Staking, in the context of cryptocurrencies, involves a user temporarily locking their crypto assets in a blockchain network in order to earn rewards and interest on their holdings. It also allows them to engage in transactions and access services on that blockchain. Simply put, staking is holding a specific amount of tokens in your crypto wallet for a predetermined period without spending them. At the end of this period, you receive rewards. Typically, staking is available for coins whose blockchains utilize the Proof-of-Stake (PoS) consensus algorithm and its variants.
You can usually stake your tokens directly from your crypto wallet. Moreover, staking is among the services offered by many online cryptocurrency exchanges. It can be seen as a cost-effective alternative to mining. Your stake assists node operators responsible for generating new blocks in the blockchain and ensuring its security and efficient operation. Therefore, a person who participates in staking is referred to as a staker.
Why staking?
Crypto staking offers several distinct advantages:
Staking is a cost-efficient alternative to mining. Traditional crypto mining, which generally uses the Proof-of-Work (PoW) consensus mechanism, requires investment in powerful hardware with high computational power, often leading to substantial electricity bills. On the contrary, PoS is a less resource-intensive algorithm that uses less electricity. A modest laptop or an affordable smartphone with a crypto wallet app is usually sufficient to set up a stake and start earning rewards. The only requirement is a consistent network connection.
You earn rewards simply by keeping tokens in a crypto wallet with a stable internet connection.
Staking doesn’t require extensive knowledge of the PoS mechanism to utilize the blockchain and reap the benefits.
Staking is generally secure. Although technically possible, owning 51% of all blockchain coins to control the network is impractical and economically nonviable. For instance, Ethereum is transitioning from PoW to PoS with its upcoming 2.0 version. If someone were to own 51% of the coin supply, the price of Ethereum would likely plummet, leading to significant losses for the majority stakeholder. Hence, it is economically discouraging for any potential attacker to undermine the network.
What are the differences between staking and farming?
Staking and farming are both methods of earning income in the world of cryptocurrencies, yet they involve different processes and risks.
Staking is associated with blockchains that use a Proof-of-Stake (PoS) consensus mechanism. In staking, investors lock up their tokens to validate transactions and create new blocks. The probability of being selected to validate transactions generally depends on the amount of tokens an investor holds; the more tokens staked, the greater the potential reward.
Farming, also known as yield farming or liquidity mining, is a more complex practice, often employed in Decentralized Finance (DeFi) protocols. In farming, users provide liquidity to a pool, which can be used by others for trading or borrowing. In return, the liquidity providers earn fees or other types of rewards, often in the form of additional tokens.
Compared to staking, farming can involve more risk and complexity. For example, farmers often need to provide two different tokens to a liquidity pool in a certain ratio, receiving liquidity tokens in return. These liquidity tokens represent their share in the pool and can be used to claim a portion of the transaction fees or other rewards.
However, farming also exposes users to «impermanent loss,» a situation where providing liquidity to a pool can be less profitable than simply holding the tokens due to price fluctuations between the provided tokens.
In contrast, staking typically involves fewer risks, and the returns are more predictable, although it often requires substantial amounts of tokens and longer commitment periods. Hence, if you prefer a more stable and less complex income stream, staking may be a preferable option.
When considering staking, there are a few factors to bear in mind. Firstly, the amount of profit you can make is directly proportional to the quantity of coins you stake – the more coins you lock up, the higher your potential returns. Secondly, the duration of staking also influences your earnings; typically, the longer you commit your tokens, the greater the rewards you can accrue.
It’s important to note, however, that the earnings from staking are generally less compared to those from mining. This is because staking, unlike mining, does not require substantial upfront investment. Miners often need to purchase specialized computing hardware, which can be expensive.
Stakers, in contrast, merely need to install a cryptocurrency wallet on their smart device or PC, and ensure its security against unauthorized access. The returns from staking will largely depend on the specific coin chosen for staking. In most cases, annual returns from staking range from 2% to 15% of the total amount staked.
APR stands for «Annual Percentage Rate». It represents the annualized cost of credit, encompassing both the interest rate on borrowed funds and any associated fees charged by the lender. It is used to provide a clear, comprehensive picture of the true cost of loans, credit cards, and other forms of debt over a one-year period.
APY stands for «Annual Percentage Yield». It indicates the real rate of return earned on a savings deposit or investment over a year, factoring in the effect of compounding interest. This measure provides a clearer idea of the potential earnings from an investment or a savings account.
One effective strategy to increase your investment returns is through the power of compound interest. This involves reinvesting the earnings from your investments, instead of spending them.
For example, compound interest comes into play when you deposit money in a bank. Upon maturity of the deposit, you can choose to reinvest the original deposit along with the accumulated interest. When you open a new deposit account with this larger sum, the interest earned will now be calculated on this increased total. This way, you’re earning interest not only on your initial deposit but also on the interest accrued from previous periods, allowing you to capitalize on your prior gains.
