In the world of cryptocurrencies, staking means that a user temporarily locks up their crypto assets on a coin’s blockchain in order to get some rewards, earn interest on their holdings, as well as to be able to transact on that blockchain and use its services. In plain English, staking is when you hold a particular amount of tokens in your crypto wallet without spending them during a certain period, so at the end of that period, you receive a reward. As a rule, staking is available for coins whose blockchains rely on the Proof-of-Stake (PoS) consensus algorithm and its variations, but not obligatory.
Generally, you can stake your tokens directly from your crypto wallet. Staking is also among the services that are offered by most online cryptocurrency exchanges. You can regard staking as a cost-effective alternative to mining. Your stake is used by the node operators who are responsible for the production of new blocks in the blockchain and maintaining its security and smooth performance. So, a person who opens a stake is called a staker.
Why staking?
Crypto staking has several obvious benefits:
1. Staking is a cheap alternative to mining. Crypto mining that generally employs the PoW (proof-of-work) consensus mechanism demands you to invest in powerful machines with high computation capacity, so your electricity bills may leave you bankrupt. On the other hand, PoS (proof-of-staking) is a less resource-consuming algorithm that does not consume much electricity. A mediocre laptop or a low-cost smartphone with a crypto mobile wallet app is generally enough to set up a stake and start earning a reward. You only need to ensure that your device is constantly connected to the network.
2. You earn rewards simply for storing tokens in a crypto wallet with a seamless Internet connection.
3. Staking does not require in-depth knowledge of the PoS mechanism to be able to use the blockchain and receive perks.
Staking is very secure. Of course, you can buy 51% of all blockchain coins and become the biggest stakeholder of the network, but you must understand that this is impractical for a hacker. For example, it is known that Ethereum is going to be updated to 2.0 version and shift from PoW to PoS. What will happen if someone owns 51% of the blockchain’s coin supply? ETH price will fall and the owner will lose most of their investment because they own more than half of all coins. So it is economically unprofitable to attack the network.
Farming is a more complex process compared to staking. Staking basically works on a Proof-of-Stake consensus algorithm, where the validator produces a new block through a random selection process and receives a reward paid by the investors of the blockchain platform. The higher stake you place, the greater reward you will receive. In farming, on the other hand, users lock their funds in loan pools, where other borrowers borrow funds in exchange for interest.
Staking usually involves large amounts of funds and can take a long time to repay the funds. On the other hand, farmers can earn multiple governance tokens in exchange for a lower commission generated throughout multiple liquidity pools.
There are two key ways how farming is different from staking. Firstly, in farming, you need two coins to convert into what is called a liquidity token. Secondly, farming allows you to withdraw fewer tokens than you sent to the farm. This is due to the so-called impermanent losses. So, if you want to have a more consistent profit, staking is always a better option.
When you decide in favor of staking, you want to pay attention to certain moments. You should realize that the more coins you lock in staking, the more profit you can make, the longer the period of staking, the greater reward you can ultimately receive. Surely, you cannot make on staking as much as you could through mining. This is so because staking itself does not involve significant investments. Miners have to buy special computing equipment that is often quite expensive.
Stakers, on the other hand, only need to download a crypto wallet on their smart device or PC and protect that wallet from unauthorized access. The income from staking will depend on the chosen coin. In most cases, profits are 2-15% per annum of the amount of the assets staked.
This abbreviation stands for Annual Percentage Rate. APR describes the annual interest rate that you pay on credit cards, loans, and other debts. It includes both the interest rate on what you borrow and any fees charged by the lender.
APY is decoded as Annual Percentage Yield and shows how much you will earn on your savings deposit or investments, taking into account the effect of compound interest.
An easy way to increase your return on investment is through compound interest. To make use of it, you just need to not spend but re-invest the income from securities.
Compound interest can also be applied when you deposit money with a bank. If the term of the deposit has expired, you simply withdraw money along with the accrued interest and open a new deposit, but with a larger amount of money. Then interest on the new deposit will be applied not only on the initial amount but also on the interest that you received from the first deposit. That is how you capitalize on your previous gains.
You can use compound interest not only when you receive the return on investment or dividends. If you capitalize on the price growth of stocks, then by investing the whole profit or its part again in securities, the profitability of your investment will be more efficient and quicker.
Banks generally offer quite small APY for their deposits, with the interest rate being often not higher than 3-8%. Staking platforms are known to offer more lucrative ROIs, such as 5-15% or even higher.
This metric shows the return on investment or the investment ratio, and this indicator is generally calculated as a percentage of the initial investment amount. This value shows how profitable or unprofitable a project or product is. If ROI is above 100%, the investment will be profitable. If ROI is below 100%, the investment will be lost.
When you stake, you get involved in a so-called shared-risk shared-reward relationship that can bring profits to both parties: the staker (a delegator or token holder) and the validator (the ledger’s node operator or miner).
A stake determines the ability of a validator to add new blocks to the distributed ledger. The higher stake is delegated to a validator, the more frequently this validator will be picked to verify transactions on the blockchain. The more transactions the validator confirms, the more rewards they will earn and the better compensation they will pay to their delegators.
Generally, staking is a secure way to capitalize on your crypto ownership. Still, there are some possible risks associated with engaging in staking:
• Account loss: if some bad player gets access to your crypto wallet, its content may be forever lost. It makes sense to use only those wallets or crypto services that allow you to recover access to your account using a seed phrase or your private key.
• Volatility of coins. If the coin you have delegated is increasing in value, your stake keeps being profitable. If the value drops, your stake may not be able to cover the losses.
• Dishonest validators. When you decide to stake your crypto tokens, you actually grant validators (blockchain operators) the right to dispose of your assets. The validator uses your stake to be able to verify transactions on a blockchain and participate in the project’s governance. There are cases when validators refused to provide the reward due to some reasons. You must always find out in advance the date and amount of the reward accrual. Also, you should never send your stake directly to a validator.
• Impossibility to use the locked assets. As you block your tokens for a certain interval, you will not be able to withdraw your funds until the lock period is over. Sometimes, you can claim the assets before the due date, but in this case, you may be charged a very high fee, without receiving any compensation for your staking.
Solana, Cosmos, and Polkadot are among the biggest and most popular blockchain projects so far. They are trusted by both beginner and institutional crypto investors, while SOL (Solana), ATOM (Cosmos), and DOT (Polkadot) coins are listed on the world’s biggest exchanges, including Binance. Staking with these projects is safe; however, you must be aware of the general risks associated with this activity.
A validator is an operator of a blockchain’s node. It is essentially a person or a group of people whom you trust your locked assets, so the validator uses your stake to support the blockchain and generate new blocks in it. Once the validator is rewarded for their contribution to the network, a certain slice of that reward goes to you, too.
You may lose the staked tokens in an event of a validator’s slashing. It is a procedure during which a percentage of a validator’s delegated stake is removed and destroyed. This may happen when a validator commits serious mistakes that may jeopardize the efficiency or security of the blockchain. An example of such a mistake could be when a validator writes an incorrect transaction or allows double-spending in the ledger.
If a validator is slashed, all crypto owners who have delegated their assets to that validator will lose a portion of their stake, too. Slashing means an investment loss for the delegator, while the validator will lose their reputation on the blockchain due to the reduced overall delegation and will not be selected often to validate transactions, thus, they will not be able to receive many rewards.
When looking for a validator, pay attention to:
• the validator’s technical setup,
• an amount of self-bonded coins,
• the current number of the validator’s delegations,
• their community involvement and slash protection,
• their ability to vote and participate in the blockchain’s governance.