What is Crypto Staking?
Crypto staking is the action of buying and then setting aside the native currency of a given cryptocurrency to become an active or passive validating node for the network. This simple act allows the buyer to become an important component in the network’s security infrastructure and is compensated accordingly with more coins. These staking rewards offer a new form of passive income to the modern investor.
Proof-of-Work vs Proof-of-Stake
Every blockchain needs a method for keeping the network secure. The blockchain that everyone knows, Bitcoin, implements a Proof-of-Work (PoW) consensus mechanism to keep the network secure. While it is indeed secure and effective, Bitcoin has faced criticism on both scalability and energy consumption – rightly or wrongly – PoW necessitates that a potential attacker would need to generate an insurmountable amount of energy to mount a successful attack on the network. Generating the power needed to run a small country is neither affordable nor feasible and would most certainly not be an environmentally friendly endeavour.
Proof-of-Stake blockchains were developed as an alternative consensus mechanism. The Proof of Stake concept allows a person to mine or validate block transactions according to how many coins they hold. The larger the PoS investor, the more control that person can have. A potential attacker would, therefore, need to hold a majority of cryptocurrency tokens to attack the blockchain, whilst an attack of this nature might be environmentally friendly, it would be extremely expensive.
Proof Of Stake networks such as Polkadot, Cardano and Ethereum 2.0 provide an immediate benefit to users beyond price appreciation, which is called staking.
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How does staking work?
As we’ve discussed before, Proof of Work blockchains rely on mining to secure the network and new blocks to the blockchain. In return they receive a block reward. Proof of Stake achieves this through the process of staking. Staking involves validators locking up their coins so they can be selected at random by the protocol to create a block. Participants that stake larger amounts typically have a higher chance of being chosen as the next block validator.
When depositing coins stakers usually have the choice of becoming a validator node in the network or donating coins to support already operational validator nodes. Both offer rewards, but most people usually choose the latter option because it’s far easier.
- Validators: Each validator is randomly selected to confirm transactions and create a new block in the blockchain. Validators are then rewarded with more tokens. Becoming a validator is certainly not for the faint hearted and requires in-depth knowledge of a blockchain.
- Delegators: On the other hand, by donating coins to other validators, staking can be completed passively. This is usually given the rather formal title of ‘delegating’.
Staking simply means keeping funds in a suitable wallet. This basic requirement enables anyone to perform simple network tasks in return for staking rewards.
Each blockchain implements its own method for staking. So before deciding on which coin(s) you will stake, you must do your own research (DYOR) on the staking mechanism, the cryptocurrency itself, the rewards & of course, where you can set aside those coins to be staked. There are typically 4 options.
Is staking the same as yield farming?
Although they are similar concepts, they are very different from one another. As mentioned, staking involves validators locking up their coins based on the PoS consensus algorithm. Yield farming on the other hand provides a lending pool that allows the token holders to generate passive income in exchange for the interest rate. Staking is typically considered less risky than yield farming.
Benefits & risks of staking
When cryptocurrencies are purchased it is usually with the intention of holding, or I should say ‘hodling’ until prices increase. But who knows how long that will take? And what should one do in the meantime?
- The key benefit of staking cryptocurrencies is that it allows these otherwise idle cryptocurrency assets to accrue interest. And not just a little bit of interest. The interest offered usually embarrasses traditional financial products with high single and double digit interest rates – allowing the investor to earn a lucrative passive income stream.
- For those committed to the success of the cryptocurrency industry, it also provides the opportunity to support favored blockchains. So this seems like a pretty good deal. But is staking just another deal that is too good to be true? Well, it’s certainly not quite as simple as watching the dollars roll in.
- The staking process allows PoS blockchains to run continuously. Staking crypto is not just good for your pocket, it’s good for the network too.
- The cryptocurrency industry is inherently digital. The downside of anything digital is that it can malfunction or be exploited. If cryptocurrency tokens are staked through an online crypto wallet or exchange the risk of losing funds through a hack is a definite possibility. Due to prior breaches the crypto industry has had to implement rigorous cybersecurity measures.
- Likewise, many platforms rely on smart contracts (digitally programmed agreements), which can malfunction from time to time. As smart contracts are designed to be irreversible, there are cases where funds have been lost.
- Another factor to think about is that staking can often require cryptocurrency tokens to be locked in the network for a set period. If that is the case, any staked cryptocurrencies cannot be exchanged or sold. If the market suddenly drops, cue March 2020, the cumulative value of staked tokens, may be worth less than when initially deposited. If you plan on holding crypto assets for the long term, this risk can be lowered but not completely removed. As we all know too well, no one can predict where the market will go in the future.
- Finally, when operating a validator node it is crucial to be aware that some blockchains implement a punishment for malicious activity. Malicious activity can include not being continually active on the network or validating transactions incorrectly – remember when we said it wasn’t for the fainthearted? The punishment usually involves burning staked cryptocurrency tokens and is given the fluffy name of ‘slashing’. Not only are a percentage of validator tokens destroyed but also a percentage of any tokens offered to them by delegators.
Mitigating the risks
Wouldn’t it be great if you could enjoy all of the upsides to staking without worrying about the risks? Well, thanks to a few staking-focused products that is now a close reality.
There are now several platforms that offer insurance for smart contract failure or loss of funds through an exchange. Companies such as Nexus Mutual, Etherisc and InsurAce, offer blockchain-based insurance solutions at a cost that varies depending on the staking platform used. Typically, staking insurance can range from 2% to +30%. When staking rewards are high enough, even with the cost of insurance, stakers can be way ahead of those hodling assets or using traditional financial products.
