What is Staking?
Definition
Staking is a way to earn interest on your crypto assets in exchange for ‘locking up’ your coins on a Blockchain and helping to validate transactions & keep the network secure.
Understanding Cryptocurrency Staking
Basically, cryptocurrencies pay people (in their own coin) to secure their networks. In the Proof of Stake method (PoS), users are rewarded with cryptocurrency for staking their coins, validating transactions and contributing to the network’s security and legitimacy.
The Proof of Stake (PoS) method is a better alternative to the Proof of Work (PoW) method aka ‘mining’, which can be highly resource intensive. Staking serves the same function as mining (creating trust in the network, adding blocks to the chain & keeping transactions validated & secure) but with minimal upfront costs & electricity.
Staking, in a way, is like earning interest through a regular savings account. Like a traditional bank account, the longer you leave your money in there the better, and the more coins you stake, the more you will earn back.
What are the benefits of staking crypto?
- The ability to earn passive income off your crypto investments while helping to keep the network secure by validating transactions
- Compared to mining, there is a lower barrier to entry (depending on the coin) and there is no need to continuously purchase costly hardware and consume unnecessary amounts of energy
- Unlike the Proof of Work system, where coins are rewarded through a random process which gives you a fairly low probability of winning a big reward, staking offers a more steady & predictable source of income
- Digital currencies remove the need for relying on banks, the stock exchange or traditional brokers for earning passive income on an investment
- Mining hardware loses value over time. The value of your staked coins doesn’t lose value in the same way (but they are affected by fluctuations in the market value of that crypto)
Cardano (ADA) is an example of a cryptocurrency that uses staking, while older cryptocurrencies like Bitcoin rely on mining and the Proof of Work method. Other cryptocurrencies (including Ethereum) are currently transitioning from mining (PoW) to a staking (PoS) model.
Key Takeaways
- Staking lets you earn passive income off your crypto investments, while you help validate transactions & keep the network secure.
- Rather than spending electricity & computing power to solve mathematical problems & confirm transactions (PoW/mining), stakers lock up their assets to confirm transactions/blocks.
- Staking suits long-term holders who will not need to access their coins in the short-term.
- Profit is not guaranteed in staking and your coins will essentially be ‘locked’ for a time period, making them subject to market volatility.
- The period in which you stake your coins can vary. If you want to access your ‘locked’ coins before the agreed upon period, there will be a penalty of some kind.
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Proof of Work (PoW) vs Proof of Stake (PoS)
Before we dive into the details how staking actually works and why it’s such a game-changer, it’s worth comparing the Proof of Work system (mining) with the Proof of Stake system.
Essentially, mining is a sort of competition where powerful computers compete against each other to solve a complex equation and guess the correct number first. The winner gets to write a new page of transactions to the ledger (adding a block to the chain, in technical terms). They are also rewarded with cryptocurrency for doing this.
This is the Proof of Work system, with the ‘work’ being the task of guessing the right number. While this format allows a shared record/ledger to be reliably and truthfully maintained among a huge number of people who don’t know each other, it is incredibly resource intensive (both expensive and taxing on the environment) to run lots of powerful computers just for the purpose of guessing a random number. And that’s where staking comes in.
What is Staking (Proof of Stake)?
Staking, on the other hand, is an alternative consensus mechanism (a way to collectively verify and secure transactions) to mining. Users secure cryptocurrency networks through a process which encourages participation in the network by ‘staking’ or ‘locking up’ a certain amount of cryptocurrency on the Blockchain, thus earning a staking reward for their participation in the network.
Staking is essentially a way of generating passive income on your crypto investments through being rewarded for participating in the network’s ecosystem. While it serves the same function as mining (creating trust in the network, adding blocks to the chain and keeping all the transactions validated and secure), it requires a lot less energy and minimal upfront costs. Instead of needing computers and energy to create new blocks, PoS does it with staked coins.
Which cryptocurrencies can you stake & earn passive income from?
There are now a number of well-established cryptocurrencies you can stake. Some of the most notable ones include:
- Binance coin
- Polkadot
- Cardano
- Stellar
- Solana
- Cosmos
- Kusama
- Neo
- Avalanche
How does staking actually work?
It sounds pretty simple, right? You hold onto some crypto and receive a reward for doing so. While this is the basic idea behind staking, there’s a bit more to it than that. Let’s see if we can wrap our heads around it.
Staking is locking up your cryptocurrency in a smart contract. Once your stake is locked up, you vote to approve transactions (although active participation in the network is recommended, in most cases, for most users, you don’t actually have to ‘vote’ as it happens automatically).
