What Is Staking?
By locking up coins to maintain the security of a blockchain network and receiving rewards in return, staking cryptocurrency has become a common approach for crypto investors to expand their holdings without selling their digital assets. However, crypto staking entails specific risks that can lead to a loss of funds.
Basics
Staking refers to a procedure where people lock their cryptocurrency (their "stake") to back up the security and operation of a blockchain network. By staking their coins, they contribute to securing the chain and confirming transactions on the blockchain.
Staking is feasible on blockchains like Ethereum and Cardano that rely on a Proof of Stake (PoS) consensus mechanism, unlike Proof of Work (PoW) used in cryptocurrencies like Bitcoin, where miners utilize computing power to authenticate transactions.
Staking coins makes users' assets less liquid since the coins get tied up in the staking process. Although individuals can typically still gain access to their staked coins, they may only be able to use them for other purposes once they are no longer staked.
Proof of Stake Consensus
The PoS algorithm uses a pseudo-random selection process to choose validators from a node group. The selection mechanism considers factors such as stake age, randomization, and the node's wealth. Each PoS cryptocurrency has unique rules and methods to create the best possible combination for the network and its users.
Unlike ASIC mining, which necessitates significant investments in hardware and energy to operate mining activities, PoS allows blocks to be generated without relying on specialized mining hardware.
In PoS, blocks are forged, not mined. Once a node is chosen to forge the next block, it validates the block's transactions, signs it, and adds it to the blockchain. The node then receives the transaction fees and, on certain blockchains, a coin reward.
When a forger node wants to cease forging, its stake and earned rewards are released after a certain period. This duration enables the network to verify that no fraudulent blocks have been appended to the blockchain by the node.
Producing blocks through staking is believed by some to enable a higher degree of scalability for blockchains. This is one of the reasons Ethereum has moved from PoW to PoS through a set of technical upgrades collectively called ETH 2.0.
How Does Staking Work in Crypto?
Crypto staking requires using a specific staking currency that is usually the native currency of the blockchain network. For instance, ETH is used to participate in the staking process on Ethereum. Similarly, new PoS blockchain networks introduce a new cryptocurrency as the staking currency. Users must acquire the specific staking coin to participate in the network.
There are various ways to stake cryptocurrencies, depending on the level of technical expertise, the amount of cryptocurrency to stake, and the preferred level of control. One option is setting up and maintaining a validator node on the blockchain, which offers the most control but requires technical knowledge and comes with the most responsibility. Another option is using staking-as-a-service platforms that allow users to delegate their stake to a trusted service provider who runs a validator node. This method offers a balance of control and convenience. Pooled staking is another option that combines the stake with other users.
Finally, some cryptocurrency exchanges offer staking services to their users, providing the most convenience. However, users should consider the exchange's security measures before staking their cryptocurrency on the platform.
Staking Pool
A staking pool refers to a group of cryptocurrency holders who pool their coins to increase their chances of being selected as validators. By joining a staking pool, users can combine their staking power and increase their chances of earning staking rewards. These rewards are distributed proportionally among each pool member based on their contribution.
Staking pools are particularly helpful for individual users who lack the resources or technical expertise to run their validator nodes. By delegating their staking power to a pool, they can earn rewards without running a node themselves. Additionally, smaller investors who do not have enough coins to meet the minimum staking requirements can also benefit from staking pools. By pooling their coins with other users, they can meet the requirements and start earning rewards.
However, it is important to note that staking pools usually charge a fee for their services, which is deducted from the staking rewards earned by users. Therefore, users should carefully research and choose a reputable staking pool with a strong track record of performance and security before joining.
The Advantages of Crypto Staking
Staking crypto has various benefits, including earning staking rewards and increasing liquidity. By participating in the validation process of a blockchain network, nodes are rewarded with cryptocurrency or transaction fees, allowing users to earn passive income without selling their holdings. Additionally, staking can help support network security by incentivizing validators to act in the network's best interest. Validators who act maliciously or violate the network's rules risk having their stakes confiscated, which deters bad actors from compromising the network.
