 ETH, worth $103,457.6 at the time of writing). Before staking, make sure that you have the necessary capital for further staking.
4. Choose the appropriate hardware.
To become a validator, you will need to set up a computer connected to the internet 24/7 and has enough power to store a copy of the entire blockchain. You also need to consider electricity costs or use cloud computing via virtual private servers.
5. Get ready and start staking.
Once you have created a wallet, transferred some coins, and set up your staking device, follow the software’s instructions and leave your device connected. If you are using a centralized provider like Binance or PointPay, it’s even easier for you — all you have to do is select your preferred currency, deposit your funds, and click the “Deposit” button. Congratulations! Now you are passively earning crypto!
Staking can be an attractive option to generate passive income for investors who want to earn interest on the assets they hold. It has become a popular way to turn cryptocurrencies into passive income. At the same time, you do not need investments in powerful hardware or electricity costs, primarily if you use a centralized exchange or wallet for staking cryptocurrency. To start earning rewards, all you need to do is visit a platform that offers a crypto staking service and follow the instructions provided. It is crucial to understand and consider the risks associated with cryptocurrency trading when managing your portfolio.
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