What Is Staking in Crypto & How Does It Work, Exactly?

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Staking crypto is a relatively new concept in cryptocurrency. Investors have taken advantage of this recent development in the financial product space as a means to generate passive income from their digital assets. Crypto staking involves locking up digital assets, usually for a certain period of time, in what’s known as a ‘stake’ to earn rewards.

In both traditional and digital finance, many people simply hold their financial assets in a bank or digital wallet, but staking enables these assets to generate additional yield or rewards. It is a way to put your assets to work. Rewards can be earned from blockchain fees, platform fees, token emissions or a combination of all. In some instances, these rewards can be incredibly lucrative for savvy investors, although higher yields are often more risky and less likely to last long term.

Remember, if the yields offered seem too good to be true, they probably are.

What is staking in crypto?

Staking in crypto requires investors to lock up some assets, and in return they receive rewards, giving them a passive income stream. There are two main activities that are referred to as staking in crypto.

The main form is staking to secure and validate a Proof-of-Stake (PoS) blockchain. A blockchain is a distributed ledger of information that is stored across many different computers, known as validators, on the same network. Every time a certain amount of information, or transactional data, needs to be stored, it is added in a ‘block’ on top of the previous ones. In return for their service, the validators are rewarded with the fee revenue from the transactions on the chain.

To become a validator on a PoS blockchain, an individual must lock up an amount of the platform’s native token, known as a ‘stake’, in a specific type of validator software. The ‘stake’ is required as it adds security by stopping a bad actor from creating a large number of their own private validators to take over the blockchain in a malicious way. For those who do not have the capital or technical know-how to set up a validator, many PoS blockchains offer ways to ‘delegate’ your tokens to an existing validator in order to earn passive income, even using a small investment.

Another more common activity that is also sometimes referred to as staking is locking DeFi tokens on specific platforms in order to earn rewards. These rewards are often a combination of platform revenue and token emissions. This form of staking is often referred to as farming.

This type of staking typically offers higher levels of ‘yield’ than the form of staking outlined above. However, it’s important to remember that this yield is often bolstered by token inflation. This means the platform is essentially ‘creating’ more tokens to pay the rewards, which adds sell pressure to the token and increases the circulating supply. This can lead to downward pressure on price. Investors should be aware of this when participating in farming, as many investors have seen the value of their staked position fall massively while chasing high yields.

How does staking work?

Staking crypto requires investors to use a Web3 wallet and interact with validator software and/or smart contracts on decentralised finance (DeFi) platforms. Web3 wallets, such as Metamask, allow users to take their assets off centralised exchanges and custodial wallets to manage the assets themselves. Doing this opens up a whole realm of options for investors to participate in staking and DeFi.

Once an investor has loaded some assets into a Web3 wallet, they can begin to explore their options for staking. For native assets of a Proof-of-Stake chain, such as ETH, SOL and ATOM, the investor must decide whether they wish to run their own validator or just delegate their assets to an existing validator. Setting up a validator does require a much larger stake and some technical experience.

It will, however, result in a slightly higher yield and will help to decentralise the blockchain further. For those who choose to just delegate their stake to another validator, this can often be done through a specific wallet or platform. This option does reduce the potential yield but is much easier to partake in.

For DeFi tokens that are native to a specific platform, it is important to see if there are any staking options available at all, and if there is, what they are. For this type of staking, or ‘farming’, it is important to check where the rewards are coming from. If you are required to lock up a stake of token X in order to earn more token X, then be mindful that it is likely that the platform is using platform emissions to pay stakes.

This puts increased sell pressure on the token and dilutes current token holders, which could affect the value of your stake. While high yields can be very tempting, the risk is always higher and there is always potential for investors to lose money, even with the high yield.

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Why don’t all cryptocurrencies have crypto staking?

Not all cryptocurrencies have staking opportunities. Cryptocurrencies that do offer staking are generally PoS blockchains which require staking to validate the transactions on the chain. Some DeFi platforms allow their native token to be ‘staked’ on the platform to earn fees and/or token emissions. This is platform specific, however. Proof-of-Work (PoW) blockchains, such as Bitcoin, do not offer staking as they use computer hardware, known as ‘miners’, to validate the transactions on the chain.

What cryptocurrencies have crypto staking?