Furthermore, staking can help decentralize the network by allowing anyone to participate in the validation process. This reduces the risk of a single entity controlling the network, which can harm its security. Another advantage is that staking is considered a more energy-efficient and environmentally friendly alternative to PoW mining as it requires less computing power to validate transactions and create new blocks.
Finally, some blockchain networks allow users who stake their crypto to have voting rights and influence the governance of the network. This allows stakeholders to propose and decide on protocol upgrades, changes, and improvements, giving them a voice in shaping the future direction of the network.
The Risks of Staking Crypto
When staking crypto, validators must conduct thorough research on the specific cryptocurrency and understand the risks and technical requirements of staking.
Firstly, there is volatility risk, where the value of the staked cryptocurrency can decrease rapidly due to market fluctuations, resulting in significant losses. Secondly, validators can face slashing risks in PoS networks for violating network rules, such as double-signing or going offline for long periods. This can result in penalties, including the loss of some or all of the staked coins. Thirdly, centralization risk may occur when a small group of validators hold a significant portion of staked coins, which can create centralization risks.
Additionally, technical risk can result in the loss of staked coins due to software bugs and other technical failures.
Lastly, lock-up periods require users to immobilize their coins for a predetermined time when staking their crypto. This can restrict immediate access to these coins, which may prevent them from selling their holdings quickly. This can lead to forfeiting potential investment opportunities or encountering an inability to respond promptly to price fluctuations.
How to Stake Your Crypto
To start staking your crypto, follow these steps:
- Choose a PoS cryptocurrency: Select a cryptocurrency that supports staking and obtain the required number of coins. Some blockchains may have minimum staking requirements that vary depending on the network.
- Set up a staking wallet: Choose a wallet that supports staking and is recommended on the blockchain's official website. Transfer your staking coins to your wallet using the network-specific instructions provided.
- Initiate staking: Refer to the official website of the selected blockchain for instructions on how to stake your coins. You can delegate coins to a validator node or run a validator node yourself. Follow the network-specific instructions carefully to avoid making errors.
Staking Rewards Calculation: How It Works
When it comes to staking rewards, each blockchain network has its unique way of calculating them. Some blockchains adjust the rewards considering several factors, while others offer a fixed percentage of rewards as compensation for inflation. Here are some factors that may affect the calculation:
- The number of coins being staked
- The duration for which the validator has been actively staking
- The validator's performance in fulfilling their responsibilities
- The total number of coins staked on the network
- Network transaction fees
- The coin's inflation rate
Inflation encourages coin usage, and staking rewards incentivize users to stake their coins rather than sell them. Validators on the network are rewarded with a fixed percentage of rewards as compensation for inflation. This approach provides a predictable reward schedule for validators, which may encourage more participants to get involved in staking. Blockchains provide network-specific instructions on how to stake and calculate rewards, which can be found on their official website.
Why Staking Is Not Available for All Coins
Only cryptocurrencies built on a PoS blockchain consensus mechanism can be staked. PoS allows users to secure the network by staking their cryptocurrency holdings, unlike PoW consensus mechanisms which require solving complex mathematical equations. It's impossible to stake cryptocurrencies built on PoW blockchain consensus mechanisms.
However, not all PoS cryptocurrencies support staking. Some PoS cryptocurrencies may have alternative mechanisms to incentivize users to support the network, such as Delegated Proof of Stake (DPoS), which may not involve staking in the traditional sense.
To ensure a successful staking experience, it's crucial to research the specific cryptocurrency and understand the staking requirements and rewards.
Conclusion
As staking crypto becomes easier, it presents a convenient opportunity to earn rewards by holding digital assets while participating in the maintenance and governance of blockchains. This lowers the entry barriers to the blockchain ecosystem and opens up more avenues for enthusiasts. However, staking isn't risk-free, as smart contracts that lock up funds can be susceptible to bugs. Therefore, it is crucial to conduct thorough research and use highly secure wallets.