What is staking and how does it work?

  • January 24, 2022

What is staking and how does it work?

When it comes to making money with cryptocurrencies, most investors contemplate purchasing or mining potential assets. Staking crypto, on the other hand, is a solution that even beginners should consider.

In this article, you’ll learn how crypto staking works, what kind of technology is at the heart of it, the cryptocurrencies that support it, and how to stake them.

What is Staking?

This is the process of storing and locking cryptocurrency in order to receive rewards or interest. Transactions on blockchains are verified via consensus procedures, and staking is one of the methods for validating those operations.

Various validation techniques are utilized depending on the type of blockchain network, with Proof of Stake and Proof of Work being the most frequent.

 

Many blockchains rely on network participants to reach a consensus. That’s where staking comes in: investors who own the native coin get involved by authorizing and validating blockchain transactions.

 

How Does Crypto Staking Work?

They are rewarded with staking rewards in the form of the native token for doing so. As a result, crypto staking is similar to making a bank deposit and earning interest.

 

Because all that is required is to keep cryptocurrency in a wallet, staking provides a source of passive revenue (except for DeFi staking where coins are locked in a liquidity pool). To allow block generation, the network takes advantage of these holdings. The system chooses a user at random to validate the next block, but the higher the likelihood, the more coins are locked.

 

From the investor’s perspective, it works like this:

  1. A user stakes (locks) tokens.
  2. Data in the coins’ blocks help the network validate the next ones. 
  3. The coin holder gets rewarded for this participation.

Why do only some cryptocurrencies have staking?

To help you understand why some cryptocurrencies like Bitcoin cannot be staked, we need to go into technical details:

  • As was previously mentioned, decentralized networks feature different sorts of consensus mechanisms. All of them are aimed at unbiased transaction validation, but only Proof of Stake and Delegated Proof of Stake blockchains enable this sort of block generation and rewarding method. 
  • Many cryptocurrencies, including Bitcoin and Ethereum 1.0, rely on Proof of Work consensus mechanisms. To enable transaction verification, PoW networks fetch resources generated during the mining process. This involves making complicated cryptographic calculations. The miner who solves the puzzle first is given the right to add the latest block of approved transactions and receives a crypto reward in return. 

 

The PoW mechanism is sufficient to execute transactions on basic blockchains such as Bitcoin. However, it isn’t scalable enough for more complex blockchains like Ethereum, which powers DeFi apps and millions of transactions every day.

Benefits of staking crypto

While crypto trading and investing have a high learning curve and are risky, staking has shown to be a more straightforward and risk-free option. Holders’ money lessens the blockchain’s vulnerability to attacks and increases its processing capability, which helps both the network and the donor. In exchange, the asset owner obtains profit without having to do anything physically.

Generation Of Passive Income

A person does not need to actively approve transactions to get a reward from staking; the network accomplishes so by retrieving the appropriate information from previously created blocks. Buying or depositing crypto assets in one’s wallet and keeping them locked is all it takes.

Low Entry Fees

Although traditional (non-DeFi) staking necessitates the ownership of a significant number of tokens (for example, 32 ETH for the Ethereum network), operational expenses are cheap and can pay off in a matter of days, if not hours. Even Ethereum gas fees might now be as high as $10-15 during periods of low network activity.

“Learn about the minimum staking requirements and transaction fees on a certain blockchain before you decide to lock your funds.” This will assist you in determining whether or not this alternative is financially viable.”

Permissionless

While staking has a financial entrance barrier, anyone can theoretically become a staker. A PoS blockchain has no limitations for the user’s location, devices used to access the wallet, or online activity because it is a totally decentralized network. All that is required is the purchase and storage of coins.

More Energy Efficient Than Mining

Staking, as opposed to mining, takes fewer resources. Cryptocurrency holders do not need to invest in expensive mining hardware or worry about GPU/ASIC upkeep. Furthermore, it is a more environmentally friendly choice that requires less energy for scaling growth.

Risks of staking crypto

So yet, none of the available consensus procedures, including Proof of Stake, have been faultless. Participants in the network are exposed to the risks associated with the performance and security of staked crypto assets. Although it’s improbable that you’ll wake up one day with an empty or non-existent wallet, there are a few things to keep in mind.

Market Risk

Cryptocurrencies are extremely volatile; a 10% or 20% price swing in a single day is not uncommon. As a result, you must keep track of these movements and reassess your investment ideas if the market begins to fall.

Liquidity Risk

Staking may compel you to lock your assets for a defined amount of time. You won’t be able to withdraw or sell your coins at this time. The unstaking process could take up to seven days. This also means that if a bear market hits, you won’t be able to sell your bitcoin right away.

How to Stake Crypto

We addressed the classic method of staking in the previous paragraphs, in which a user immediately becomes a validator by holding a certain number of the blockchain’s native currency. This is not, however, the only way available. Even if you don’t have many cryptocurrencies in your wallet, you can stake them.

Using an exchange

Many well-known worldwide crypto exchanges, like Kraken, Coinbase, and Binance, allow users to stake cryptocurrencies with relatively low entrance requirements. The interest rate, which varies depending on the lockup duration, can range from 3% to 15% on average. Some cryptocurrency exchanges, such as HotBit, don’t even require locking: by merely storing any coin in their account, customers can earn 3-8 percent APY.

Joining a pool

Staking has been transformed by DeFi (decentralized finance), which now offers four-digit APYs. Generous gains, on the other hand, come with significant dangers. Scam farms exist, therefore do your homework before transmitting funds from your wallet to a new protocol, especially when dealing with newly announced projects and cryptocurrencies.

Becoming a validator

This alternative has already been discussed. To connect to the network, you must have a certain amount of coins in your wallet and run the necessary launchpads. Don’t forget about the hardware requirements: a smartphone won’t cut it; you’ll need a computer that can run the essential software.

FAQ: Frequently Asked Questions

What is cold staking?

This is a way of staking where your coins do not leave your wallet, for example, when you use cold storage in your hardware wallet. 

What is a staking pool?

Think of it as a depository where all coin providers’ coins are locked. When the lockup period ends, the funds get returned to the user’s wallet from the pool (or it can be done manually if there’s no deposit term). 

Is staking profitable?

It’s proven to be a more profitable option than traditional bank deposits. However, crypto staking comes with higher risks. 

Can I stake Bitcoin?

You cannot become a validator in the Bitcoin blockchain because it’s driven by the Proof of Work consensus mechanism. However, BTC staking is widely spread on DeFi protocols. 

What crypto is best to stake?

You should find the best cryptocurrency for staking by comparing reward rates, risks, coin price trends, lockup terms, and other factors.

 

Movine Oduor
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