What is Cryptocurrency Staking?
By Bahira Maisoon, Updated on: Apr 07 2023.
Staking is a passive method for earning income by locking up your cryptocurrencies in a liquidity pool for a particular period in return for some crypto rewards from a blockchain network. Staking helps to establish the proper working of a blockchain network. All the cryptocurrencies do not allow for a staking facility, instead, they use different mechanisms to work. Ethereum, Solana, Cardano, Polkadot, Avalanche, Cosmos, and Tezos are some crypto that enables the staking method.
We know that cryptocurrencies have several use cases that are worthful to gain profit for crypto enthusiasts. Imagine if your hands are full of passive income in the form of rewards. Obviously, you will run for to grip on such a lucrative gain. This is the specialty of crypto staking, where you store your coins for a set period and earn rewards.
How Does Crypto Staking Work?
Staking is not only about earning rewards, but it is also a framework for the easygoing of a blockchain network. We know that cryptocurrencies are decentralised with no central governance body. The absence of centralisation is challenging for blockchain technology as there must be some system to validate transactions, and here is where a consensus mechanism substitutes. Each coin uses a suitable working mechanism called the consensus mechanism. As the word suggests, a consensus is a mutual understanding or agreement between nodes, miners, validators, or simply participants for the smooth working of a system.
In blockchain technology, all transactions and validations undergo a specific mechanism. Proof of Stake (PoS) is one such consensus mechanism that allows staking on cryptocurrencies. As we have already learned, not all coins allow for crypto staking. Now, let's learn in detail about the Proof of Stake mechanism.
Proof of Stake Consensus Mechanism
In simple words, Proof of Stake is evidence or proof of the working of a blockchain network. This mechanism validates transactions through staking. A blockchain network participants stake their coins to participate in deciding which "block" must be added to the chain. In other words, participants/stakers vote to approve a transaction, and in turn, receive rewards such as newly created cryptocurrencies.
In September 2022, the Ethereum blockchain shifted from the Proof of Work (PoW) mechanism to the Proof of Stake mechanism. So, what is the mechanism used in Proof of Work?
In the PoW system, network validators use high computational power to validate transactions and vote for the suitable block. As there is high computational power in PoW, the PoS system came as a remedy to resolve the high energy consumption issue. In PoS, there is low energy consumption and transactions are faster and cheaper. Also, the PoS algorithm ensures high scalability under a heavy workload and removes complex calculations, thereby easily generating blocks.
In short, the PoS mechanism validates the block that has the most number of crypto staked and the PoW algorithm mines the block that performs high computational calculations.
How to Start Staking?
Any crypto holders can take part in staking and get income out of it. But, you cannot stake all the coins because all the cryptocurrencies do not use the Proof of Stake mechanism which is relevant for staking. Basically, you need an idea about the basic technical process of staking and how to participate in it. One important thing you need is a computer that can function at any time and do validations without any impairment.
1. Choose a Cryptocurrency from a Crypto Exchange
You can choose any cryptocurrency from a crypto exchange to start staking. Remember, not all coins allow for staking, so, choose the one that works on the Proof of Stake mechanism. As mentioned earlier, Ethereum, Cardano, Solana, Polkadot, and Tezos are a few of the coins that function staking process. Notably, you can see many crypto exchanges that show detailed steps on how to stake coins. Some of the exchanges that allow staking include Coinbase, Binance, Kraken, KuCoin, and Gemini.
2. Deposit the Purchased Crypto in a Wallet
After you buy coins, directly transfer them into a crypto/blockchain wallet that is protected with a private key. Some exchanges provide their own wallet with which you can store your crypto. You can withdraw the coins you purchased using the exchange account and directly transfer them to your wallet by clicking the 'deposit' button.
3. Choose a Staking Pool
A liquidity pool or staking pool is the place where crypto holders deposit their coins in return for obtaining rewards. Once you get coins filled in your wallet, start staking your coins by depositing them in the pool. People who stake their coins in a pool are known as Liquidity Providers (LPs). Notably stable pair pools are the safest and less risky pool for staking your coins. A few examples of stable pairs are:
- ETH/USDT- Tether for Ethereum
- SOL/USDT- Tether for Solana
- ADA/USDT- Tether for Cardano
However, before you stake your digital assets, do not forget to do proper research on all the possible factors of a good liquidity pool. There are certain reasons why a pool functions in a good way. Saturation is one of the best factors that measures the level of stake in a pool and determines the level at which rewards stop surging. This factor opposes people to commit their coins to an oversaturated pool. Therefore, a pool with a level of stakes near saturation gives more rewards to stakers.
