Crypto Guide: What is Staking?
For the average retail investor and consumer, the best way to profit from cryptocurrency is to sell your holdings when its market price increases. But did you know there's another popular way of making money in crypto? We call it staking, a process where you put your digital assets to work and potentially earn passive income without selling them.
Staking in crypto is somewhat similar to your high-yield savings account. When you put your money in a savings account (and the bank lets it out), you earn interest on your account balance. Theoretically, cryptocurrency staking and putting your money in a high-yield savings account are similar as both bring incentives. However, many details come into play during the process that every retail investor or crypto enthusiast should know.
A look into 'staking' in crypto
Staking is when an individual locks a crypto asset for a period to support the blockchain's operations. In return for this commitment, the individual receives additional crypto. Some blockchains rely on the proof-of-stake (PoS) consensus mechanism. Here, participants who want to support the blockchain by validating transactions and adding blocks must 'stake' a specific sum of cryptocurrency. By staking crypto as a requirement for blockchain participation, trust in transactions and the blockchain in general increases.
You can think of the staked crypto as 'insurance,' so the community can count on legit transactions. If there's an improper or fraudulent data validation, he may lose some or all of the staked crypto as a penalty. But if they validate correct and legitimate transactions and successfully add blocks to the blockchain, they can earn crypto as a reward.
In the crypto industry, we call this process mining a popular way to earn crypto from the blockchain. Popular cryptocurrencies like Ethereum and Solana use staking as part of their consensus mechanisms, and the actual rules and rewards vary depending on the blockchain.
Individuals and investors also have the option to set up a crypto wallet that supports staking. If your wallet supports staking, you can allocate a part of your portfolio for staking. Under this mechanism, you must choose from different staking pools to find a validator. Then, all tokens are combined with others who use this approach to boost their chances of generating blocks and collecting rewards. We call this 'pooled staking,' explained in detail below.
Staking in the Ethereum blockchain (and others with PoS mechanism)
To fully understand crypto staking, let's take the Ethereum blockchain as an example.
In Ethereum, staking is depositing 32 ETH to activate the validator software. As one of the blockchain's validators, you'll be responsible for storing data, processing transactions, and adding new blocks. By joining the pool of validators, you'll keep the blockchain secure and earn new cryptos.
Popular approaches in crypto staking
At least three approaches to staking on Ethereum and other blockchain projects: solo, staking as a service, and pooled staking.
Solo staking in the Ethereum blockchain is the most popular and efficient option. This staking approach allows for full participation and rewards and improves the blockchain's decentralization since there's no need to trust anyone else with the funds. In solo crypto staking, you'll need at least 32 ETH and a dedicated computer linked to the internet 24/7.
If you don't have a techie background and still want to stake your 32 ETH, then staking-as-a-service is the best option. You delegate the job's techie aspect here but still earn crypto rewards. Ethereum and other blockchains that offer this option provide walkthroughs on creating a set of validator credentials, uploading the signing keys, and depositing the staked amount. The service validates on your behalf. The provider has a certain level of trust, but you also mitigate the risk by controlling the keys to ETH withdrawal as an investor.
If you don't have 32 ETH or are uncomfortable staking this amount, you can join a few pooling solutions. In the Ethereum blockchain, we also call this 'liquid staking,' which involves the ERC-20 liquidity token representing the staked ETH. In liquid staking, investors can quickly join and exit anytime, giving them control as they hold the assets in their wallets. Remember that pooled staking isn't native to the Ethereum blockchain; these are developed and run by third parties, which comes with some risks.
In addition to these three popular crypto-staking approaches, some centralized exchanges offer staking services . Experts recommend working with these if you're uncomfortable holding ETH in the wallet and want to earn additional crypto with minimal effort or oversight. However, there's a trade-off here since centralized providers consolidate large crypto pools to run many validators. This is risky for the network and users since it creates a large centralized target and potential point of failure, thus making the blockchain more vulnerable.
Are there benefits to crypto staking?
Yes, crypto staking can be potentially rewarding to investors and validators. In the Ethereum blockchain alone, 32,060,092 ETH is staked on the Beacon Chain, not including the balances over 32 ETH, representing 1,003,902 validators. Also, the Ethereum blockchain boasts an average annualized financial return of 3.2% per validator. Staking your crypto is a worthy investment alternative with the following potential benefits:
- Earn a passive income with crypto staking. Let your holdings work for you by staking your coins for passive income.
- It's an easy and convenient staking process. You don't need much or have technical skills to participate in staking. A specific kind of crypto staking allows you to stake less, enable others to participate on your behalf, and still earn the rewards.
- Support your favorite blockchain project. Staking is also an effective way to promote and support your favorite blockchain project. By staking your crypto, you help the platform become more resistant to attacks and improve its capability to process transactions.
Are there risks in crypto staking?
Crypto staking may seem attractive due to the rewards, but there are also risks involved that you should be aware of . One risk is that by staking, you'll temporarily let go of your crypto for a period, thus depriving you of a chance to cash out or sell your holdings if the price increases. Remember, cryptocurrencies, like Bitcoin and Ethereum, are highly volatile investments with wild price fluctuations. Or, if you work with a dishonest validator, you could lose some of your investment.
Plenty of instances exist when validators' and investors' staked cryptocurrencies are slashed or partially confiscated for violating network protocols. Finally, crypto staking is also regulated. So, if you have questions or complaints about the system, you can't find a government agency that can hear your grievances and provide remediations.
So, is crypto staking still a worthwhile activity? Yes, staking is still a good option for investors and individuals interested in generating passive income and aren't bothered by short-term fluctuations in crypto prices. If you want to continue staking, only stake a portion of your holdings you can afford to lock up. It's also recommended to carefully review the terms of the staking period and other requirements, including how long you'll get your money back before opting in. Finally, always work with legitimate companies with modern security standards or a stake in the platform you believe in.
