What is Cryptocurrency Staking?
Most people interested or invested in crypto will have heard the term “cryptocurrency staking”, but not everybody will understand what it is and how it works. To put it simply, staking allows investors to earn rewards by locking up their crypto coins or tokens for a set period of time.
While staking can be an excellent option for those interested in earning passive income, it also has the added benefit of helping to secure the blockchain and verify transactions.
What is Proof of Stake?
Proof of Stake (PoS) is a method by which some blockchains process transactions. Blockchains employ a variety of methods (called consensus mechanisms) to remain decentralised and ensure that transactions are legitimate.
For example, Bitcoin uses a Proof of Work (PoW) consensus, which requires participants – or node operators – to solve complex computational problems in order to validate transactions. The person that does this first is given the opportunity to create the next “block” in the blockchain.
Bitcoin, alongside other PoW networks, has been criticised for its high energy usage. Some of this is caused by the amount of computational power being used as people compete to solve the equation quickly. Proof of Stake blockchains are typically much more energy efficient than Proof of Work blockchains.
On a PoS network, those interested in verifying transactions will offer an amount of the network’s native cryptocurrency as collateral. Those that deposit, or stake, their cryptocurrency coins or tokens are entered into a lottery to validate the next block in the chain. Typically, validators are selected at random, avoiding the need for competition.
Successful validators will be rewarded with a set number of new cryptocurrency tokens as a result.
How Does Staking Work?
As mentioned above, staking works by allowing investors to “lock up” their crypto assets to maintain the security of the network. This will work slightly differently for each network, although the underlying process is usually very similar.
Although staking works by randomly selecting validators, it is often the case that larger contributors – those that choose to stake larger amounts of tokens – will have a better chance of being chosen. Therefore, it can be very difficult for one individual to access staking rewards.
Instead, investors will often need to utilise a “staking pool”, which is a collection of funds that have been contributed by a number of different crypto holders. Those that have added their crypto tokens to the successful staking pool will receive a share of the rewards as a result.
For some blockchains, investors will need to lock up a minimum number of tokens for a set period of time. This will depend on the blockchain in question; some networks will allow you to stake as little as one token for any length of time, while others will have considerably higher requirements.
Which Cryptocurrencies Can Be Staked?
Any cryptocurrency built on a Proof of Stake blockchain can be staked. Ethereum is one of the world’s most popular cryptocurrencies that uses a PoS consensus mechanism, although there are plenty of well-known, stakeable currencies.
Ethereum
Ethereum was originally designed to be a Proof of Work blockchain. However, in September 2022, an event referred to as “The Merge” saw Ethereum transition from PoW to PoS. From this point onwards, Ethereum users were able to stake ether (ETH) and receive rewards for doing so. Interestingly, it was only after the “Shanghai Upgrade” in April 2023 that stakers were able to unstake their ETH tokens.
Staking ETH also has a fairly high barrier to entry, with validators being required to stake a minimum of 32 ETH in order to participate. As of February 2024, this would be more than £60,000. This means that a lot of retail investors – individual or non-professional investors – are priced out of the opportunity to help secure the Ethereum network.
Solana
Solana is actually different to other Proof of Stake networks, in that it uses a unique combination of Proof of History (PoH) and Dedicated Proof of Stake (DPoS) consensus mechanisms. The former involves using timestamps to verify the legitimacy of a transaction, which is one of the reasons that Solana is so fast, while DPoS allows network users to vote on which validators will validate the next block, rather than relying on a lottery system.
Staking rewards for Solana depends on a number of factors, including the cryptocurrency’s current inflation rate, the total amount of SOL tokens that are staked, and a validator’s commission. Unlike the Ethereum network, Solana does not need individuals to stake a minimum amount of SOL, although some third-parties have implemented minimum staking requirements.
Cardano
Cardano is also one of the most popular Proof of Stake networks, although it was not always possible to stake ADA tokens. During Cardano’s “Shelley Era“, a specific period of time in which the network focused on increasing its decentralisation, the ability to stake ADA was initialised.
ADA holders are able to either join or run a staking pool, and it is possible to calculate Cardano staking rewards on the Cardano website. As with Solana, there are no minimum staking requirements, although the rewards received for helping to validate transactions will depend on the amount of ADA that has been staked.
How To Stake Crypto
Typically, investors will be able to start staking crypto by purchasing their chosen asset. Decide which cryptocurrency you would like to stake, and find a reliable crypto exchange on which to purchase it. Remember, only cryptocurrencies associated with Proof of Stake blockchains will be eligible for staking.
Some exchanges will allow investors to stake directly on their platform. For example, it is possible to stake on Coinbase, although only certain assets are eligible, and Coinbase takes a percentage of all staking rewards.
For the most part, investors will need to transfer their tokens to a wallet in order to start staking. There are different wallets available, but investors will need to set up a hot wallet, meaning a wallet that is connected to the internet, in order to use it to stake. Use your wallet’s unique address to transfer your cryptocurrency from the exchange to the wallet.
