Staking has become one of the go-to ways to make an income on blockchains like Solana, Tezos, Ethereum, and many others!
Staking is of interest to traders and investors who are keen to reap the rewards of mining without investing in expensive hardware or worrying about maintenance. It’s one of the most popular forms of passive income for crypto enthusiasts.
This guide will break down how staking works and how to get involved in it.
What is Staking and how does it work?
Staking is a process that involves the "locking up" of a portion of cryptocurrency for a period of time as a way of contributing to a blockchain network. It is a process whereby a token holder locks tokens in a particular wallet that gives the holder access to participate in a Proof of Stake network. In exchange, stakers can earn rewards, typically in the form of additional coins or tokens.
Staking essentially involves going into an agreement with a blockchain network to approve and verify transactions, and getting a staking reward in return. The amount of the reward varies from network to network. If the staker approves transactions that violate the network rules then they may lose some of their stake. Most times this is done automatically which makes staking a good way to earn passive income. The specifics of the process depend on the network, some networks require you to lock away all your coins, but they usually compensate better, while some networks require you to stay online in order to receive your staking reward.
Staking rules vary from network to network, however, the following gives a general idea of what a staking agreement would look like:
• The staker agrees that they’ll only validate valid transactions on the network. I.e. they will not vote to approve double-spend transactions.
• In exchange for approving valid transactions, the network rewards the staker with a staking reward.
• If staker votes to approve illegal transactions, they may lose some or all of their stake.
This is much easier than mining and as a result, acts as a great “passive income” opportunity for those who want to support crypto networks while making mostly hands-off money.
What is Proof of Stake?
Proof of Stake is a blockchain verification method that is much more energy efficient and less risky than the more common Proof of Work method. It is a cryptocurrency consensus mechanism for processing transactions and creating new blocks in a blockchain.
The Proof-of-stake (PoS) system entails individuals staking cryptocurrency to validate transactions. A consensus mechanism is a method for validating entries into a distributed database and keeping the database secure. In the case of cryptocurrency, the database is called a blockchain. The consensus mechanism secures the blockchain. Proof of stake is the main alternative to cryptocurrency mining. The term Mining is replaced with Validation, and a Miner is replaced with Validator.
The Proof of Stake method allows only one staker at a time to validate the blockchain. However that staker must lock up coins as collateral. The staker risks certain punishments for creating fraudulent transactions, this includes losing their collateral. The staker is rewarded for good transactions by the creation of new coins and possibly with the transaction fees the sender paid.
Benefits of Staking
For crypto holders and stakers, staking is a very lucrative method to earn passive income on their idle funds generating rewards, rather than collecting dust in their crypto wallets. Staking has the added benefit of contributing to the security and efficiency of the blockchain projects you support. In comparison with mining, the process of staking is less resource-intensive and easy. Cold wallets make the process of staking super safe and reliable
By staking some of your funds, you make the blockchain more resistant to attacks and strengthen its ability to process transactions. Some projects also award “governance tokens” to staking participants, which give holders a say in future changes and upgrades to that protocol. Also, some staking pools provide derivative tokens against the staked tokens that give liquidity to a staker.
The benefits of staking are numerous, however, there are many risks and limitations that one should consider before staking his or her tokens.
Risks Involved in staking
• One of the biggest risks an investor faces in the process of staking is the change in market prices. A potential adverse price movement in the asset(s) they are staking can lead to a major loss. If, for example, you are earning 15% APY for staking an asset but it drops 50% in value throughout the year, you will still have made a loss. Crypto investors, therefore, need to choose carefully the assets they decide to stake and are advised not to choose their staking asset purely based on APY figures.
• Another risk factor to be aware of is the Liquidity (or illiquidity) of the assets you are staking. When staking a micro-cap altcoin that barely has any liquidity on exchanges, difficulties may arise in selling your assets or converting your staking returns into bitcoin or stablecoins. Staking liquid assets with high trading volumes on exchanges can mitigate liquidity risk.
