What Is Crypto Staking?
Crypto staking allows people to stake their digital assets towards a blockchain network’s smooth running and contribute to its general network security. People who stake crypto will lock up their coins in exchange for profit. This can be compared to a high-interest savings account in a centralized banking system. Traditionally, the bank would take the money people have locked in and lend it to others. In return, the banks would give their customers a percentage of the loan interest. This percentage is usually smaller compared to what decentralized platforms provide.
However, because of the decentralized system, the percentage yield is considerably higher in the crypto world. And with smart contracts, the process is more transparent and secure. Users that hold proof of stake tokens or any altcoin can lock in their assets and make money easily (without trading).
Staking cryptocurrency has become one of the most popular ways of earning. As of April 2022, the total value locked (TVL) from cryptocurrencies staked across all major DeFi platforms had surpassed the $300 billion benchmark.
How Does Staking Work?
Staking works by using the proof-of-stake model; this model allows for new blocks to be added to the blockchain.
The first thing that happens is for users to commit their coins to a blockchain protocol. For these users, a person is selected to be a validator, and they are chosen based on the size of their pledge. The job of a validator is to validate and verify transactions and ultimately add them to the blockchain. Depending on the size of their stake, they will get an opportunity to propose a new block and get a reward. Because the crypto world is trustless, these validators are kept in check through their tokens. If they act dishonestly, it will also affect their staked amount and profit. Therefore, the user with the highest pledge is typically selected as a validator because they would have more to lose and have even more reason to act honestly.
Some sanctions can be placed on the validator; for example, they could be penalized if offline for an extended period. They also might be banned from the consensus process and, in some cases, even have their pledge removed. This is called slashing; although it hardly happens, it has occurred in the Polkadot and Ethereum Blockchain. In addition, validators are paid in the cryptocurrency they staked; however, some networks have a two-token system that rewards validators in a second cryptocurrency.
It is important to note that because validators are selected on the size of their stake, users have the option of making a staking pool to pull money together to have a higher chance of being chosen as a validator; staking pools usually have a representative to handle the validation and creation of blocks.
Certain things need to be understood before a user can dive into staking, so users understand the fundamental mechanics of staking.
Lock up periods
Depending on the staking platform users are using, there might be a lock-up period where a user can not take their tokens out. The reason for this is to ensure a smooth running for the blockchain, but sadly they might be to the detriment of users sometimes; for example, if the market crashes and users would want to take action to prevent the crash from affecting them, they would not be able to withdraw the tokens if the lock-up period has no elapsed.
On-chain vs. off-chain staking
On-chain staking is the default staking process and is usually just called staking; this staking is done entirely on the blockchain and is primarily what this article speaks on. However, off-chain staking, on the other hand, happens outside the blockchain and is better understood in contrast to on-chain staking.
Off-chain staking is done in several ways; it can simply be an agreement between the transacting parties, it can be done by using a 3rd party guarantor who peonies to honor the agreement, or if a user buys a coupon in exchange for a token and then the user processed to give the code to someone else who then redeems it.
Some users seem to prefer off-chain staking because it gives a level of anonymity that in-chain staking does not allow, it also has no transaction fees making, and it’s faster because there is no miner verifying it, so it’s users like this because it seems easier, especially if a large sum is involved. However, without the blockchain verifying transactions and keeping parties in check, parties in an off-chain stake are more vulnerable.
Compound interest strategy
Crypto staking gives users interest, and this is good profit and a good way to generate passive income. However, there is a strategy for users to get even more interest, and token holders who want to save for the long term can compound their interest. Compound interest is like taking the seed from a fruit, planting it, waiting for it to grow and bear more fruit, then taking the seeds from the fruit and planting it again, repeating this process till a whole farm is born. Users simply have to take their interest earned and add it to the currently staked tokens, increasing the profit users will get.
Compounding interest in crypto is advisable because users have a host of coins to choose from, including ETH, DOT, SOL, and other altcoins. Users can pick the best one or even spread out their funds in a few of them to increase their chances of getting good returns. An added benefit is that if the value of these coins increases, so does their compounding interest.
How to Start Staking Crypto:
Users eager to start trading crypto need to follow the proper procedures to stake their crypto and start making a profit successfully.
1. Buy a cryptocurrency that uses proof of stake
Not all cryptocurrencies allow users to stake; the only ones that do this are those that use the proof-of-stake mechanism. Some of the top DeFi cryptocurrency projects use PoS, including Cardano, Ethereum, Solana, or Avalanche, as it is less energy-consuming.
2. Transfer your crypto to a blockchain wallet
Once a cryptocurrency is bought, it is available for exchange at the point where it was purchased, exchanges could have their staking service, but it is advisable first to transfer the tokens to a personal crypto wallet. This wallet could be a software wallet that can be downloaded on Android and iOS devices or a cold wallet like Ledger Nano. Then users can then select the deposit option on the crypto wallet; the wallet would create a wallet address, and then the user would need to go to the exchange account and withdraw by inputting the wallet address.
3. Join a staking pool
The proof-of-stake mechanism allows the highest pledge to be selected as a validator. Still, because most times, a single individual would not come to pledge enough to be chosen, cryptocurrencies use staking pools. These pools allow several people to come together and pull money together to pledge. If the pool is selected, a representative will be the validator while the other pool members benefit from it.
