What is staking and how does it work?

When it comes to earning with cryptocurrencies, investors usually consider buying prospective assets or mining them. However, there is an alternative option that should be considered even by beginners: staking crypto. In this guide, you will find out how staking in crypto works, what sort of technology lies at the core of this method, the cryptocurrencies supporting it, and ways to stake them.

What is Staking?

This is the process of holding cryptocurrency and locking it in order to earn rewards or interest. In blockchains, transactions are verified in different ways called consensus mechanisms, and staking is one of the approaches for validating those operations. Depending on the type of blockchain network, various validation processes are applied, with Proof of Stake and Proof of Work being the most commonly used ones. 

In many blockchains, a consensus is achieved thanks to network participants. That’s where staking comes in: investors holding the native cryptocurrency participate in the process by approving and verifying operations in the blockchain. 

For doing so, they get staking rewards in the form of the native token. Hence, crypto staking is similar to making a bank deposit where the depositor earns interest. 

How Does Crypto Staking Work?

Staking is a source of passive income because all it requires is holding cryptocurrency in a wallet (except for DeFi staking where coins are locked in a liquidity pool). The network exploits these holdings to enable block generation. The protocol randomly chooses the user to validate the next block, but the more coins are locked, the higher the chance. 

From the investor’s standpoint, it works the following way:

• A user stakes (locks) tokens.
• Data in the coins’ blocks helps the network validate the next ones. 
• The coin holder gets rewarded for this participation.

Why do only some cryptocurrencies have staking?

To help you understand why some cryptocurrencies like Bitcoin cannot be staked, we need to go into technical details:

• As was previously mentioned, decentralized networks feature different sorts of consensus mechanisms. All of them are aimed at unbiased transaction validation, but only Proof of Stake and Delegated Proof of Stake blockchains enable this sort of block generation and rewarding method. 
• Many cryptocurrencies, including Bitcoin and Ethereum 1.0, rely on Proof of Work consensus mechanisms. To enable transaction verification, PoW networks fetch resources generated during the mining process. This involves making complicated cryptographic calculations. The miner who solves the puzzle first is given the right to add the latest block of approved transactions and receives a crypto reward in return. 

For simple blockchains like Bitcoin, the PoW mechanism is enough to process transactions. But it’s not scalable enough for more complicated blockchains, such as Ethereum, which fuels DeFi applications and millions of transactions daily.

Benefits of staking crypto

While crypto trading and investing have a steep learning curve and come with risks, staking has proven to be a simpler and relatively safer option. It benefits both the network and the contributor: holders’ funds reduce the blockchain’s vulnerability to attacks and boost its processing capability. In return, the asset holder receives profit without physically doing anything.

• Generation Of Passive Income. To reap a reward from staking, a person does not need to manually approve transactions; the network does it by fetching the necessary information from previously generated blocks. All it takes is buying or depositing crypto holdings in one’s wallet and keeping them locked. 
• Low Entry Fees. Although classic (non-DeFi) staking requires participants to own a pretty large amount of tokens (for example, 32 ETH for Ethereum blockchain), operational fees are low and can pay off in a few days, if not earlier. Today, even Ethereum gas fees can be around $10-15 at a time of low network activity. “Before you decide to lock your assets, learn about the minimum staking requirements and transaction fees on a particular blockchain. That will help you define whether this option is affordable at all.”
• Permissionless. While staking comes with a financial entry threshold, theoretically anyone can be a staker. Being a purely decentralized network, a PoS blockchain does not have requirements to the user’s location, devices used to access the wallet, or online activity. All it takes is buying and keeping coins. 
• More Energy Efficient Than Mining. As opposed to mining, staking requires fewer resources. Crypto holders don’t need to install costly mining hardware and bother about GPU/ASIC maintenance. Besides, it’s a more eco-friendly option that doesn’t require much energy for scalability growth. 

Risks of staking crypto

So far, none of the existing consensus mechanisms is perfect, including Proof of Stake. Network participants face the risks connected with the performance and security of staked crypto assets. Although it’s unlikely that one day you can wake up and discover your wallet is empty or non-existent, there are still a few things to be aware of.

• Market Risk. Cryptocurrencies are volatile: a 10% or 20% price swing over a day is a common occasion. So you have to track these changes and rethink your investment strategies if the market suddenly catches a downtrend. 
• Liquidity Risk. Sometimes, staking requires you to lock your assets for a particular period. During this time, you won’t be able to withdraw or sell your coins. The unstaking process also may take seven days or longer. That also means that you won’t be able to sell your crypto immediately if a bear market strikes.

Mining Vs. Staking: What Is The Difference?

Both approaches to transaction validation have pros and cons for the networks and their participants. In any case, you will need an initial investment, either on mining hardware or on the assets to be locked. Here’s a comparison table to help you choose and make an informed decision: 

• Staking (Proof of Stake) Mining (Proof of Work)
• The user’s validating capacity is defined by the number of coins staked in the network. The miner’s capacity depends on the equipment’s computational power.
• Stakers are not given block rewards but get transaction fees instead. Miners get block rewards for performing complex computations (solving mathematical puzzles). 
• To get control over the network, hackers need to own at least 51% of all the cryptocurrency in the network. That makes hacking practically impossible. Hackers need to have more than 51% of the network’s entire computational power to release a malicious block. 

