What is Crypto Staking?
6 mins read
1 yrs ago
Trading, mining, and investments aren't the sole means to earn on the blockchain network. You can earn additional cryptocurrencies by contributing to the blockchain network. Specific blockchain protocols allow users to earn rewards through staking. Staking will enable you to actively participate in the governing of the blockchain network and earn a passive income.
What is staking?
Staking centres on actively participating in a Proof of Stake blockchain to validate transactions. Staking requires you to hold a minimum balance of a specific cryptocurrency before you can partake in the staking process and earn rewards.
Staking merely involves holding a certain balance of cryptocurrency in your wallet to support the blockchain network's operations and security, which in turn generates a profit for you. You have the option to either stake directly from your crypto wallet, such as Trust Wallet, or use a crypto exchange to stake crypto, such as Coinbase. Staking is similar to mining as it also helps a crypto network achieve consensus with a reward after a certain period. It is important to note that staking operates on a consensus mechanism, the Proof of Stake blockchain.
What is Proof of Stake?
New blocks of bitcoins are introduced to the blockchain through a process known as Proof of Work. Miners are required to solve certain mathematical puzzles to generate blocks that would be introduced to the blockchain. However, Proof of Work requires expert computation skills to generate blocks to gain profit. Proof of Stake offers a more inclusive process to the running of the blockchain network without computer proficiency.
Proof of Stake is a consensus mechanism that allows blockchains to run on less energy while still maintaining a certain level of decentralisation. Proof of Stake will enable participants to stake their coins at specific intervals to validate a new block. The protocol mechanism determines who gets the right to validate the next block. Although the participant is selected at random, the probability of being chosen is largely dependent on the amount of coins that has been staked.
Unlike with the Proof of Work, participants without expert computer skills can generate a new block which is dependent on the number of coins they are staking. This is why newer blockchains use Proof of Stake, as it requires less energy consumption and allows participants to earn a passive income by staking their coins.
How does staking work
Proof-of-Stake blockchains are built to generate new blocks through the process of staking. Participants interested in staking must hold a minimum amount of coins to partake in the staking process. However, the right to a block is primarily determined by the amount of coins that are staked. Coins can be generated without having to rely on certain high-level mining hardware.
Mining requires an investment in mining hardware, while staking allows participants to invest in the cryptocurrency and earn rewards directly. Similarly to the Proof of Work, Proof of Stake is done to improve network security and improve its efficiency. Stakeholders are active participants in the protection of network security. Therefore, the crumbling of the network security system would put the stakes at risk.
Generally, staking is done using a particular currency; however, rewards may be made in another currency, creating a two token system. In essence, staking centres on holding crypto in a wallet so that it can be used to perform certain network functions.
What is a staking pool?
A staking pool, as the name suggests, is a pool of investors collating their tokens together. It is run by a pool operator who is in charge of allocating and managing stakes on behalf of other investors. This allows beginners without an in-depth knowledge of the blockchain network's inner workings to actively participate in the network.
However, you may need to pay certain fees to get started in a staking pool. Although the chances of earning rewards may be higher, however, the reward may be lower as it would have to be distributed among investors in the pool. However, investors who seek a more consistent payout and have no interest in actively participating in the network may consider lending a more suitable option.
Pooling their resources together increases the chance of being selected to validate the blocks and receiving rewards. However, setting up and running a staking pool requires expertise and a lot of time. Investors have to invest a certain minimum to join the staking pool and agree to a fixed time to lock their coins in a stake. Staking pools are usually most efficient when the conditions to stake are relatively high. A staking pool offers an avenue to meet these requirements and requires no expertise from investors.
What is cold staking?
Staking requires that you lock your coins in a wallet for a specific period to generate passive income. However, these wallets don't need to remain connected to the Internet. Cold staking involves staking your coins in an offline wallet that isn't connected to an Internet connection, such as a hardware wallet. Some networks allow individuals with cold wallets to stake their coins.
Cold staking is often used by investors with significant large holdings of cryptocurrency. They enjoy the benefits of a cold wallet (that is, additional security from theft and tampering) while enjoying the rewards of staking. However, they would need to leave their coins in cold storage for that period; moving their coins out of cold storage means losing out on the rewards.
Why is staking limited to specific cryptocurrencies?
Staking isn't general to all cryptocurrencies; Bitcoin, for example, does not allow staking. Cryptocurrencies like Bitcoin and Ethereum 1.0 already utilise Proof of Work in validating blocks that would be introduced to the blockchain. A lot of money is channelled towards solving mathematical puzzles which are built to improve network security. Proof of Work remains a scalable solution to these cryptocurrencies, and deviating from these protocols may result in a fork. Examples of currencies you can stake include Ethereum 2.0, Tezos (XTZ), Algorand (Algo), Icon (ICX), and more.
Risks in Crypto Staking
Staking involves locking up your funds in a wallet such that they can't be transferred or withdrawn during a specific period. This may have some drawbacks as you cannot withdraw or trade cryptocurrencies even during price shifts. Apart from this, investors in staking also have to put into consideration the possibility of slashing.
Slashing occurs when the transactions in the new block generated are discovered to be invalid. The investor has a certain amount of their stake (crypto in holding) burned in the network, referred to as slashing. Each currency has its policies and protocols regarding staking. It is best to research the staking requirements thoroughly before getting started on staking.
How are staking rewards calculated?
Each currency has its specifics on how the staking rewards are calculated. However, certain conditions are general to determining the staking rewards. They include:
- How many coins have been staked by the investor
- The number of coins staked in total on the network
- How long the investor has been actively staking
- Inflation rate
This, among other factors, determines the staking rewards. However, some currencies have a fixed staking rewards percentage. Validators receive these rewards as compensation for the inflation rate. With a fixed percentage, validators can calculate how much they would be earning. A predictable reward may incentivise more participants to start staking as it allows them to earn a passive income.
Staking is an avenue to earn an income by simply holding your coins in a wallet for a certain period. With staking, you can actively participate in the running of the blockchain network as a validator. As sensitisation towards staking increases, it is getting easier to stake as staking barriers are gradually getting lower. However, you should lock up your funds with a trusted exchange or wallet, such as Trust Wallet. Staking remains a relatively straightforward way to earn additional income from simply holding your coins in a wallet.
Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.