Staking is the process of locking up a specific amount of crypto in the blockchain. While your funds are staked, you can’t use them for trading or buying assets.
If you want to earn cryptocurrency without the stress and risks of trading, you can try staking your crypto to earn rewards. When you stake crypto, you agree to lock up a specific amount through a smart contract. This means you won’t be able to trade or use this staked crypto to buy other assets for a certain period of time. While your crypto is staked, it is used to help secure the network and validate transactions, and in return, the network rewards you with additional cryptocurrency.
It’s similar to what happens when you deposit money in the bank. The bank uses those funds to generate income. In return for allowing the bank to use your money, the bank pays you interest in exchange for trusting them with your funds.
Similarly, when you stake your cryptocurrency, the blockchain uses your staked crypto to validate transactions, secure the network, and ensure that everything runs smoothly. Just like the bank, the blockchain network benefits from the use of your assets, and in return, it rewards you with additional cryptocurrency. The main difference is that with staking, you also contribute to the security of the network.
Cryptocurrencies that offer staking options include Ethereum, Cardano, and Polkadot.
Staking is made possible by the Proof-of-Stake (PoS) consensus mechanism. A consensus mechanism is a set of rules the network uses to record new data on the blockchain. To get a chance to validate the next block of transactions and receive a reward, you need to “stake” or lock up some of your crypto.
Let’s take Ethereum, one of the most popular blockchains using PoS. To be selected to validate new blocks, you need to stake a minimum of 32 ETH — an amount larger than what most users can afford. However, even if you don’t have enough crypto to become a validator, you can still stake a small amount of crypto through a staking pool. In a staking pool, your smaller amount of crypto is combined with the crypto staked by other users until the pool reaches the minimum staking requirement. You all share the rewards proportionally to what you have staked.
Although Proof-of-Stake is the most common mechanism for staking, it’s not the only one. Some blockchains use variations of PoS, such as Delegated Proof-of-Stake (DPoS) or Nominated Proof-of-Stake (NPoS). For example, in a Delegated Proof-of-Stake (DPoS) system, you don’t need to stake directly to participate. Instead, you can delegate your tokens to a trusted validator, who then stakes them on your behalf. This allows you to earn rewards without directly locking up your crypto, though you still receive a portion of the rewards.
However, staking doesn’t work in a blockchain that uses completely different consensus mechanisms, such as Bitcoin’s Proof-of-Work (PoW) which requires miners to solve complex cryptographic puzzles, or Proof-of-Authority (PoA) which selects users to add the next block based on their reputation in the network.
Staking has become popular for several reasons. First, it’s an easy way to earn crypto without being actively involved in trading. Once your crypto is staked, you continue to earn rewards as long as it remains locked in the network. Second, it helps keep the blockchain secure by letting you participate in the blockchain consensus process. Third, it doesn’t require you to use advanced equipment, which can be very expensive. Finally, staking is also energy-efficient and eco-friendly compared to mining in PoW systems since it does not require powerful computers to solve complex puzzles.
The main disadvantages of staking are volatile crypto prices, long lockup periods, and security risks.
Volatile Prices: Although staking lets you earn more of a certain cryptocurrency, the value of that cryptocurrency can fluctuate during the time that your funds remain staked. Imagine you’re staking a new crypto called “CryptoX” in exchange for an annual return of 5% in additional “CryptoX.” However, while your tokens are staked, the price of “CryptoX” drops by 20%. Even if you earn more tokens by staking, the total value of all your coins is lower than what it was when you started. If you had chosen to trade your “CryptoX” tokens instead of staking them, you would likely not have suffered a loss.
Lockup Periods: Some staking programs require you to lock up your funds for a certain period, which can range from weeks to months or even years. During this time, you cannot use your funds to buy or trade.
Security Risks: When you stake your assets, you often transfer them to a staking contract or third-party platform, which means you no longer have direct control over them. The safety of your staked assets depends on the security of the platform. If it gets hacked, you can lose your staked crypto.
Staking is a simple and low-risk way to earn passive income, but it’s important to understand both the benefits and the risks involved. By carefully considering the pros and cons, you decide whether staking is the right strategy for your crypto investments.