Find a staking pool that is suitable for you. Look for a reliable staking pool that has significant uptime, because it is not possible to earn staking rewards when the pool’s servers are down. Check the fees or commission associated with the staking pool, and decide which size pool you are interested in. Typically, larger pools are more likely to be chosen to validate blocks, but smaller staking pools will often generate larger rewards.
Once a staking pool has been chosen, investors will need to use their cryptocurrency wallet to start staking!
Advantages of Staking Crypto
There are plenty of advantages to crypto staking. Understanding the benefits of staking your cryptocurrency can help to make the decision to stake easier, and so some of the key advantages are broken down in more detail below.
Passive Income
Cryptocurrency is a particularly volatile asset class, meaning that prices are prone to very sudden and significant swings. Although this is one of the main reasons that investors are interested in crypto, it also makes it an incredibly risky investment.
Staking crypto allows investors to earn passive income on their investments, regardless of price swings. Although the rewards for staking will vary depending on the network, it is not uncommon to see annual returns of up to 20%, far surpassing the average annual percentage yield (APY) of a traditional savings account.
Crypto staking is a truly passive method of income; once crypto tokens are locked away, rewards will be generated until they are unstaked, regardless of price movements.
No Equipment Requirements
Unlike Proof of Work blockchains, which require individuals to invest in expensive, energy-intensive mining equipment, there are no such requirements on Proof of Stake networks. It is often possible to stake cryptocurrencies with nothing more than a phone and a crypto wallet.
Environmentally Friendly
Although the overall goals, namely blockchain security and transaction validation, are the same, Proof of Stake blockchains have the added benefit of being far more environmentally friendly than Proof of Work networks. This is because staking does not require significant computational power in the same way that crypto mining does.
Beneficial For The Blockchain
Although cryptocurrency staking allows investors to earn passive income, it is also incredibly beneficial for the associated blockchain. Staking directly contributes to the efficiency and security of a blockchain, enabling better transaction processing and increasing the network’s resistance to malicious attacks.
Although many cryptocurrency investors are interested in the space for the profit-related reasons, there are many who believe crypto to be the future of finance. If this is the case, it is an added bonus that projects will benefit from the staking of their native cryptocurrency.
Risks of Staking Crypto
Although there are numerous advantages to staking cryptocurrencies, it is not without its risks.
Lockup and Unstaking Periods
Most cryptocurrencies will have minimum lockup periods. This can range from a matter of days to several months, and during this time it is impossible to move, or even access, your crypto tokens. Although this is not dissimilar to some traditional finance (TradFi) savings accounts, it is important that investors consider this before locking up their funds.
A lot of Proof of Stake networks will also have unstaking periods. Even if an investor is able to stop staking a cryptocurrency, it will likely be subjected to an additional period of time over which the unstaking will occur. This could be minutes, hours or days.
Cryptocurrency Volatility
Cryptocurrency is subject to significant volatility, and prices can rise or fall incredibly quickly. When staking, investors are not able to immediately take advantage of price increases or quickly reduce the size of their position. This makes cryptocurrency staking less suitable for short-term traders, and is probably best left to those interested in crypto as a long-term investment.
Technical Knowledge is Required
Although relatively straightforward, there is some technical knowledge required by those interested in staking crypto. For the most part, it is essential to own a cryptocurrency wallet and understand staking requirements. While some crypto exchanges make it possible to stake directly on their platform, this is not the case for every Proof of Stake cryptocurrency. In these instances, users will need to set up a wallet and understand the staking process, which may differ depending on the network and cryptocurrency in question.
Network Risk
Cryptocurrency is still a very new industry compared to many traditional alternatives. While blockchain technology is inherently secure, not all projects or networks are equal in this regard.
There are, unfortunately, some malicious players within the space, and so it is important to conduct thorough research into a project before purchasing and staking a cryptocurrency. Typically, the larger the cryptocurrency by market capitalisation, the more reliable it will be. However, this is not always the case, as seen by the Terra (LUNA) crash in 2022, during which time the cryptocurrency lost more than 99% of its value in a matter of days.
Conclusion
Cryptocurrency staking is a useful method for generating passive income, helping to secure a blockchain network, and getting more involved in different crypto projects. Although there are risks attached to staking, as well as cryptocurrency in general, it is a relatively straightforward process that can be mutually beneficial for investors and blockchain projects alike.
FAQs
Why Can’t All Cryptocurrencies Be Staked?
Only cryptocurrencies that are built on Proof of Stake blockchains can be staked. All other cryptocurrencies, including bitcoin (BTC), use a different method for validating transactions, and so cannot be staked.
Is Crypto Staking Legal?
Crypto staking is legal, although it is important to understand that cryptocurrencies are largely unregulated. Check the specific legislation where you live to understand what protections, if any, are in place for staking. Staking rewards are also subject to capital gains tax in the same way that profits from other investments are, so investors should take this into account when deciding to start staking.
Is Cryptocurrency Staking a Good Idea?
In theory, staking cryptocurrency is a good idea; it can provide investors with passive income and help to secure blockchain networks. However, there are many risks associated with staking, and so investors should consider whether staking – or cryptocurrency in general – suits their specific risk-profile and overall investment goals.
