Staking cryptocurrencies involves buying and setting aside cryptocurrencies to earn rewards. When tokens are staked, it helps to validate transactions on their network while also rewarding token holders, and these holders earn interest and/or rewards for staking these tokens. In other words, you can earn cryptocurrency while contributing to the network’s security and efficiency.
If you are familiar with cryptocurrencies, you may know that it is possible to “mine” them. Bitcoin, for example, can be mined, and it operates on a proof-of-work consensus mechanism. However, many other cryptocurrencies operate on a proof-of-stake model. Similar to how individuals can mine proof-of-work cryptocurrencies, proof-of-stake cryptocurrencies can be “staked.”
What does staking crypto mean
When you “stake” cryptocurrency, it means that you are actively participating in transaction validation on its native network. In other words, you are opting-in to earn rewards based on the number of crypto tokens you own. So, the more you own, the more you can stake, and the more you can stake, the more rewards you can earn.
Several of the biggest cryptocurrencies offer staking, including:
- Ethereum
- Cardano
- Solana
Ethereum, one of the most popular cryptocurrencies in the world, recently moved to a proof-of-stake model. Other cryptocurrencies that can be staked include projects/tokens such as Polkadot, Tezos, Cosmos, EOS, and Lisk.
So, why would a network offer staking to a crypto investor?
The purpose of rewarding holders is to incentivize individuals to stake their tokens as much as possible to validate the network. Many cryptocurrency investors have turned to staking crypto as a passive way to earn income, and the rewards are proportional to the number of tokens held. Additionally, staking can come with voting rights in some networks.
Let’s take a deeper look at cryptocurrency staking and how it works.
What is proof-of-stake?
The proof-of-stake concept allows an individual coin holder to validate more transactions depending on the amount of cryptocurrency they hold. This model was created as an alternative to the aforementioned proof-of-work model. Many experts and analysts believe that the cryptocurrency sector, in general, has shifted towards the proof-of-stake model.
Many attribute the first mention of “proof of stake” to the Peercoin paper, published in 2012. The proof-of-stake consensus mechanism is becoming more popular since it is more energy-efficient than the proof-of-work model, which is often criticized for its negative environmental impact. Many cryptocurrency experts have stated that proof-of-stake networks are much easier to scale, as well.
How does crypto “staking” work?
The general concept of staking cryptocurrencies is relatively simple. First, you must own cryptocurrency to stake it. In many cases, you must have a minimum balance of cryptocurrency to begin staking cryptocurrency. Those who stake cryptocurrency are known as “stakers” or “validators.”
One stakes their assets via a “node.” The crypto staking occurs when the proof-of-stake model selects validators depending on the amount of cryptocurrency held in the node. Once the minimum deposit is reached, then the node deposits that amount into the network, and that is considered their “stake.” If the forged block is legitimate, the “staker” gets back their staked amount, and an additional reward.
Once the node successfully creates a block, then rewards are distributed to validators. The validators have chosen to “stake” these coins and validate blocks, which helps to ensure network integrity. The more cryptocurrency you stake, the larger the rewards, and validators are chosen depending on the amount of tokens they hold. The rewards for staking cryptocurrency vary depending on the token as well as other factors.
Some cryptocurrencies require a minimum balance to stake them, while other cryptocurrencies do not. Many long-term cryptocurrency investors might decide to stake some of their assets to earn passive income rather than worry about risks associated with actively trading their crypto assets.
The amount of tokens being staked is another obvious factor. Other relevant factors that can determine staking rewards include how long the validator has been actively staking, the inflation rate of the token, and how many total number of coins staked on the network.
Mining vs staking
The first major difference between mining and staking cryptocurrency is that mining requires more resources. The proof-of-stake model has been discussed and marketed as a more sustainable model, and cryptocurrencies can be staked on everyday laptops and computers. Ultimately, staking cryptocurrencies is much more energy-efficient than mining cryptocurrency.