• Some staking assets don’t pay out staking rewards daily. As a result, stakers have to wait to receive their reward. This shouldn’t affect your APY if you “HODL” and stake the entire year. However, it will reduce the time that can be used to re-invest your staking rewards to earn more yield (either by staking or by deploying assets in DeFi protocols). To mitigate this risk, it is advisable for investors to choose to stake assets that pay daily staking rewards.
•A staker may lose his funds through “slashing” if a validator misbehaves or breaks any protocol. Slashing conditions are mentioned in the Terms and conditions of staking of the respective network.
• While staking investors risk validator costs, staking with a third-party provider typically costs a few percentage points of the staking rewards. Costs are something that crypto investors need to keep an eye on to make sure that they don’t end up eating too much into staking returns which leads to loss of profits.
•In case of custodial staking, i.e., where the token holder does not have custody of his funds, if the exchange or wallet is hacked, it may lead to loss of funds for the token holders. Also, there is always the potential that you lose your wallet’s private keys or that your funds are stolen if you don’t pay adequate attention to security. it is therefore advisable to stake using apps where you hold the private keys as opposed to using custodial third-party staking platforms.
•Some stakable assets come with locked periods during which you cannot access your staked assets. Tron and Cosmos would be examples of this. If the price of your staked asset drops substantially and you cannot unstake it, that will affect your overall returns. Staking assets without a lockup period would be a way to mitigate lockup risk.
Your staking checklist
These are some factors to be considered before staking:
• How reliable the exchange, staking pool, or wallet is?
• Is the validator authentic, reliable, and experienced?
• Is there a lock-in period on the staked funds? If yes, what is the lock-in period?
• What fee would be charged by the validator or staking pool?
• Who has custody of staked funds?
• What is the liquidity position of the token being staked?
How to stake crypto
The simplest way to start staking as a beginner is via an online crypto exchange or platform. Steps for staking vary depending on the platform/method. Platforms in the same category will have essentially identical steps for staking. However, the initial steps remain the same across all methods:
• Choose a coin: look at factors like APY rewards, minimum stake, lock-up periods, and other aspects of the crypto. Do adequate research before picking up unknown/obscure cryptos.
• Validator or not: for some cryptos, the validator requirements are quite steep. They also require desktop PC hardware 24/7 internet connectivity. Setting up the node also requires advanced skills.
• Download a wallet: a software wallet is essential to the staking process as it is where you store the funds used for staking. Simply go to the website of the coin you want to stake and download the wallet.
For Crypto Exchanges/Platforms
• Create an account: visit the crypto exchange and sign up on an online exchange/staking platform. Link your crypto wallet to your account.
• Compare different cryptos: APY, lock-up period, minimum stakes, etc
• Buy the required number of crypto tokens: if you already have cryptos in your wallet, buy them from the exchange.
• Go to Staking Page: find the dedicated staking page for the crypto on the online exchange.
•Tweak Your Preferences: Some exchanges offer different pools with varying lock-ups, APYs, and other special features.
• Enter Stake: enter the number of coins you want to stake and confirm the order using the button provided.
For Crypto Wallets
• Download app: some wallets like Ledger, you can download and install the coin’s app to the device. If there are no apps in the absence of any downloadable apps, you may link the wallet to a third-party crypto staking app/web platform.
• Set Stake: specify the tokens you want to stake using the linked wallet mobile app/platform to set your Stake and confirm.
The Proof of Stake consensus mechanism and staking is becoming increasingly popular in the cryptocurrency ecosystem. It comes with many benefits like earning rewards on your assets in addition to an increase in the value of your assets. It also fixes some of the issues that come with a Proof of Work mechanism. However, some risks are involved and it is advisable to go through the checks above to be on the safer side.
If you are new to staking, ensure that you understand all of the risks involved, as this is a relatively untested and new technology. Learn the basics and start staking with a small amount of crypto and along the line, you can increase your investment.
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