The cryptocurrency space is known for its many avenues that allow investors to generate passive income. One of the first and most popular means of making such income is staking.
Staking lies at the heart of some of the most popular blockchain networks and is an alternative to mining in terms of both network operation management and investment. In the given material we will explore the basic principles of staking and its advantages and disadvantages.
What Is Staking?
If staking were to be compared to anything in the real world, then it would have to take the form of a bank deposit. Much like the money deposited in a bank, the tokens or coins that a user deposits in a staking pool will generate a certain amount of passive income. The pool where the assets were deposited will maintain the assets in a fixed manner and will not have the right to dispose of them, as they act as a pledge of trust on the part of the stake providers.
Much like a bank deposit, users have the right to withdraw their stake from the pool at any time and look for more profitable pools. However, there may be a penalty fee for withdrawals earlier than a certain date as prescribed in the staking contract. At present, the average rate of return for staking on the cryptocurrency market does not exceed 4%. Any promises of higher returns are either extremely high-risk, or are simply fraudulent schemes, often Ponzi or rug-pull in the scheme format.
How Staking Works
Staking is a means of ensuring the operation of a blockchain network that works on the Proof-of-Stake consensus algorithm. Under the given mechanism, the network is run by a strictly defined number of nodes, which are managed by validators.
Each node is responsible for processing transactions being transmitted by users across the blockchain. In order to have the right to process a transaction, a validator must wield a sufficient amount of trust on the part of network participants, which is expressed in ‘stakes’, or the number of native blockchain coins that are entrusted to the validator by users. The reward for processing a transaction is a certain amount of native blockchain coins. In exchange for the trust shown, the validator shares with the stakers a percentage of the commission earned for processing the transaction.
When staked, the assets allocated to a validator’s pool will not be available for withdrawal for a certain period of time. Early withdrawal may result in penalty fees in some cases. However, emergency scenarios are also possible, for instance in cases when the asset experiences a sudden and sharp drop in value, resulting in a dump.
The Proof-of-Stake algorithm was first introduced in 2012 as an alternative to Bitcoin’s Proof-of-Work algorithm, which was deemed too energy-intensive and costly to operate. In addition to being more energy-efficient, Proof-of-Stake networks are also much faster than Bitcoin and allow participants to earn on the process of transaction processing. Unlike mining, which involves a race between the miners for the fastest solution, staking does not involve any complex mathematical problem solution on the part of the stakers. Instead, the validators receive the right to mine the native blockchain tokens based on the share of the stake they are granted by network participants.
Types of Staking
There are generally two types of staking on the cryptocurrency market – self-staking and delegated staking.
Self-staking involves the user staking their available assets by themselves on a selected network or in a staking pool. The process requires the user to sign up to the selected platform and complete all the staking procedures by themselves. Naturally, the process requires a considerable amount of time and knowledge about the market to avoid mistakes.
Delegated staking is the method by which a user delegates their assets to a validator via an intermediary, which can be a cryptocurrency exchange or a staking provider service. The given method will entail a small service charge.
Staking is also divided into two main types by venue – network and pool.
Network staking takes place on a Proof-of-Stake network, such as Ethereum or Solana. Under the given type, the users stake their asset directly with network validators and are involved in maintaining its operation.
Pool staking involves users providing their assets to a cryptocurrency pool, which aggregates excess liquidity from users and lends it to trading venues, such as exchanges, in exchange for a commission fee. The given type of staking entails the liquidity staked in a trading pair with another asset and is generally more risky.
There are also fixed and flexible types of staking options on staking platforms.
Fixed staking means that the user determines the period of staking. Fixed staking is usually more rewarding, as it provides a certain measure of guarantee of liquidity availability to the staking service.
Flexible staking has no set period of time and the user has the right to withdraw their assets at their whim. The given option involves slightly lower returns, but is ideal for users who are adept at hopping between platforms in search of better percentage yields.
Users willing to stake their available assets have a choice of platforms they can resort to. Luckily, the cryptocurrency market has evolved over the past few years to offer a number of flexible and convenient venues for staking, namely:
Cryptocurrency exchanges were quick to dive into the staking phenomenon and virtually all of the popular ones, such as ByBit, KuCoin, Binance, Kraken and others offer a wide variety of staking pools for any number of assets and trading pairs. Exchange staking is best known for being both riskier, due to the vulnerable nature of exchanges, and more convenient, considering the wide variety of options such platforms offer.
Staking platforms are specialized services that give users the ability to earn passive income for lending their assets into staking pools. The users will receive rewards in the form of commissions from the transactions processed using their staked assets.
Hardware wallets also offer staking options. By locking their funds on hardware wallets, users will essentially be providing them to a staking venue in offline mode and will not be able to move them.
Advantages and Disadvantages of Staking
Staking offers a number of considerable advantages over other types of revenue generation from cryptocurrencies, namely:
- No need to delve into complicated cryptocurrency processes;
- No need for specialized hardware, as in the case of mining;
- Direct involvement in blockchain network operation;
- Higher-than-average returns and lower risks if compared to cryptocurrency trading;
- More environmentally friendly than mining.
Disadvantages of staking:
- Price volatility may trigger a considerable drop in value of the assets while they are staked;
- Early withdrawal penalty fees;
- Some staking options do not allow immediate withdrawal of coins from pools;
- High risk of hacking of staking platforms and loss of staked assets.