While staking rules vary by network, the following provides us with a general idea of a staking agreement:
- The staker agrees that they’ll only validate valid transactions on the network. i.e., they will not vote to approve double spend transactions.
- In exchange for approving valid transactions, the network rewards the staker with a staking reward.
- If a staker votes to approve illegal transactions, they may lose some or all of their stake.
So, instead of competing for the next block by solving a complex algorithm (mining), PoS validators are selected based on the number of coins they are staking, and how long they have been staked.
Here’s some key points about how staking actually works:
- Staking involves validators who lock up their coins and are then randomly selected at specific intervals to create a block.
- The ‘stake’ is what incentivises validators to maintain network security. If they fail to do that, the network would be insecure and their entire stake might be at risk.
- Usually, there is a minimum amount needed to stake your crypto (or you can use a staking pool). Participants that stake larger amounts have a higher chance of being chosen as the next block validator.
- A staking pool allows multiple stakeholders to combine their resources and staking power as a way to increase their chances of being rewarded.
- Validators lose part or all of their stake if they double-sign or attempt to attack the network.
From the user’s perspective, staking is a way of being rewarded (through passive income) for participating in the network ecosystem and keeping it secure.
Note: While staking can be a great way to earn passive income on your cryptocurrency, by locking your coins up in a network you are opening yourself up to the possibility of the value of your assets rising/falling with the market. As your coins will be in a locked state for a period of time (the longer you stake the higher the gains), the amount earned through staking may not be enough to cover the price depreciation during a strong downwards trend, and some volatility is to be expected.
What is a staking pool?
A staking pool is where a group of stakeholders of a coin pool their stakes together to increase the chance of receiving staking rewards. Some coins require a fairly high minimum staked amount, so this can be handy for new & casual investors.
Staking Pools provide more flexibility for each individual staker in the network. Thus, joining in the stake pool may be better for new users than staking solo. Essentially, users combine their staking to more effectively verify and validate new transactions/blocks, increasing their collective probability of earning rewards.
How staking rewards calculated?
Staking rewards differ between Blockchains, but the main factors that influence your staking reward include:
- The number of coins you are ‘locking up’
- The active time period you are staking
- The total amount of coins staked in the network
- The inflation rate
- A few other minor factors in the network
In some Blockchain networks, the rewards are fixed percentages and are given to you, the validator, as compensation for inflation (which we will explain in the next section).
Why do Proof of Stake networks have built-in inflation?
PoS cryptocurrencies have a built-in inflation mechanism that increases the supply of coins/tokens. These new coins are created and distributed proportionally to the coins that have been staked.
If every person in the network were to participate in staking, everyone’s stake would remain the same because the new supply is distributed proportionally to those who are staking (in this case everyone). With the PoS system, anyone who does not stake their coins is not helping secure the network and is effectively punished with token dilution.
Thus, staking is designed to encourage every owner of a crypto to participate in the network. They are incentivized by the fact that their token ownership will be diluted through the built-in inflation mechanism if they do not. The process of inflation also encourages users to spend their crypto coins rather than holding them, increasing their usage and flow through the system.
How do I make money from staking?
The options for staking are endless, with more and more cryptocurrencies offering this feature. A good place to start is StakingRewards.com. Staking on Ethereum is becoming increasingly common but it is well worth doing a bit of research and finding out what the staking return for a certain coin is and what is the minimum staking investment (it is currently 32 ETH for the Ethereum network (though there are always staking pools)).
Another great resource is the Best Proof of Stake Coins which tells you which coins have the highest staking reward and the easiest way that you can stake them in order to start earning passive income.
What are some of the risks of staking cryptocurrency?
There are some risks and precautions that you should consider before staking a cryptocurrency.
Firstly, there is no certain profit to be expected, and in some cases, the rewards for staking are comparably less than the usual rewards for blocks issued by the network through mining.
It is also important to keep in mind that crypto is a relatively new phenomenon. There is still a lot of speculation and uncertainty around the decentralised finance space. All potential investors should do their research, approach with caution and know how to spot a scam! For a guide on how to trade cryptocurrency safely, click here.
Digital Surge is the easiest way for Australians to buy, sell & store over 250+ cryptocurrencies. With extremely low fees, a uniquely user-friendly interface and a customer-support team you can rely on, getting involved in crypto has never been easier. Sign up today and enjoy safe, stress-free trading.
Crypto-curious? The time you spend here will be the best investment you ever make.
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