By Isaac Francis
What does Crypto staking mean? Is it a smart way to earn passive income? Are there any risks that come with staking? What do you need to get started with staking?
What is Crypto Staking?
Like everything in the crypto space, staking can be a little complicated.
Staking is a way to earn rewards for holding certain cryptocurrencies. But even if you’re only interested in earning passive income from staking, it’s still important you know a little bit about staking and how it works.
How does Crypto Staking work and should you be involved in it?
If you own digital assets like Cosmos, Tezos, and Ethereum (through the new ETH2 upgrade) that allows staking, you can stake some of your digital assets or all of it and earn a percentage reward over time.
Staking usually happens through a staking pool, which is pretty similar to an interest-bearing savings account.
If you’re wondering why your staked crypto earns you a reward while being staked, it is because the blockchain puts your locked crypto to work. Majority of the cryptocurrencies that allow staking deploy the consensus mechanism called Proof of Stake. This unique consensus mechanism ensures that all transactions on the network are verified and secured without a payment processor or bank acting as intermediaries.
Once you stake your cryptocurrencies, it becomes part of the process of ensuring that the network works optimally.
Why do only a few digital assets allow staking?
Wondering why only a few cryptocurrencies allow staking? Well, this is where things get a little complicated. For instance, Bitcoin doesn’t allow staking, and to understand why, we will give you a little background.
- First off, cryptocurrencies are decentralized by nature. What this simply means is that there is no central authority calling the shots. Now, the big question is, how then do all the computers in a decentralized network like Bitcoin and Ethereum arrive at the same answer without being fed by a central authority like a credit card company? Well, it’s simple, they use what’s called a consensus mechanism.
- Many digital assets including Bitcoin and Ethereum 1.0 are popular for using the Proof of Work consensus mechanism. Through the Proof of Work consensus mechanism, the network leverages a huge amount of computing power to solve problems, including validating transactions and making sure no party spends the same amount of Bitcoin or Ethereum twice. This process also involves miners all over the world competing to solve different cryptographic puzzles. Whoever solves the cryptographic puzzle earns the right to add the latest block of verified transactions to the blockchain. Plus, the winning miner also gets some crypto in return.
For the Bitcoin blockchain which functions pretty much like a bank ledger that keeps track of incoming and outgoing transactions, its Proof of Work consensus mechanism offers a scalable solution. But for a complicated blockchain like Ethereum, which has a variety of dApps including DeFi running on its blockchain, its Proof of Work consensus mechanism can result in bottlenecks because of too many activities taking place. To this end, transaction times can be quite longer along with insane transaction fees.
Understanding Proof of Stake
Proof of Stake is a newer consensus mechanism, being leveraged by a number of cryptocurrency projects. This consensus mechanism aims to increase transaction speed and efficiency while lowering transaction fees.
One of the major ways the Proof of Stake Consensus mechanism reduces cost is by not requiring miners to solve cryptographic problems, which can be energy-intensive. Instead, this consensus mechanism allows transactions to be validated by users who invested in the blockchain through staking.
- Just like mining, staking serves a pretty similar function, especially considering that the process involves network participants being selected to add the latest batch of transactions to the blockchain. For their services, they are rewarded with some cryptocurrency.
- Though the exact implementation of the Proof of Stake consensus mechanism can differ from project to project, the crux of the matter is that the Proof of Stake consensus mechanism requires users to stake their tokens in a staking pool, to add a new block to the blockchain in exchange for a reward. What this simply means is that their staked tokens act as a guarantee of legitimacy for new transactions added to the blockchain.
- Every crypto project that uses the Proof of Stake consensus mechanism chooses validators based on the amount of their stake and the timeframe they have held. This means the most invested users are rewarded. If the network discovers that new transactions added to the blockchain are invalid, users can have some of their staked tokens burned by the network, through what is referred to as a slashing event.
What are the benefits of crypto staking?
Many crypto enthusiasts see staking as a brilliant way to put their digital assets to work for them as it earns them passive income, instead of just allowing their cryptocurrencies to sit idle in their crypto wallet.
More so, staking helps provide security and guarantees the efficiency of the blockchain projects you’re involved in. By staking some of your cryptocurrencies, you’re contributing to the security of the network and ensuring that it is resistant to attacks. Also, it strengthens its ability to process transactions quicker.
Some projects in the crypto space that use the Proof of Stake consensus mechanism also award governance tokens to users for staking their tokens. These governance tokens give holders a say on any future changes or upgrades to the protocol.
Are there any risks that come with crypto staking?
We get asked this question a lot and today, we would like to set the record straight. Staking usually requires asset holders to lock up their digital assets in a staking pool. During this time, you can’t transfer your assets for a certain period of time. This can be a huge drawback as you aren’t allowed to trade your staked tokens, even if the price rallies. So before deciding if staking is for you, take a minute to go through the staking requirements and rules for each project you’d like to join. This should give you some pointers on what you should expect. This way, you know what you are getting into and ready for the outcome.
How can I get involved in crypto staking?
When it comes to staking, there is no barrier to entry as it is open to anyone who wants to participate. However, to become a full validator, you’ll need to own a substantial minimum investment. On ETH2 for instance, you need to have a minimum of 32 ETH to become a validator. More so, you’ll need to have a bit of technical knowledge and a dedicated computer you can deploy to perform validation day and night, non-stop.
When participating at this level, keep in mind that it requires security consideration and a serious obligation as any downtime can result in a validator’s stake being slashed.
Nonetheless, for many staking-based cryptocurrency projects, it is pretty easy to take part as many of the projects only require individuals to contribute an amount they can afford to a staking pool. The thing with this type of project is that you earn rewards according to your stake in the general staking pool.