The concept of compound interest is not limited to interest or dividends from investments. It can also apply to capital gains from appreciating assets. If you reinvest the profits from the sale of securities back into the market, the growth of your investment can accelerate, leading to more efficient and faster wealth accumulation. This reinvestment effectively applies the principle of compound interest, multiplying your returns over time.
When comparing the potential returns, banks typically offer relatively modest Annual Percentage Yields (APYs) on their deposits, often in the range of 3-8%. In contrast, staking platforms within the cryptocurrency sector can provide more attractive Return on Investments (ROIs), typically between 5-15% but potentially even higher.
However, it’s important to consider the different risk profiles of these two options. While staking may offer higher potential returns, it also carries higher risks related to the volatility of cryptocurrency markets and the security of the staking platforms. In contrast, bank deposits, especially those insured by entities like the Federal Deposit Insurance Corporation (FDIC) in the U.S., carry much lower risk. It’s crucial to consider these factors when choosing between staking and a bank deposit.
ROI stands for «Return on Investment». It’s a metric used to measure the efficiency or profitability of an investment. ROI is generally expressed as a percentage and is calculated by dividing the net profit from the investment by the initial cost of the investment, and then multiplying the result by 100.
This metric helps investors determine the extent to which a project or product is profitable. If the ROI is positive, it indicates that the gains from the investment outweigh the costs, making the investment profitable. Conversely, a negative ROI suggests that the costs of the investment exceed the returns, indicating a loss. ROI is a useful tool in comparing the profitability of different investments.
When you participate in staking, you enter into a relationship often referred to as ‘shared-risk, shared-reward’, which can yield profits for both parties involved: the staker (also known as the delegator or token holder) and the validator (the ledger’s node operator or miner).
A stake influences a validator’s chances of adding new blocks to the blockchain. The more stake a validator has, the higher the likelihood they’ll be selected to verify transactions on the blockchain. More transactions confirmed equals more rewards earned, leading to better compensation for their delegators.
Overall, staking is a secure method to earn returns on your cryptocurrency holdings. However, there are potential risks associated with staking:
• Account loss: If an unauthorized individual gains access to your crypto wallet, you could lose your assets permanently. Therefore, it’s advisable to use wallets or crypto services that enable account recovery using a seed phrase or private key.
• Volatility of coins: If the value of the coin you’re staking increases, your stake will remain profitable. However, if the coin’s value decreases, your stake might not offset the losses.
• Dishonest validators: When you stake your crypto tokens, you effectively allow validators (blockchain operators) to control your assets. There have been instances where validators failed to distribute the expected rewards. Always verify the date and amount of the reward payout in advance. Additionally, it’s important to never send your stake directly to a validator.
• Inaccessibility of locked assets: When you stake tokens, they are locked for a specific duration, meaning you cannot withdraw them until the staking period ends. Some platforms may allow early withdrawal, but this typically incurs high fees and you might not receive any compensation for your staking efforts.
Solana, Cosmos, and Polkadot are among the most prominent and widely-recognized blockchain projects currently in operation. They have built a strong level of trust with a broad range of cryptocurrency investors, from beginners to institutional stakeholders. Their respective coins, SOL (Solana), ATOM (Cosmos), and DOT (Polkadot), are listed on some of the largest exchanges in the world, including Binance.
However, while staking with these established projects is generally considered safe due to their prominence and reputation, it’s critical to remember that all forms of investment carry some degree of risk. This includes, but is not limited to, potential vulnerabilities in the staking platform, the volatility of the cryptocurrency market, and the risk of loss if private keys or wallet information are mishandled. Therefore, even when staking with well-established projects, investors should always exercise due diligence and take necessary precautions.
A validator is an operator of a node within a blockchain. Essentially, this is an individual or a group of individuals to whom you entrust your locked assets. Your staked tokens allow the validator to support the blockchain network and generate new blocks. When the validator is rewarded for their contribution to the network, a portion of this reward is distributed to you.
However, you can lose your staked tokens due to an event known as validator ‘slashing’. This is a process where a portion of a validator’s staked tokens is taken away and destroyed if they commit severe errors that could compromise the blockchain’s efficiency or security. For instance, slashing could occur if a validator records an incorrect transaction or allows double-spending within the ledger.
If a validator is slashed, all the token holders who have delegated their assets to this validator will also lose a portion of their stake. This means a financial loss for the delegators. At the same time, the validator’s reputation within the blockchain network will suffer due to the decrease in total delegation, reducing their opportunities to validate transactions and hence, earn rewards.
When choosing a validator, it’s important to consider the following factors:
• The validator’s technical setup
• The amount of self-bonded tokens
• The current number of delegations the validator has
• The validator’s involvement in the community and their protection against slashing
• Their capacity to vote and participate in the governance of the blockchain.