You can also rely on the pools that provide competitive fees. Staking pools hold a certain amount of rewards from what you obtain called pool margin. Usually, this is a reasonable staking fee and depends on cryptocurrencies. Mostly, it covers around 2% or 5% of the reward you get.
Here is the list of some staking coins and the reward they provide to stakers.
- Ethereum- 3.92%
- Cardano- 3.32%
- Solana- 7.06%
- Avalanche- 9.13%
- Polygon- 14.45%
Size of a liquidity pool matters when you stake your crypto assets. You can look for medium-sized pools that bring profitable rewards. In the case of small pools, rewards would be high but chances for validating blocks are low. Also, the largest pools may be oversaturated with limits for staking rewards. So, it is best to stick to medium-sized pools
While you follow all these factors, do not forget to contact pool operators because they can provide you with accurate knowledge of the complete working of the staking pool.
With a thorough understanding of all the above factors, you can easily turn on your staking and earn rewards.
How Do You Earn Money From Staking?
So far, we have understood how to begin staking in simple steps. Now, you may ask how to earn income or how is an income generated. Once you start staking your coins, the income starts generating in your wallet. You can choose any coin based on the staking rewards and popularity of that coin. Also, try to rely on mid-sized liquidity pools with many stakers as they can offer you more rewards. If there are many stakers for a particular coin, you can definitely choose that one. So, if you are bored of trading your assets, start staking them to earn passive income.
How Profitable is Staking?
Crypto staking is obviously profitable as you can earn income passively. All you need to do is have an idea of a list of crypto that ensures the best staking rewards. Also, learn about different staking platforms and the timely market conditions. You can earn profit from the direct trading of coins. But, staking offers you a unique way to passively obtain extra coins. If you have temporarily halted trading your coins, then this would be the best time to stake them and earn incentives.
If you want to know about the profit you get from staking, then research well on the market value of the crypto you own, the amount of reward, and the size of the staking pool. As explained earlier, go for medium-sized liquidity pools, as you can obtain a good amount of reward. Different cryptocurrencies have different staking rewards, so, choose the one that you find suitable. The market value is another factor that matters to the profit you earn. If the price of a stakeable coin is low, then you may get fewer rewards. You would get higher rewards if the value of the coin goes up.
Advantages and Disadvantages of Staking
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Staking your crypto brings many benefits to you, and at the same, there are some significant disadvantages you should be careful about.
Advantages
Earning Rewards Through Passive Income
Basically, what you can get through staking is passive income after holding your assets for some time in a staking pool. You can stake any coins that work on the Proof of Stake algorithm. Also, before you stake check the rewards offered by each coin and then select the appropriate one that you like.
Low Energy Consumption
Proof of Consensus consumes less energy to validate and add blocks to a blockchain. Any validations performed on a PoS-based coin are energy efficient and do not cause any environmental impacts. Unlike in the Proof of Work system, where computational calculations consume high energy, the PoS mechanism takes less energy and completely works on staking as proof.
Moreover, the validation of transactions and block creations is much faster in PoS than that in the PoW system.
No Specific Hardware Required
As we have learned, staking is a simple process without any need for special hardware or equipment. All you need is a well-functioning computer and a good internet connection, along with, relevant knowledge to perform staking.
Disadvantages
Less Democratic
One notable downside of staking is its nature of selecting validators depending on the amount of money they deposited. The more the validators have money in the pool, the more the chance for them to get selected and thereby, earn rewards. Additionally, the early adopters of staking or the people who are early investors may have more control over introducing new coins in the PPoS mechanism. In these ways, we can say that staking is less democratic.
Chances for Security Issues
The PoS mechanism in staking is sometimes risky due to the chance of security issues. Unlike, the PoW mechanism, PoS is not tightly secured and is less tamper-resistant. PoW uses relevant hardware and consumes high energy, which is absent in PoS, making it less secure. In detail, a hacker can easily get a large amount of staked tokens from the PoS system. Meanwhile, in the PoW system, the attacker would have to acquire a lot of special mining equipment and consume high electricity to attack 51% of computing power. Another reason for the insecurity in PoS is the absence of computational power used for validations.
Lack of Decentralisation
PoS setup is more leaned toward centralisation because it mostly favours validators holding the most number of tokens than those with less number of tokens. We know that the decentralsied structure is distributed equally among all the users. Although PoS works on a decentralised notion, it more likely wears a centralised look as stakers with more coins have a higher chance of voting power to verify blocks. Also, these validators receive higher rewards than those with lower amounts of coin.
Can You Stake All Cryptocurrencies?
