What is crypto staking?
Crypto staking involves locking up one’s cryptocurrency holdings to earn interest or rewards. Technically, “staking” is how certain blockchain networks verify transactions.
From an investor’s perspective, staking cryptocurrency is a way of growing one’s crypto holdings without needing to buy more. Staking crypto for maximum passive income is a legitimate way of earning yields through one’s existing crypto holdings. Investors who participate in staking enjoy interest that is greater than what is offered through a regular bank account.
If you’re interested in staking cryptocurrency but are unfamiliar with the term, let us get you up to speed. Before we go there, it’s essential to understand the concept of blockchain technology. Cryptocurrencies are built with blockchain technology. Transactions involving such cryptocurrency need to be validated before the corresponding data can be stored on the blockchain. This validation process is called staking.
Let’s break it down further.
Because blockchain networks are decentralized, there are no middlemen. This is in stark opposition to traditional financial systems that use banks, for example, to serve as a repository of the public’s money.
As such, decentralization calls for a publicly accessible record across the network to ensure there is complete transparency and validity across all transactions. Transactions are collated into “blocks” and are submitted for inclusion into this record, which is immutable.
That’s kind of the greatest security feature of blockchains, by the way. Since everything is accessible and verifiable through a distributed public ledger (the record), it’s very hard to trick or hack.
That being said, once these blocks are accepted, users who own these blocks get a transaction fee as payment in the form of cryptocurrency.
What does staking have to do with all of this? you might ask. Simply put, staking is a safeguard against errors and fraud that may happen during the process.
Every time a user proposes a new block or votes to accept a proposed block, they place some of their cryptocurrency on the line. This process incentivizes adhering to the rules. So, in principle, the more crypto a user puts at stake, the higher the chances of earning transaction fee rewards.
However, if a user’s proposed block is found to have fraudulent or inaccurate data, they can lose what they put up as a stake. This process is called ‘slashing.’
How does crypto staking work?
There are many ways to start staking crypto. For starters, you can choose to validate transactions using your own computer. You can also “assign” your crypto to someone you trust and ask them to validate you.
Note that not all cryptocurrencies can be used to stake. We’ll discuss more of this later, so keep reading.
What is proof-of-stake?
Proof-of-stake is a consensus mechanism that allows blockchains to validate transactions. In proof-of-stake (PoS), the number of coins (or the amount of stake) determines the chances of validating a new block.
PoS was created as an alternative consensus mechanism to the original proof-of-work (PoW). PoS is one of the most common consensus mechanisms and is continually gaining traction for its efficiency and the possibility of earning crypto staking rewards.
Unlike PoW which is very energy-intensive and requires a lot of computing power, PoS does not require as much computational work to verify transactions. Coin owners “stake” their coins as collateral in order to validate blocks.
What are staking rewards?
Staking rewards are incentives provided to blockchain participants. In every blockchain, there is a certain amount of crypto rewards allotted for the validation of transactions. As such, participants who stake crypto receive staking rewards when they are chosen to validate transactions.
Basically, staking allows participants to earn more crypto. Interest rates vary depending on the network, but participants can earn as much as 20% to 30% yearly. Many people stake crypto to earn passive income or invest their money.
Ways to Stake Crypto
To stake crypto, one must select crypto that uses the proof-of-stake model, such as Ethereum. There are various ways to stake cryptocurrency:
Through an exchange
You can choose to use an exchange to stake your tokens on your behalf. An exchange is an online service that specializes in crypto matters. Most exchanges ask for a commission in exchange for staking services. Some popular exchanges that offer staking are Binance.US, Coinbase and eToro.
By joining a staking pool
Some investors don’t use exchanges simply because not all of these platforms support a wide array of tokens. So, another alternative is joining what’s called a “staking pool,” typically operated by another user.
You’ll have to connect your tokens via your crypto wallet with the validator’s pool. To ensure the legitimacy of these validators, ensure you check out the official websites of proof-of-stake blockchains to understand how they should operate.
