Staking cryptocurrency is a yield generation strategy that is often used by cryptocurrency investors who want to put their assets to work.
What is Crypto Staking?
Staking is one of the most popular activities in the world of decentralized finance, or DeFi. When a user stakes their crypto assets, they’re essentially pledging those coins to the blockchain to help secure the network. In return for pledging their coins for network security, the user receives a staking reward that is generated from the fees that validators earn from confirming transactions.
How Does Crypto Staking Work?
To stake on the blockchain, the crypto holder will need to have coins in a wallet that can be delegated to a validator. This means the coin holder, or delegator, is pledging the assets to the network to help secure the blockchain. When the validators confirm transactions on the blockchain, the block reward is then paid to the validators by the network. The validators then share a portion of that reward with the delegators who have pledged their coins. This is the staking reward.
Why Do Only Some Cryptos Have Staking?
Not every cryptocurrency can be staked on the blockchain to earn the block reward because many cryptocurrencies operate on Proof of Work consensus mechanisms where block rewards are paid to miners rather than stakers. Proof of Stake blockchains have staking capability, as staking is critical to the blockchain’s security. Many of the top cryptocurrencies by both market capitalization and daily volume operate on Proof of Stake blockchains. Each of these cryptocurrencies are Proof of Stake chains that have enabled block reward payments to staking participants:
Coins like Bitcoin (BTC-USD), Dogecoin (DOGE-USD), Litecoin (LTC-USD), and Monero (XMR-USD) live on blockchains that utilize Proof of Work consensus mechanisms and can’t be staked on the native chain.
What is Proof of Stake?
Proof of Stake is simply a type of consensus mechanism that is used by many notable blockchains. It differs from Proof of Work in that the block reward isn’t earned by computers solving complex math problems, but rather validators who verify transactions in exchange for block rewards from transaction fees. Proof of Stake is generally viewed as more environmentally friendly than the Proof of Work consensus mechanism. This is because Proof of Stake doesn’t require nearly the same level of electricity that is necessary to power the computers that confirm transactions with Proof of Work blockchains.
There is some debate among notable cryptocurrency market participants pertaining to Proof of Stake vs Proof of Work. Some believe Proof of Stake will become more centralized over time if stakers don’t spread out their staking delegations well enough. Others say Proof-of-Stake is the better way to decentralize blockchain validation because mining through Proof of Work requires expensive machines that create a high barrier to entry.
Learn more about Proof of Work vs. Proof of Stake.
What are the Benefits of Staking?
Staking can be beneficial to the coin owner in multiple ways. If a cryptocurrency is relatively new or still has a high level of inflation remaining, staking the coin and receiving a portion of the block reward can help the coin holder offset any supply dilution from the block reward emissions. This is especially important in a bear market as cryptocurrency prices struggle. Staking helps the user possibly generate a real yield even if the price of the coin has gone down.
Staking can be beneficial in a bull market because it pays the user to sell coins through the reward. In this way, staking can become a passive income vehicle if the prices of the coins are rising while the staker is rewarded from the block reward. Staking on the blockchain directly can also provide other benefits like airdrops. For example, in 2021 people who were staking on Cosmos (ATOM-USD) were airdropped Osmosis (OSMO-USD) tokens.
What Are The Risks of Staking?
There are several concerns pertaining to cryptocurrency staking that investors should be aware of before deploying any of their assets in a staking protocol.
Depending on the blockchain where the staking is taking place, oftentimes staking will require committing coins to a validator for a specific duration. This essentially limits the staker’s control over the assets during the time period when the coins are staked. Another potential issue to consider when staking is validator selection. The fee rewards will vary depending on what each validator offers.
Another risk to consider when staking is validator selection. Bad actor validators can experience something called slashing if they don’t behave properly. Slashing is when the network community decides to punish a certain validator by either burning or redistributing a portion of their stake for committing network offenses. These offenses can be downtime or malicious activity. Some chains don’t punish the delegator for the validator’s offense; others do.
How to Start Staking
More sophisticated users might be more inclined to stake their assets directly on the blockchain themselves by becoming a validator. However, becoming a validator is a large commitment and requires reliable equipment and constant uptime. For most, it’s probably easier to simply delegate their coins to a validator stake and share the block rewards that are earned by that validator. This can be done by simply holding the coins in a self-custodial wallet interface that has staking capability. When selecting a coin for staking on-chain, be mindful of staking minimums as some chains have high minimums and other chains have no minimum staking requirement.
For cryptocurrency holders who don’t self-custody their coins, staking can also be done through an exchange. Many exchanges offer these services within their platforms and take a small fee for facilitating the transactions on-chain on behalf of their customers. For instance, Coinbase (COIN) offers Ethereum staking as a service and has since become one of the largest depositors on the Ethereum Proof of Stake chain, as have Kraken and Binance (BSC-USD).
Staking is a way for cryptocurrency users to generate yield on assets that they’re otherwise not using. The added reward from staking cryptocurrencies does come with some risks. It’s important to know what you’re committing to before you determine if staking is right for you. But for blockchain networks that have strong communities and good fundamentals, staking might be something to consider both to participate in the security of the network and to earn yields on coins.