You cannot stake all the cryptocurrencies as many coins do not hold a staking mechanism. There are crypto that works on Proof of Work consensus mechanism like Bitcoin, which cannot be staked for earning rewards. Instead, coins with the Proof of Stake algorithm can only be used for staking. As we have already said, Ethereum, Cardano, Polkadot, Solana, Avalanche, Tezos, Cosmos, Binance Coin, DeFiChain, NEAR Protocol, etc. are a few coins used for staking purposes. The blockchain network of all these coins is formed when validators (participants) stake coins and vote to add blocks to a chain.
Is Staking Crypto Safe? Are There Any Risks?
At a glance, you may feel that staking is perfectly safe and you can easily earn incentives. This is true to some extent, but wait! the condition of the crypto market matters a lot. We know that cryptocurrencies are volatile in nature depending upon several macroeconomic factors, and the value of your assets may go up or down. This price fluctuation will directly impact the rewards you earn. If the value of your staked asset is down, then the rewards you obtain will also be less.
You cannot earn rewards at any time after you stake. You need to wait for a minimum staking period and then only you will get the desired incentives. To note, during the staking period, investors are not allowed to withdraw their assets for trading or any other purpose. Likewise, there is a specific period for unstaking your crypto. Usually, unstaking takes seven days or more than that.
Another concerning matter is the chance for security issues as the PoS mechanism in staking is not 100% able to battle security threats.
When You Should Stake Crypto?
In general, there is no specific time to stake your crypto. Whenever you have some crypto in your hands and you don't want to trade them, then the best option is to stake them and earn passive income. However, do not forget to check the market value of the crypto you stake. As you know, if the value of your coin is less, then the rewards you obtain will also be less. Therefore, try staking your assets when their market value shows an uptrend.
How Are Staking Rewards Calculated?
You cannot get staking rewards in any random ways as you wish. Different staking platforms or coins use different parameters to arrange rewards for the stakers. Liquidity pools work based on certain parameters such as; the number of coins a validator stakes, duration of staking, inflation rate, the market value of the staked assets, the total number of coins staked in a network pool, etc. If you stake more coins for a long time, you would get more rewards. Moreover, you can start earning rewards the moment you start staking.
Conclusion
With staking as an outstanding feature, the crypto industry shows us that the utility of crypto does not lie in trading alone, but is more exposed for staking. This indicates that crypto lovers can earn money not only through trading but also through staking coins. Crypto staking is the passive way of earning income when you stake/lock your Proof of Stake-based coins in a liquidity pool. Although several staking crypto platforms take 2% to 5% of the staking rewards you earn, the percentage of the profit you get is satisfactory.
The Proof of Stake consensus mechanism deployed in staking makes transactions faster and easier than the Proof of Work setup. Also, staking requires only less energy to validate blocks as the PoS system consumes less electricity. This feature works contrary to the PoW mechanism, where high energy is consumed for the computational mining of blocks. However, the PoS setup selects validators by giving more priority to the stakers with the highest number of coins. This factor is challenging for those with fewer coins staked. Moreso, these participants with more priority get the power to vote on validating blocks. Although the PoS system has these flaws, crypto traders are more running towards staking as it provides them rewards, makes transactions faster, and brings a sustainable environment by reducing energy consumption.
Sometimes, staking may work inversely to your expectations that when the market value of your staked crypto goes down, you would get only fewer rewards. The amount of rewards you obtain also depends on the quantity of the staked coins and the period of time you spend on locking your coins.
In September 2022, Ethereum shifted from PoW to PoS mechanism to make the network transaction faster, energy-efficient, and bring higher scaling solutions. Also, by implementing the PoS concept, Ethereum has started providing staking opportunities and rewards for all the stakers.
Frequently Asked Questions
Is staking really good?
Staking is a good method for earning income that is actively practiced by several crypto holders. This method's passive way of earning income is the best part that invites more stakers to deposit their crypto assets to a liquidity pool. The more you stake your coins, the more you receive incentives.
How to choose the best coin for staking?
There are several coins that offer you the best staking rewards based on certain criteria. Some staking platforms allow flexibility in the staking period in which users can withdraw their coins as per their wish. The best staking projects are the one that provides a fixed staking period. You can choose a coin based on the level of activities and community engagements over a stakeable coin and its liquidity pool. Annual Percentage Yield (APY) is also another factor to hang on to. This metric allows stakers to know the percentage of rewards they get yearly.
How much can you earn through staking?
Staking crypto allows you to earn rewards based on the number of coins you stake, the duration of staking, and the market value of the crypto you stake. You can passively earn even up to 20% to 25% of your staked value. Coins such as DeFi Coin (up to 75%), Hydra (49.7%), Cosmos (19.14%), and Polkadot (13.99%) have the highest staking rewards or APY.