Users should look for a few things in a staking pool before joining. First, the users should pick a reliable pool with 100% uptime, as they would not make any money if the servers are down. Users should also ensure reasonable fees, 2% to 5% is common, but this varies between cryptocurrencies. The last and most important thing users should look out for is the size of the pool. Smaller pools are less likely to be selected because the cost is likely to be generated, and they could potentially fail. However, big pools can become too crowded, so medium-sized pools are the best for most users.
How to Choose a Staking Platform
In choosing a staking platform, the best thing for users is ease and benefit; finding a platform that has the most ease and gives the users the best benefits would be the most suitable.
Top Staking platforms
The top crypto exchanges in the world like Coinbase, Binance, Crypto.com, and Kraken offer great staking options across multiple liquidity pools from several tokens. In addition, DeFi platforms are dedicated to providing users with staking and yield farming options. The top crypto DeFi platforms right now are PancakeSwap, UniSwap, Katana DEX, and many more.
Additionally, there are extra staking service providers like EverStake, blockDaemon, figment, and myContainer. These platforms major in finding the best Interest rate for users’ digital assets. These services are very beneficial to many users.
Benefits of staking
Staking is very beneficial, especially to long-term investors who do not mind the prices fluctuating in the short term.
It is also beneficial to users who don’t want to trade. The risk and labor incentive nature of trading make it undesirable to some users. Letting tokens collect dust is not an option, so staking becomes the easier and most beneficial option.
Staking also gives the additional benefits of securing the blockchain. Users who stake their tokens can be proud that their tokens are pledged toward the blockchain’s good that benefits everyone in the crypto space, including those who staked their tokens.
Risks of Staking
There are two sides to every coin, and digital coins are no exception. There is a myriad of benefits to cryptocurrency staking, but it doesn’t come without its risks. These risks can be mitigated with proper research into each project, including the token and the staking platform. Here at some of the risks involved with crypto staking:
Platform risk
The staking platform users would determine a host of things about the profit users eventually receive.
For example, some coins have a minimum number of days that stakes would have to be locked in; this means that even if a user wanted to divert their resources to other investments, they wouldn’t be able to do this until the lock-up period has elapsed. This can be an issue if there is an eminent market crash, and there is nothing a user can do but watch their digital assets devalue while they’re locked in.
Another platform risk users might face is in the staking pools. The biggest risk is that the user would not see a reward if the designated validator does not perform their task well and is penalized. Another risk is that staking pools are liable to be hacked, and if this happens, the users in the staking pool would almost definitely not be compensated as the pool is not covered by insurance.
Market Value Risk
The crypto market is volatile, and because of this, the market can rise and fall in response to various factors.
When users stake their crypto, there is a risk that the market value falls while it is locked in, and at the maturity date, their stake is seriously devalued. This is why crypto staking is usually done by long-term investors who are fully aware that the market will rise and fall but are willing to wait out the storm; there is stability, and profit can come in as it should.
What is Proof of Stake?
The proof of stake is a protocol that came into play after the proof of work Protocol, which was worse for the natural environment as it required large computing power.
The idea behind the prior stake protocol is that users lock in their coins (stake) as a pledge, and the protocol chooses a validator for the next block. This selection process is at a particular interval, and the chances of being chosen are proportional to the number of stakes the user has.
The validator has to act appropriately because of the coins already pledged; this keeps the two parties in check as the blockchain needs a validator, and the validator needs profit; it is a trustless system.
Why Do Only Some Cryptocurrencies Have Staking?
Only some cryptocurrencies have staking because staking is the security layer that helps verify transactions and add new transaction blocks to the blockchain. Staking is attributed to a proof-of-stake consensus mechanism, which has gained popularity in the past few years as it is less energy consuming, ensures enough users become token holders, and, most importantly, increases transaction output and network scalability.
Coins You Can Stake
There are a host of coins that can be staked because they use the proof of stair protocol, which is the only protocol that can be used for crypto staking. Users can use coins like:
Staking FAQ
The best crypto-staking coins are; Tezos (XTZ), Ethereum 2.0 (ETH), Polkadot (DOT), Cardano (ADA), and Solana (SOL)
The best crypto-staking wallets are the exodus wallet, Trezor wallet, and the ledger wallet.
The cheapest way to stake crypto is through stake pools. And the price to stake would depend on the staking pool requirements; for example, Cardano requires at least one ADA.
The average return is about 5%. However, the top 261 asset stakes saw between 11% to 20% returns annually.
This would vary depending on the coin staked. For example, staking with Tezos (XTZ) will see users receiving their first earnings from their validator in 5 weeks, and then they would accept it after three days.
Most countries around the world consider staking crypto as income, and as such, it is taxed. Likewise, selling staked rewards is also seen as a taxable event.
The Future of Staking
The future of staking looks bright. As more people realize the profitability of crypto staking, it will become easier to perform and get more investors. This, in turn, will widen the pool of funds available in DeFi protocols. However, there will probably be more government regulations to guide the staking process as more funds become available within the space.
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Reviewed and Fact Checked by Eugene Abungana , Investment Analyst, Financial Analyst, and Institutional Trader