Crypto mining requires that an individual invest in additional hardware and electricity. An individual who stakes cryptocurrrencies would hold them in their wallet and be rewarded from the network for validating transactions. In other words, there is a lower entry barrier for staking cryptocurrency than mining it, and it requires much less technical knowledge.
Another major difference involves regulation: many countries have cracked down or taken steps to regulate cryptocurrency mining. China is an obvious example. The country was once home to some of the largest Bitcoin miners in the world, but crypto regulation has caused those mining companies to migrate. In other words, mining is more susceptible to censorship and mining crackdowns. While cryptocurrency regulation, in general, can still be ambiguous, staking cryptocurrency does not carry a similar risk.
Some experts argue that staking cryptocurrencies can help encourage financial stability in the crypto markets. Since token holders are incentivized to hold their tokens, staking can help protect a token’s value against massive sell-offs or other cryptocurrency market-related volatility.
Where can you stake cryptocurrencies?
You can often stake cryptocurrencies on major cryptocurrency exchanges, including Binance, Coinbase, Kraken, OKEx, and more. The exchanges differ in terms of what cryptocurrencies can be staked, any associated fees, and the overall “lockup” period.
There are also various third-party providers and companies that offer “staking as a service.” You can delegate your staking to these providers, who will then collect a percentage of the staking rewards in return. Investors can also join staking pools, as well, which offer their own benefits.
If you choose to become a “validator” and run your own node, then it will require some technical knowledge and a computer that can perform validations consistently. There also may be a minimum amount of tokens needed to become a validator. To stake ETH 2.0, for example, you will need a minimum of 32 ETH.
Many wealthy cryptocurrency investors decide on “cold staking” as their staking approach. This involves stalking cryptocurrency held in cold storage, and it’s common among larger token holders. Through cold staking, token holders can support the network while also ensuring a maximum level of security, since their funds are still held offline.
The potential risks of staking crypto
While it’s true that staking crypto can generate passive income in crypto, the truth is that there are still risks associated with staking. First, there is the obvious market risk that one must consider.
For example, let’s say you decide to stake a fictional token called the XLZ token. You’ve purchased a massive amount of XLZ tokens and believe in its potential to grow in value. You decide to stake your massive token holdings for a 20% APY and are excited about the potential rewards.
After several months of staking the XLZ token, you realize that the market has changed, and the XLZ token is down 50%. Now, even though you will receive staking rewards, your XLZ holdings will still lose a significant amount of their value. This is an obvious risk to staking any and all cryptocurrencies, and any investor should consider the market risk.
Second, staking cryptocurrency can end up costing a significant amount of money since running validator nodes requires hardware and electricity. This is one reason why some individuals end up hiring third-party providers for staking crypto, and these providers end up taking a percentage of the rewards.
There are also other risks associated with staking crypto, involving lockup periods and liquidity. These risks are somewhat related to overall market risk. To be rewarded, you may need to lock up your cryptocurrencies for an extended period of time.
If the value of the token drops significantly, then your crypto portfolio can end up taking a massive hit. Similarly, you may end up staking a cryptocurrency that is difficult to liquidate down the line, which is another risk to consider before staking crypto.
The future of staking cryptocurrency
The cryptocurrency sector is moving towards a proof-of-stake model, and more cryptocurrency investors are interested in staking crypto as a means of passive income. While there are still risks regarding crypto staking, JP Morgan estimates that Ethereum 2.0 can help propel crypto staking into a $40 billion dollar industry by 2025.
You should do your own due diligence and research before staking crypto of any kind. Regardless, validators are critical to validating blockchain networks that operate on the proof-of-stake model. Overall, the proof-of-stake model will likely help the entire cryptocurrency sector become more energy-efficient.
About the Author
Michael Hearne
About Decentral Publishing
Decentral Publishing is dedicated to producing content through our blog, eBooks, and docu-series to help our readers deepen their knowledge of cryptocurrency and related topics. Do you have a fresh perspective or any other topics worth discussing? Keep the conversation going with us online at: Facebook, Twitter, Instagram, and LinkedIn.
