What is Crypto Staking?

It’s becoming more and more common these days to see cryptocurrency exchanges offering “staking” services. Staking is a growing and increasingly important part of the crypto landscape and one that can allow you to earn passive income on the coins that you’re holding.

So, how does staking work? How can you get involved? And what are some of the key risks to consider before you take the plunge. Luke Ryan from Coinjar explains.

What is cryptocurrency staking?

There are two major types of blockchain: Proof-of-Work and Proof-of-Stake. These terms refer to the way in which the network verifies transactions and adds them to the blockchain.

Bitcoin is what’s known as a Proof-of-Work (PoW) blockchain. In PoW networks, new coins are created through “work” – typically by asking computers to try and solve complex cryptographic equations. If they solve the equation, they’re rewarded with a certain amount of cryptocurrency. The more computing power you have, the more crypto you’re likely to receive.

A growing number of coins have pivoted to an alternative system called Proof-of-Stake (PoS). In PoS, holders of a given coin can “stake” them, locking their assets in a contract for a period of time in return for new coins. Similarly to PoW, the more coins you have to stake, the more coins you’re likely to receive.

Ethereum, the second largest cryptocurrency, is in the process of moving to a PoS blockchain. However, many other major cryptos already use PoS, including Solana, Algorand, Cosmos, Polkadot, Polygon/Matic, Cardano, Tezos, Fantom and many more.

What are the pros and cons of Proof-of-Stake blockchains?

Bitcoin’s prodigious energy usage is one of the asset’s most problematic aspects. By some estimates, Bitcoin consumes as much energy through its Proof-of-Work consensus mechanism as a mid-sized country. There are also significant cost overheads for participants in the form of mining-specific computer chips and huge amounts of associated e-waste.

Proof-of-Stake offers to cut those emissions drastically as well as eliminating the need for specialised computer equipment. It’s expected that Ethereum will consume 99% less electricity when it makes the full transition to PoS, while also increasing the number of transactions the network can process per second.

While the PoS mechanism itself appears to work as well as PoW when it comes to network security, it encourages centralization by incentivising parties to attain and hold as much of the coin as possible. In extreme cases this could lead to one party staking more than 50% of the coins on the network and gaining the ability to rewrite the blockchain.

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How does staking crypto make money?

Proof-of-Stake protocols function in a similar way to a bank paying out interest on a savings account. Banks gain value by having your cash in their accounts, while PoS networks gain value by using your coins to help validate transactions.

Staking rewards will typically be set algorithmically, as a function of network usage and the total amount of a token being staked. For most chains, this is designed to fall somewhere between 3% and 10%. If there’s more demand on the network, the staking rewards will be expected to drop. If demand eases, rewards are likely to increase.

How can I stake my crypto?

Different cryptos have different staking mechanisms, but in general there are two major ways to stake your crypto.

• Through a token wallet (directly)
• Through a crypto exchange (indirectly)

Staking through a token wallet

If you’re staking directly, you’ll first have to find and download the appropriate crypto wallet. Take note of the wallet address and transfer to that address the amount you want to stake. Note that some coins have a minimum amount required to begin staking; in the case of Ethereum that’s 32 ETH.

There may be additional steps required to begin staking (many require the wallet to have a permanent internet connection), but if so they’ll be documented on the asset’s official homepage.

If you want to stake directly but can’t meet the minimum asset requirements, or are finding the setup too complicated, it’s also possible to join a staking pool. As the name suggests, these sites pool your assets together with other holders, allowing you to collectively claim a higher share of the staking rewards. However, these pools often charge significant fees for entering and exiting the pool, so a lengthy staking period could be required to make it worthwhile.

Related article: How to buy cryptocurrency in Australia

Staking through a crypto exchange

An increasingly large number of cryptocurrency exchanges offer automatic or opt-in staking rewards. Some exchanges offer automatic staking for certain cryptocurrencies. This means that if you hold particular PoS tokens on their platform they’ll automatically stake them for you and pay out the rewards on a set cycle.

A more common approach is opt-in staking, where the platform lets you choose to place all or some of your crypto in a staking contract. As a user, you’ll usually agree to a certain rate of return and (in some cases) a lock-up period. It’s a simple approach, but exchanges will typically take a cut of the yield, so your returns might not be as high as if you handled the staking yourself.

What are the risks of staking crypto?

The biggest risk to crypto staking is that the price of the asset could crash. If you’re earning 8% per year on your staked coin, but the value of the coin drops by 50% in that time, you’re still going to be significantly down on your investment.

This risk can become particularly acute in so-called “locked” staking, which functions much like a term deposit – you receive a better rate of return but can’t access your tokens for a set amount of time, anywhere between a few days and a year.

There are also risks associated with staking your tokens with centralised exchanges or staking pools. If the service holding your coins disappears or goes under, it may be very difficult to claim your assets.

So do your research before giving anyone your crypto and remember: if it sounds too good to be true, it almost certainly is.

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