What is staking in cryptocurrency?

Cryptocurrency staking is a yield-generating 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 essentially pledge those coins to the blockchain to help secure the network. In exchange for pledging their coins for network security, the user receives a staking reward which is generated from the fees validators earn by confirming transactions.

How does crypto staking work?

To stake on the blockchain, the crypto holder will need to have coins in a wallet which can be delegated to a validator. This means that the coin holder, or delegator, pledges the assets to the network to help secure the blockchain. When validators confirm transactions on the blockchain, the block reward is then paid out to validators by the network. Validators then share a portion of this reward with delegators who have pledged their coins. This is the wagering reward.

Why only certain cryptos have staking?

Not all cryptocurrencies can be staked on the blockchain to earn the block reward, as many cryptocurrencies operate on proof-of-work consensus mechanisms where block rewards are paid out to miners rather than stakers . Proof of Stake blockchains have staking capability, as staking is critical to blockchain security. Many of the top cryptocurrencies, both in terms of market capitalization and daily volume, run on Proof of Stake blockchains. Each of these cryptocurrencies are proof-of-stake chains that enabled bulk reward payments to staking participants:

Coins like Bitcoin (BTC-USD), Dogecoin (DOGE-USD), Litecoin (LTC-USD), and Monero (XMR-USD) live on blockchains that use proof-of-work consensus mechanisms and cannot be staked on the native chain.

What is proof of stake?

Proof of Stake is simply a type of consensus mechanism used by many notable blockchains. It differs from proof of work in that the block reward is not earned by computers solving complex mathematical problems, but rather by validators verifying transactions in exchange for block rewards from transaction fees. Proof-of-stake is generally considered to be more environmentally friendly than the proof-of-work consensus mechanism. This is because Proof of Stake does not require nearly the same level of electricity as is needed to power the computers that confirm transactions with Proof of Work blockchains.

There is a debate among notable players in the cryptocurrency market regarding proof of stake versus proof of work. Some believe that proof-of-stake will become more centralized over time if stakers do not distribute their staking delegations well enough. Others say proof-of-stake is the best way to decentralize blockchain validation because mining via proof-of-work requires expensive machinery that creates a high barrier to entry.

Learn more about Proof of work versus proof of participation.

What are the benefits of staking?

Staking can benefit the coin owner in several ways. If a cryptocurrency is relatively new or still has a high level of inflation, staking the coin and receiving a portion of the block reward can help the coin holder offset any supply dilution due to block reward issuances. This is especially important in a bear market when cryptocurrency prices are struggling. Staking helps the user to eventually earn a real return even if the price of the coin has gone down.

Staking can be beneficial in a bull market as it pays the user to sell coins through the reward. This way, staking can become a vehicle for passive income if coin prices increase while the staker is rewarded with the block reward. Direct staking on the blockchain can also provide other benefits such as airdrops. For example, in 2021, people who bet on Cosmos (ATOM-USD) were dropped Osmose (OSMO-USD) tokens.

What are the risks of staking?

There are several concerns regarding cryptocurrency staking that investors should be aware of before deploying any of their assets in a staking protocol.

• Unlock Periods

• Asset Control

• To cut

Depending on the blockchain where staking takes place, staking will often require coins to be pledged to a validator for a specific duration. This essentially limits the staker’s control over the assets during the period the coins are being staked. Another potential issue to consider when staking is validator selection. Fee rewards will vary depending on what each validator offers.

Another risk to consider when staking is validator selection. Malicious actor validators can experience something called slashing if they misbehave. Slashing occurs when the network community decides to punish a certain validator by burning or redistributing part of their stake for committing offenses on the network. These violations can be downtime or malicious activity. Some strings do not punish the delegator for the validator’s violation; 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 big commitment and requires reliable equipment and constant availability. For most, it’s probably easier to just 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 on-chain staking, keep staking minimums in mind as some chains have high minimums and other chains have no minimum staking requirements.

For cryptocurrency holders who do not custodian their coins themselves, staking can also be done through an exchange. Many exchanges offer these services within their platforms and charge a small fee to facilitate on-chain transactions on behalf of their clients. For example, Coinbase (PIECE OF MONEY) offers Ethereum staking as a service and has since become one of the largest depositors in the Ethereum Proof of Stake chain, along with Kraken and Binance (BSC-USD).

Conclusion

Staking is a way for cryptocurrency users to generate a return on assets they don’t otherwise use. The added reward of staking cryptocurrencies comes with some risk. It is important to know what you are getting into before determining 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 network security and to earn returns on coins.