Staking is an innovative approach to earning passive income in the world of cryptocurrencies. By locking a specific number of coins in a digital wallet, individuals can participate in maintaining the stability and functionality of a blockchain network based on the Proof-of-Stake (PoS) consensus algorithm or its derivatives.
The act of staking serves a similar purpose as mining does in a Bitcoin network, and provides an attractive alternative to simply holding cryptocurrencies. The return on investment in staking can vary, with some blockchains offering yields that reach into the tens of percent annually. Participating in staking is like making a bank deposit in the cryptocurrency industry, providing a unique opportunity for passive income.
2. What is the Proof-of-Stake (PoS) algorithm and how does it relate to staking?
Proof-of-Stake (PoS) is a consensus mechanism used in blockchain technology where the right to validate transactions and generate new blocks is assigned based on the amount of coins a node holds.
Staking allows cryptocurrency holders to take part in the maintenance of the blockchain network and receive rewards in return. The method by which rewards are distributed varies between cryptocurrencies, but the basic principle remains the same. Generally, the more coins a node holds, the greater their reward will be for processing and verifying transactions on the network.
Proof-of-Stake was first introduced in 2012 with the PPCoin cryptocurrency, which is now known as PeerCoin. The algorithm has since become a popular consensus mechanism in blockchain projects, allowing network participants to earn rewards while contributing to the security of the network.
Delegated-Proof-of-Stake (DPoS) is a widely adopted variation of the Proof-of-Stake consensus mechanism. It was created in 2013 by Daniel Larimer for the BitShares blockchain platform and has since been implemented in numerous other networks.
DPoS offers a unique benefit to coin holders as it allows them to delegate their staking rights to professional validators. This means that they do not need to run their own nodes, saving time and resources while still being able to participate in staking and earn rewards.
In addition several other consensus mechanisms have been developed that are based on the principle of delegation.
Leased Proof-of-Stake (LPoS) is used on the Waves network and allows for the leasing of staking rights to validators.
Nominated Proof-of-Stake (NPoS) is used in the Polkadot blockchain and requires nominators to pay a deposit for validators and be held responsible for their good faith.
Proof-of-Staked-Authority (PoA) is a hybrid algorithm that combines Proof-of-Stake and the reputation of validators (Proof-of-Authority). BNB Chain operates on PoSA, leveraging the strengths of both consensus mechanisms to provide a secure and efficient network.
3. How does staking work in Proof-of-Stake?
In Proof-of-Stake (PoS) cryptocurrency networks, every official wallet serves as a full node responsible for verifying and confirming transactions and producing new blocks. The technical specifications for running a node can vary from blockchain to blockchain.
Some networks can be managed and maintained using just a basic home computer, while others require more advanced, professional server equipment. This ensures the network’s security and decentralization without the high energy costs that are present in Proof-of-Work consensus mechanism-based cryptocurrencies.
To participate in staking, one must acquire the native coin they want to stake and either send it to their wallet or delegate it to a validator. Staking conditions may differ among networks. The reward rate for staking can range from tens to hundreds of percent, depending on the speed at which coins are issued. However, it is important to keep in mind that staking is a method of issuing new coins and excessive rewards can result in inflation and reduced profits.
4. What is the difference between staking in Delegated Proof-of-Stake?
In Delegated Proof-of-Stake (DPoS) blockchains, wallets with coins can cast votes for designated validators to serve as computing nodes for verifying transactions, generating blocks, and receiving rewards and commissions.
The number of validators in a blockchain can vary greatly, with as few as 21 in BNB Chain and as many as 1800 in Solana.
For example, to participate in staking Cardano (ADA), one must install a wallet such as Daedalus or Yoroi, wait for synchronization with the blockchain, create a new wallet address, transfer at least 10 ADA, and select a validator to delegate their coins to. The staking rewards are credited to the wallet at the end of each five-day period. A similar process applies to other PoS networks.
To stake Solana (SOL) coins, one must select a suitable validator from the list in the Phantom wallet and delegate their coins. Rewards are distributed at the end of each era (approximately two days) with a yield of 7% per annum. The profitability of staking depends on the proportion of the total supply of coins that are locked in validators’ wallets, which can range from 50-90% for popular blockchain platforms.
