Crypto Staking Basics
Crypto Staking Basics
With cryptocurrency, one way to make a profit is to sell your investment when the market price increases.
There are other ways to make money in crypto, like staking. With staking, you can put your digital assets to work and earn passive income without selling them.
In some ways, staking is similar to depositing cash in a high-yield savings account. Banks lend out your deposits, and you earn interest on your account balance.
In theory, staking isn’t too different from the bank deposit model, but the analogy only goes so far. Here’s what you need to know about crypto staking.
What Is Staking?
Staking is when you lock crypto assets for a set period of time to help support the operation of a blockchain. In return for staking your crypto, you earn more cryptocurrency.
Many blockchains use a proof of stake consensus mechanism. Under this system, network participants who want to support the blockchain by validating new transactions and adding new blocks must “stake” set sums of cryptocurrency.
Staking helps ensure that only legitimate data and transactions are added to a blockchain. Participants trying to earn a chance to validate new transactions offer to lock up sums of cryptocurrency in staking as a form of insurance.
If they improperly validate flawed or fraudulent data, they may lose some or all of their stake as a penalty. But if they validate correct, legitimate transactions and data, they earn more crypto as a reward.
Popular cryptocurrencies Solana (SOL) and Ethereum (ETH) use staking as part of their consensus mechanisms.
Proof of Stake Validation
Staking is how proof of stake cryptocurrencies cultivate a functioning ecosystem on their networks. Typically, the bigger the stake, the greater chance validators get to add new blocks and earn rewards.
“In PoS, validators stake their assets as a skin-in-the-game, which gets slashed or destroyed if they behave maliciously,” says Gritt Trakulhoon, lead crypto analyst for Titan, an investment platform. For example, trying to create a fraudulent block of transactions that didn’t happen.
As validators amass larger amounts of stake delegations from multiple holders, this acts as proof to the network that the validator’s consensus votes are trustworthy, and their votes are therefore weighted proportionally to the amount of stake the validator has attracted.
Plus, a stake doesn’t have to consist of just one person’s tokens. For example, a holder can participate in a staking pool, and stake pool operators can do all the heavy lifting in validating the transactions on the blockchain.
Each blockchain has its set of rules for validators. For example, Ethereum requires each validator to hold at least 32 ETH. At the time of this writing, that’s about $55,000. A staking pool allows you to collaborate with others and use less than that hefty amount to stake. But one thing to note is that these pools are typically built through third-party solutions.
How Does Staking Work?
If you own a cryptocurrency that uses a proof of stake blockchain, you are eligible to stake your tokens.
Staking locks up your assets to participate and help maintain the security of that network’s blockchain. In exchange for locking up your assets and participating in the network validation, validators receive rewards in that cryptocurrency known as staking rewards.
Many leading crypto exchanges, like Binance.US, Coinbase and Kraken, offer staking rewards. “A more passive or novice user can just stake their cryptos directly on the exchange for slightly more convenience, in return for the exchange taking a portion of the staking yields,” says Trakulhoon.
You can also set up a cryptocurrency wallet that supports staking.
Read More: The Best Staking Platforms
“Each blockchain network typically has one to two official wallet apps that support staking. For example, Avalanche has the Avalanche wallet, and Cardano has Daedalus and Yoroi wallets,” Trakulhoon points out.
If you have your tokens in one of these wallets, you can delegate how much of your portfolio you want to put up for staking. You pick from different staking pools to find a validator. They combine your tokens with others to help your chances of generating blocks and receiving rewards.
How To Make Money Staking Crypto
When you choose a program, it will tell you what it offers for staking rewards.
As of July 2022, the crypto exchange Kraken offers a 4% to 6% annual percentage yield (APY) for Cardano (ADA) staking and 4% to 7% for Ethereum 2.0 staking. Because the Ethereum 2.0 network upgrade isn’t complete yet, there are a few caveats on Kraken for staking Ethereum.
Once you’ve committed to staking crypto, you will receive the promised return according to the schedule. The program will pay you the return in the staked cryptocurrency, which you can then hold as an investment, put up for staking, or trade for cash and other cryptocurrencies.
The program could also have restrictions like you must commit your staking for three months before you get your tokens back.
What Are The Benefits of Staking Crypto
- Earn passive income. If you don’t plan on selling your cryptocurrency tokens in the immediate future, staking lets you earn passive income. Without staking, you would not have generated this income from your cryptocurrency investment.
- Easy to get started. You can get started staking quickly with an exchange or crypto wallet. “It’s as easy as setting up a crypto wallet, loading it with cryptos, and clicking the ‘staking’ button on validators or staking pools within the wallet app,” says Trakulhoon.
- Support crypto projects you like. “Staking has the added benefit of contributing to the security and efficiency of the blockchain projects you support. By staking some of your funds, you make the blockchain more resistant to attacks and strengthen its ability to process transactions,” says Tanim Rasul, chief operating officer and co-founder of National Digital Asset Exchange, a cryptocurrency trading platform in Canada.
What Are The Risks Of Staking Crypto
When you stake your tokens, you may have to commit them for weeks or months depending on the program. During this time, you wouldn’t be able to cash out or trade your tokens.
In response to this problem, Trakulhoon notes that “for some blockchains like Ethereum, there are decentralized finance (DeFi) applications such as Lido Finance and Rocket Pool that offer “liquid staking” products. These products offer a tokenized version of the staked assets, essentially making them “liquid.”
Still, since you’re selling on a secondary market, you need to find a willing buyer or lender. Plus, there’s no guarantee you’ll be able to do so or get all your money back early.
Cryptocurrencies are also extremely volatile investments, where double-digit price swings are common during market crashes. If you’re staking your cryptocurrency in a program that locks you in, you wouldn’t be able to sell during a downturn. The staking platform you choose could offer lucrative annual returns, but if the price of your staked token falls, you could still incur losses.
Many proof of stake networks use “slashing” to punish validators who take improper actions, destroying some of the stake they put up on the network. If you stake with a dishonest validator, you could lose part of your investment for this reason.
“The slashing mechanism aims to incentivize token holders to only delegate their tokens to validators they feel are reputable or trustable, and not to delegate all their tokens to a single or small number of validators,” Trakulhoon says.
Should You Stake Crypto?
Staking is a good option for investors interested in generating yields on their long-term investments who aren’t bothered about short-term fluctuations in price. If you might need your money back in the short term before the staking period ends, you should avoid locking it up for staking.
Rasul advises that you carefully review the terms of the staking period to see how long it lasts and how long it would take to get your money back at the end when you decide to withdraw.
He recommends only working with companies with a positive reputation and high-security standards.
If the interest rates seem too high to be true, you should approach cautiously, experts say.
Last, staking, like any cryptocurrency investment, carries a high risk of losses. Only stake money you can afford to lose.