Some cryptocurrencies that offer staking include Ether (ETH), Solana (SOL), Cosmos (ATOM) and Tezos (XTZ), although there are now many other cryptocurrency projects that offer staking. Staking strengthens a project’s network, and many companies now enable the process and provide rewards as incentives to participate. If you are holding assets that can be staked, you may want to consider putting them to work via staking. Put simply, staking digital assets can be thought of as similar to putting them in a high interest savings account with a minimum deposit period.

Staking Ethereum

Thanks to the upcoming upgrade to the Ethereum blockchain, staking is now available for ETH. The Ethereum chain will move to PoS after the upgrade, known as ‘The Merge’. Staking Ethereum solo is not the easiest task for the uninitiated. The PoS consensus mechanism, which will be taking over from the old PoW system, utilises validators that are activated by locking up, or staking, some ETH in return for a portion of the transaction fees from transactions. In preparation for this change, staking ETH is now possible. To run a validator (the name given to software that is responsible for adding new blocks to the blockchain), you must lock up a stake of 32 ETH and run a reasonable hardware setup. There are also other staking methods that don’t require you to put so much money down in advance.

If you would like to participate in validating the Ethereum network and earning some rewards in return, there are staking providers such as Rocketpool and Lido that will stake your ETH for you and distribute the rewards after taking a small cut. However, you must always be aware that staking never provides a guaranteed return and these options always come with their own unique set of risks.

What is Proof-of-Stake?

Proof-of-Stake (PoS) is a consensus mechanism that some blockchains use to validate the transactions on the chain. PoS requires a certain amount of the blockchain’s native asset to be locked into a program that activates validator software. The stake is required as it ensures that one individual cannot set up a massive number of validators to try and take over the blockchain without an enormous amount of capital.

The PoS consensus mechanism differs from Proof-of-Work (PoW) as it does not require extensive computer hardware and energy usage to validate the blocks in the chain. This makes the blockchain more environmentally friendly while also making the barrier to entry for validators much lower. In turn, this allows for more validators to enter the network, further decentralising the blockchain and increasing the security and capacity for transactions.

Advantages of crypto staking

There are many advantages for investors looking to take part in staking crypto. The main advantage is the yield generated from existing assets, creating a passive income stream. If the investor’s stake is substantial and the token’s value remains relatively stable, this can be a substantial source of income. Being involved in staking for a PoS blockchain also assists in securing the blockchain, especially if the investor is running a validator themselves. Staking on PoS chains is advantageous in many ways, including increased decentralisation, security and potential capacity, and drastically reduced energy consumption when compared to PoW consensus.

Risks of crypto staking

As with all investments, crypto staking has its own unique set of risks. Cryptocurrencies and digital assets are a relatively new investment class, so extreme volatility is to be expected. Decentralised finance is an even newer innovation that exposes investors to technical, code-based risks. So, if you cannot audit the software or smart contracts you are using for staking, then you cannot be sure of the risk of a malicious attacker exploiting your funds.

Staking involves ‘locking up’ your assets, which introduces another risk — the inability to sell quickly if necessary. If something were to go wrong with the project, or if you needed the funds quickly, your assets may not be available to sell immediately. You can end up waiting for a significant period of time until your assets are released from the staking contract. This is something to consider when deciding if staking is right for you.

How to get started with crypto staking

Staking crypto can be as easy or as complicated as you would like it to be. If you have decided you would like to try staking, you need to decide what asset you would like to stake (making sure it can be staked at all, of course) and how you would like to stake it. There are three main options when it comes to staking:

  • Staking yourself by setting up a validator
  • Delegation staking or staking via a staking pool
  • Staking on an exchange

The first option is for those who wish to take part in validating the PoS blockchain they have chosen to stake with and are happy to take on an increased level of difficulty in order to (potentially) earn a slightly higher reward than the other options.

The second option, which is the most popular, is for those who have taken control of their own assets in a Web3 wallet and are comfortable with delegating assets or depositing them into DeFi staking pools.

The third option is best for those who wish to keep their assets on an exchange and let the exchange do the hard work. Only some exchanges offer staking and it is important to note that the exchange will generally charge a fee for this service.

After all that: what is crypto staking? Crypto staking is a way to put your assets to work by locking them up, allowing investors to create a passive income stream from their investments. Staking doesn’t need to be complex, but before deciding if staking is right for you, it is important to consider all the risks.