The Beginner's Guide to Crypto Staking
Nov 22, 20227 min read
What Is Staking?
Most of all, staking resembles a bank deposit. But users do not transfer assets to anyone but freeze them on their accounts (on a wallet, an exchange, or a decentralized finance service). Maintaining a digital currency network that uses a Proof of Stake consensus algorithm is necessary. In simple words, staking coins means ensuring the security and operability of the cryptocurrency blockchain.
Staking is not only about your benefit but probably even, first of all, about projects. It helps achieve the consensus necessary to ensure the network’s security. The authenticity of each new transaction recorded in the project’s blockchain is also confirmed.
Staking Vs. Mining
Staking provides several advantages over traditional cryptocurrency mining. The difference is due to a different consensus protocol. Mining uses a Proof of Work consensus algorithm (the main representative is Bitcoin), and staking uses Proof of Stake (refers to Ethereum). The table shows other, less obvious differences:
Functioning by calculating cryptological tasks, the complexity of which constantly increases.
Stakeholders participate in the verification of new blocks by locking their assets in a smart contract. It does not require additional powerful computing equipment, so this process is much more environmentally friendly.
Mining requires special equipment that costs a lot of money (ASICs, powerful video cards, roomy hard drives). At the same time, a lot of electricity is consumed.
Minimal power consumption (there are even hardware wallets that do not need a permanent Internet connection). It does not require special equipment. It can be launched even from a smartphone.
Computing power will be crucial for mining. The higher it is, the more chances there are to be the first to find the answer to a mathematical puzzle, generate a block, add it to the blockchain, and receive a reward.
The priority is the number of native coins. The user with the maximum volume will likely be selected to add new elements to the blockchain and receive the reward.
The mining process requires constant user attention. You have to monitor the equipment and have the necessary knowledge for this.
Users with locked tokens are almost not involved in the mechanism of the PoS protocol. You don’t need to have programmer knowledge.
How Does Staking Work?
The whole mechanism of the staking looks like this. Distributed registries based on the PoS algorithm use a special type of nodes called validators to register transactions or generate new blocks of the chain. They perform the same role as miners in networks with the PoW algorithm. Only for work, not the computing power of computers is used, but the coins stored in the wallet.
The type of consensus influences the actions of the validator during sole staking, thanks to which the network security of a particular project is achieved, and blocks are checked. Namely PoS, LPoS, or DPoS.
To understand exactly how this works, we should start with PoW, although it is not applicable here.
In the PoW blockchain, new blocks are generated by solving mathematical puzzles. The reward for solving such a task and, accordingly, creating a block is coins. Therefore, coins are mined by miners, providing the issue of assets.
Similarly to this consensus, but with less energy consumption, Proof of Stake works. Here validators confirm the correctness of transactions. A validator can be a person or a group of people. They decide which block is correct and which is not. The chance to add a new block to the chain and get rewarded for it is proportional to the number of tokens that the validator locks for this purpose. In addition, other indicators can be taken into account, for example, the age of the stake. The reward is accrued when a new block is found. The rewards distribution principles differ for different coins and the interest rate. A platform offering staking services also play a role. In addition to monetary rewards, staking participants can receive certain privileges in the project, voting power, or other non-financial bonuses.
Since the chance to win the next block for verification (and receive a reward) directly depends on the number of coins in the user’s wallet, pooling may be beneficial.
In this case, the participants share the profit in proportion to the invested share. This method is convenient for novice validators with a small number of crypto assets, especially if the minimum staking amount is high enough. Well-known exchanges, such as Binance or Kraken, and independent decentralized projects have pools for staking.
- Sole. The entry threshold is very high. To become a validator, you will need your own server or a special wallet with an additional staking function. You also need basic technical skills to handle assets without problems and ensure their security;
- Exchange. Crypto exchanges act as providers, temporarily locking the users’ deposits and charging them a pre-agreed percentage. Some platforms do not even lock assets, leaving the opportunity to withdraw them at any time;
- DeFi. Assets locked on the DeFi platform ensure the operation of a specific financial system (a crypto exchange, a service for issuing loans, etc.). Profitability is high. Smart contracts at the heart of transactions reduce the risk of fraud and partially guarantee the safety of funds. Profit is accrued automatically.
In addition, staking can be classified by the type of plan:
- Fixed. It’s like a deposit without the possibility of withdrawal. You specify in advance how long you place the currency on the account. You won’t be able to withdraw it at any time. You get a fixed reward — as a rule, the interest rate is high. It reaches 20% per annum. This option is worth choosing if you do not need assets shortly.
- Flexible. You do not specify the period for the locking of tokens and can terminate it at any time. Interest is accrued exactly until the withdrawal of tokens. Such a plan is ideal if you are for flexible asset management and do not want to freeze them for a long time.
Where Can You Stake Coins?
Almost all major exchanges provide the possibility of staking. With this tool, traders increase the profitability of assets and diversify their funds — that is, they invest them in different cryptocurrencies to increase the security of the deposit.
To become a participant in the process, it is necessary to transfer cryptocurrency to the exchange wallet, navigate to the staking section, and determine the period for locking funds. Then it remains only to monitor the growth of your assets.
Please note that the annual return interest rate is a floating value and may vary depending on the market situation, the capitalization of the project, and other objective parameters.
- Crypto Wallets
Cryptocurrency wallets are multifunctional and multicurrency ecosystems that provide owners with the opportunity for additional earnings.
To stake coins, you need to create a crypto wallet, purchase crypto, select the staking option in the functionality, and lock a certain amount of funds, specifying the locking period.
- Staking Platforms
Special platforms for staking are mainly decentralized platforms that work in automatic mode. Smart contracts manage them. To participate in the staking, you must go through the registration procedure, get a wallet on the platform and top it up.
Many DeFi projects offer to stake their native tokens. You purchase the platform's currency, maintain its operability, and provide liquidity for other network participants.
How to Choose Cryptocurrency?
The most important criterion for choosing a coin is the interest rate. It shows the level of profitability of staking and depends on a combination of factors:
- The number of users in the network. The more of them, the smaller the percentage. The highest rates are for projects with a small capitalization, but the market risks are also high.
- Internal policy of the platform. Each validator has its rules and conditions: some require mandatory locking of assets, and others give users complete freedom — this is what almost all DeFi platforms do.
- The locking period. The longer the term, the higher the percentage.
- Type of staking. Fixed is estimated to be 10-20% higher than flexible because, in the first case, the user is guaranteed to leave the currency on the account for a specific period.
Staking Pros & Cons
- Passive income that requires minimal effort and costs.
- Low power consumption and environmental friendliness. Unlike mining, staking requires much less electricity.
- You do not need any special knowledge or skills.
- The threshold for entering this way of earning is quite low. You do not need to invest in expensive equipment and pay large electricity bills. To begin with, a small investment in the purchase of tokens is enough.
- It is believed that cryptocurrencies based on the PoS algorithm are much better protected from attacks. This reduces the risk for their owners and, consequently, for validators.
- The biggest risk factor is volatility. If an increase in the price of a digital currency significantly increases the profit from staking due to the higher value of coins, the opposite happens with a bearish trend. When your funds are locked, you cannot sell them correctly.
- The profit is relatively small. It does not exceed 15% per year for the most popular assets.
Considering all the facts, staking is a good option for additional income for people investing in cryptocurrencies.