What is Proof of Stake?

Proof of Stake (PoS) is a blockchain consensus mechanism where 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 more coins the validator has staked, the more weight his vote will have when proving the bet. For locking their assets and providing services to the blockchain, validators receive a reward in the form of new coins from the network.

In the PoS protocol, to become a network node (validator), you need to keep a certain number of coins in your wallet. This number depends on the network. Also, PoS blockchains have an inflationary mechanism, and payments to validators or network participants are made due to this inflation.

What is Delegated Proof of Stake (DPoS)?

DPoS enables users to use their coins as votes with voting power depending on the amount of cryptocurrency owned. These votes serve to elect delegates who manage the network and maintain its safety. As a rule, staking rewards are distributed over delegates who send them to electors proportionally to their activity and contributions. 

DPoS was designed to achieve consensus with fewer validators without hurting network performance. However, that means a lower level of decentralization because of the smaller group of validating nodes.

What is Proof of Work?

With the Proof of Work algorithm, new blocks are generated by solving mathematical problems. The reward in the form of cryptocurrency is given for making these calculations and, accordingly, creating a new block. The miner who solves the riddle first is given the right to release the block. 

In the PoW consensus, the complexity of mathematical puzzles keeps growing, which requires more and more computational power. For example, Bitcoin mining difficulty has increased by more than 5X since 2018. 

Popular Crypto Staking Coins

Now that you know that staking is only available on PoS blockchains, it’s time to review the most commonly used coins that you can buy and store for earning a passive reward. Please note that each of the below-mentioned networks has different requirements for the minimum staking amount. 

• Ethereum (ETH). The world’s second-largest cryptocurrency, Ethereum is a great investment option that can pay off well. However, you must have a minimum of 32 ETH to become a validator. Rewards are different: network participants receive from 5% to 17% per year.
• EOS. The EOS blockchain was designed to solve Ethereum’s scalability challenges, and it also supports decentralized applications. In mid-2021, the average return on EOS staking was around 3.2% per year. The coin price has been displaying a slow but steady growth, too.
• Tezos (XTZ). One more alternative to the Ethereum network, Tezos is a publicly available blockchain. Its native token XTZ can be staked on different platforms at an average interest rate of 6%.
• Cosmos (ATOM). This blockchain was created with the idea of uniting and interconnecting all decentralized networks. The creators hope to enable interoperability and transactions between blockchains, which can positively impact the ATOM price in the future.  So far, ATOM can be staked in the Coinbase, Kraken and Binance exchanges. The average yield is 7% per year. 
• Cardano (ADA). This blockchain is somewhat similar to Ethereum, but the Cardano blockchain comprises several layers with one of them processing ADA transactions, while the other serves for the development of decentralized apps. In mid-2021, the interest rate for ADA staking on Binance was up to 24%. 
• Polkadot (DOT). Although it’s a relatively new cryptocurrency, Polkadot has all chances to unleash a huge potential by supporting “parachains,” i.e. ensuring blockchain interoperability. The average yield you can expect on DOT is 10-12%.

How to Stake Crypto

In the paragraphs above, we discussed the traditional way of staking, where a user automatically becomes a validator by holding a particular amount of the blockchain’s native coins. However, this is not the only method available. You can stake even if you don’t have much cryptocurrency in your wallet. 

Using an exchange. Many popular global crypto exchanges, such as Kraken, Coinbase and Binance, allow users to stake coins with a pretty low entry threshold. The interest rate can vary from 3% to 15% on average and depends on the lockup period. Some cryptocurrency exchanges like HotBit don’t even require locking: users can enjoy a 3-8% APY by simply storing any coin in their account. 

Joining a pool. DeFi (decentralized finance) has revolutionized staking by offering four-digit APYs. However, generous rewards come with huge risks. You can become a victim of scam farms, so do your research before sending coins from your wallet to a new protocol, especially when you deal with newly released projects and cryptocurrencies,

Becoming a validator. This option has already been discussed above. You must hold a minimum amount of coins in your wallet and run certain launchpads to connect to the network. Don’t forget about hardware requirements: a smartphone is not enough; you should have a PC that works with the required software. 

FAQ: Frequently Asked Questions

• What is cold staking? This is a way of staking where your coins do not leave your wallet, for example, when you use cold storage in your hardware wallet.
• What is a staking pool? Think of it as a depository where all coin providers’ coins are locked. When the lockup period ends, the funds get returned to the user’s wallet from the pool (or it can be done manually if there’s no deposit term).
• Is staking profitable? It’s proven to be a more profitable option than traditional bank deposits. However, crypto staking comes with higher risks.
• Can I stake Bitcoin? You cannot become a validator in the Bitcoin blockchain because it’s driven by the Proof of Work consensus mechanism. However, BTC staking is widely spread on DeFi protocols.
• What crypto is best to stake? You should find the best cryptocurrency for staking by comparing reward rates, risks, coin price trends, lockup terms and other factors.