By being a validator
Validators are coin owners with staked coins. They are selected at random to validate a block. It’s the equivalent of ‘mining’ when using a competition-based mechanism such as proof-of-work.
Naturally, one of the most effective ways to stake crypto is by becoming a validator yourself. Blocks are validated by more than one validator, and when a specific number of the validators verify that the block is accurate, it is finalized and closed.
However, it’s a bit more complicated than using an exchange or joining a pool, as it requires you to build your own staking infrastructure. You need to have the proper equipment with adequate computing power and software and download the blockchain’s entire transaction history.
Becoming a validator typically involves a high entry cost as well. On the Ethereum network, one needs to have at least 32 Ether (ETH), which roughly converts to $140,000, give or take. Read more about staking and becoming a validator on the Ethereum network here.
Is staking crypto profitable?
So, the burning question really is: How does staking crypto make money?
Let’s put it this way. If you’re already familiar with the practice of mining and trading crypto, then that’s a great start. Staking can be just as profitable, minus the risk that comes with mining and trading.
So, yes, staking crypto is profitable. Basically, you have to buy and hold some coins and add them to the mining pool. The profits you make, which typically come in the form of transaction fees, will depend on how much you stake and how long you do it.
Things to consider when increasing your staking profit
Generally, you make more profit with staking as you continue to stake more. However, there are other things to consider when it comes to increasing your profits:
- Coin value: Steer away from staking a coin with very high inflation rates. You may earn big rewards initially, but since the value of the coin is volatile, you may be left with little to no profit.
- Fixed supply: Ensure that the token or coin has a fixed supply. Limited circulation of coins within the market ensures a healthy demand and constant price boost.
- Actual applications: Cryptocurrency demand largely depends on a coin’s actual applications. If it is widely used for various applications in the real world, such as for digital payments, it will continue to have a healthy demand and price.
Which crypto is best to stake?
As mentioned earlier, not all crypto is viable for staking. Bitcoin (BTC), for example, does not support staking because it uses a different method of validating transactions: proof-of-work. Generally, if a cryptocurrency is linked to a blockchain that uses proof-of-stake as its incentive mechanism, it might be eligible for staking.
Ethereum offers substantial staking returns because it remains one of the most popular altcoins in the market today. The average rate of return for staking Ethereum is at 5-17% annually.
Like Ethereum, Cardano is also a smart-contract platform. Cardano (ADA) is the digital currency that powers the platform’s proof-of-stake network. Binance supports the staking of ADA and offers yields of up to 24%.
Dubbed the ‘internet of blockchains,’ Cosmos allows different blockchains to transact with each other via interoperability. Various platforms support the staking of Cosmos (ATOM) including Coinbase, Kraken and Binance. ATOM staking yields an average of 7% per year.
Tezos is an open-source network with Tezos (XTZ) as its native currency. XTZ can be staked on various platforms like Kraken, Binance and Coinbase. The average yield for staking XTZ is currently at 6%.
Polkadot, like Cosmos, encourages interoperability between various blockchains. Despite being relatively new, staking Polkadot (DOT) is supported by several platforms including Kraken, Fearless and Binance. The current average yield for staking Polkadot is at 12% yearly.
Can you lose money staking crypto?
When investing, the first and most important thing to consider is the risk involved. So, is staking crypto safe?
You bet it is, but there are definitely a few risks involved.
Generally speaking, you cannot “lose” money from staking crypto per se. What you have to look out for are things such as inflation and illiquidity, to name a few. Given how volatile cryptos are, there are chances that the coin you put up for staking could fall. For example, if you stake your crypto and it loses value even after you earned yields after staking, then technically speaking, you could still lose money.
And, if you’re a day trader, you cannot use the coins for several weeks or months and thus miss the opportunity to bet on lucratives. This is why it’s important to be wise when choosing which coins you want to stake.
Review the tips we outlined in the section “Is staking crypto profitable?” to ensure that you’re making the right choice before staking.