5. Who are staking providers?
Staking has become a favored investment strategy for digital assets. Yet, setting up a node or staking in a specific crypto project can be a time-consuming process. These platforms allow users to pool their funds and send them to various pools via the provider’s wallet. They provide an easy way to analyze the current staking profitability of a selected network and present other relevant data.
Staking platforms simplify the process for users by charging a small commission on the rewards earned. Both specialized staking services (such as Midas Investments, Everstake, Stake.fish, etc.) and centralized crypto exchanges (such as Coinbase, KuCoin, eToro, etc.) offer staking services. Staking is also possible through multi-currency wallets like Trust Wallet and Atomic Wallet. The current ranking of staking services can be found on the Staking Rewards website.
6. How does ETH staking work in Ethereum 2.0?
In 2020, Ethereum 2.0 was launched, which marked a major update to the Ethereum blockchain. The update involved transitioning the blockchain to the Proof-of-Stake (PoS) algorithm, with a new network called Beacon Chain serving as its foundation. The final integration of Beacon Chain with the current Ethereum mainnet, known as “The Merge,” was merged in September 2022.
Staking is a crucial component of Ethereum 2.0, and individuals can participate by sending their ETH coins to a designated smart contract. Those holding at least 32 ETH can even become validators on the network. For those who don’t possess the required number of coins, staking service providers offer alternative options.
For example, the decentralized application Lido Finance allows for staking by blocking any amount of ETH, which is then delegated to large validators. Staking rewards in the form of stETH tokens are distributed to holders on a daily basis. However, it is important to note that once coins are sent to the staking contract, they cannot be retrieved until after The Merge is completed. This restriction may not apply to all staking service providers, so it is recommended to carefully review the terms and conditions beforehand.
7. What are the risks of staking cryptocurrencies?
Staking may seem like a profitable and low-risk alternative to simply holding cryptocurrencies, with potential returns that can be substantial. But there are a number of factors that can greatly impact expected returns and even result in losses.
Firstly, changes in the exchange rate of the cryptocurrency being staked will affect the invested funds and the actual profitability of staking.
Secondly, some PoS-cryptocurrencies offer high staking returns (up to hundreds of percent per annum), but this often results in a rapid drop in the market price of the coin and rapid depreciation of the investment.
Additionally, staking may require the blocking of coins for a certain period of time, during which the owner cannot access or sell their coins.
Furthermore, using staking providers carries the risks associated with trusting a third party, which may be vulnerable to attacks by hackers or embezzlement of assets collected from stakers.
8. What other types of staking are there?
Staking in the DeFi space refers to the act of locking up various types of tokens, such as utility and governance tokens, or NFTs, in a smart contract to earn rewards or gain access to services. This approach is frequently utilized by blockchain projects to boost liquidity and enhance the value of their native tokens.
DeFi exchanges and services are among the most active users of DeFi staking, rewarding their users for providing liquidity with their management tokens. Additionally, some blockchain games have embraced NFT staking by offering in-game tokens as a reward, releasing other NFTs, or providing entry to the game through staking.
9. Frequently asked questions
What is the essence of staking?
Staking refers to the act of holding and locking up a certain amount of cryptocurrency to support the network by validating transactions and producing new blocks. As a reward for their contribution, Stakers are given newly minted coins of the particular blockchain. In essence, it’s a way for holders to earn passive income while supporting the network’s security.
How to participate in staking?
Staking involves the participation of validators, who are responsible for overseeing nodes and serve a similar purpose as miners in blockchains utilizing the Proof-of-Stake consensus mechanism. This means that even individuals holding a minimal amount of cryptocurrency can delegate their holdings to validators and partake in staking, earning rewards in return.
Is it possible to make money on cryptocurrency staking?
Staking in cryptocurrency has become a popular means of earning passive income. The level of profitability is determined by two key factors: the amount of rewards earned, i.e. the rate of new coin production through staking, and the value of the cryptocurrency.
How is mining different from staking?
The main difference between mining and staking is the hardware requirements, as mining requires specialized computing equipment while staking simply requires ownership of the relevant blockchain’s coins, which can be done through delegation to a validator. Networks utilizing the Proof-of-Work algorithm, like Bitcoin, utilize mining as a consensus mechanism.
What is the difference between staking and farming?
Staking involves maintaining the integrity of a blockchain using its native coins. Conversely, farming refers to the act of receiving fees for providing liquidity to a decentralized exchange, which is a blockchain-based application.