Alternatively, if staking coins for a set period isn’t your ticket, there are now blockchains that do not require a specific lock-up period. These blockchains, such as Tezos, are ideal options for those that want to capitalize on the volatility of the cryptocurrency markets.
Finally, if you can stake from a ‘cold’ (offline) crypto wallet, then this is something worth seriously considering. Staking through a cold storage crypto wallet completely removes the risk of an online hack or breach.
While not all risks are 100% avoidable, by combining some, or all, of these techniques, risks can certainly be reduced in your favor.
Lets talk about Staking rewards
Now that you understand the risks & the rewards and you have a better understanding of how to protect your coins. Then you’re probably eager to know more about the rewards you can earn. Afterall, these incentives are meant to be attractive, they were created to lure you in!
Staking rewards are often displayed as annual percentage yields (APYs) and collected as the same cryptocurrency. Rewards usually trickle in every day, in comparison to the snail-pace monthly payments offered by traditional savings accounts.
What are the top staking coins?
Lower market cap coins usually offer the highest rewards, but they don’t always offer the best staking opportunity. All staking options should be evaluated for ease of use, liquidity of the associated token, and lockup period. Let’s check out some of the more stable options.
- Stablecoins. Stablecoins, of which Tether (USDT) is best known, are US Dollar stablecoin. The benefit of staking stablecoins is that you know the market price should always remain at $1, which removes any volatility. The returns are good too. Infact, the 8.8% returns offered on the Celsius network represent “the real value of the US dollar” according to CEO Alex Mashinsky.
- Bitcoin (BTC). While not a PoS blockchain, there are decentralized finance (DeFi) platforms that now offer users the opportunity to earn rewards for depositing BTC. Pretty handy for an asset that the majority of crypto investors hold.
- Ethereum (ETH). The second-largest market cap blockchain is currently upgrading from a PoW to a PoS consensus mechanism. To secure the network while this process completes ETH token holders can now stake in the network for rewards.
How to start staking
For all the technological finesse behind the scenes, staking can be broken down into some really simple steps.
First of all, you need to purchase some cryptocurrencies. If you haven’t purchased any yet, decide which blockchain or cryptocurrency offers the best staking opportunity for you. Purchase the minimum amount of cryptocurrencies required for staking. This will vary based on the blockchain.
Next you need to choose your staking platform. Find out if your crypto coin of choice requires a specific digital wallet for staking. If not, are you going to complete the process through a crypto exchange or through your own crypto wallet?
Where to stake
If you wish to become a validator in a network, head over to the associated blockchains website, pour some coffee, and start reading the documents for setup. If you’re in it purely for monetary rewards, then read on as you can stake via a wallet, on an exchange, Staking platforms and also via DeFi staking platforms.
Staking via a wallet
Often, it can be performed from a standard cryptocurrency wallet such as Trust Wallet or Ledger or it may require the use of a wallet native to the blockchain. Some also require users to lock up coins for a set period of time, but others don’t.
- Ledger – Ledger is the industry leader for cold wallets & offers secure staking from the safety of your own wallet. Ledger provides staking for five coins: Tezos (XTZ), Cosmos (ATOM), Tron (TRX), Algorand (ALGO) and Polkadot (DOT).
- Trust Wallet – Trust Wallet is a private wallet supported by Binance. The wallet allows users to earn staking rewards from the following coins: Algorand (ALGO), Tezos (XTZ), Cosmos (ATOM), IoTeX (IOTX), Tron (TRX), TomoChain (TOMO), Callisto (CLO) and VeChain (VET).
Staking on exchanges
Thanks to cryptocurrency exchanges the process was made even easier with many now offering their own staking products, such as Binance, Kraken, Coinbase & eToro. While validator nodes are randomly selected, in most networks the more cryptocurrency locked up the more likely a node will be chosen. With huge user bases, exchanges can act as validators and gather pools of coins within staking products. Not only does the exchange profit but it is super convenient for the average cryptocurrency investor.
Similar to Exchanges, Staking-as-a-Service platforms enable investors to stake their stakable PoS coins via a third-party service which takes care of all the technical aspects. In return for simplifying the process, these platforms take a percentage of the rewards earned to cover their fees. Staking on these platforms is commonly known as soft staking.
- MyCointainer – Estonia based MyCointainer makes it easy for users to purchase, store, and profit off staked coins.
- Celsius Network – USA based Celsius Network is a peer-to-peer lending company that facilitates the borrowing and lending of cryptocurrencies.
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- Stake Capital – Stake Capital provides financial instruments and services on top of the leading DeFi and staking networks.
- Stakewith.us – Since 2019 Singapore based Stakewith.us offers secure blockchain staking to institutional and retail clients around the world.
- Staking Lab – Stakinglab is a leading European staking service provider that enables users to soft stake and host masternodes for a variety of stakable digital assets.
- P2P Validator – US based P2P Validator is a non-custodial staking-as-a-service platform, allowing users to compound their crypto assets on more than 25 networks.
DeFi (short for Decentralised Finance) refers to financial services companies that provide new decentralised solutions to the world. They endeavour to make financial services accessible to everyone, whilst providing complete control over their own assets using blockchain technology.
Staking on DeFi protocols is popularly known as liquidity mining or yield farming. Both the DeFi token holders and the protocol operators benefit from this, as while the token holders earn interest and rewards, the process provides liquidity to the DeFi protocol.
- Maker (MKR) – MakerDAO enables the generation of Dai, the world’s first unbiased currency and leading decentralized stablecoin. The platform allows users to borrow stablecoins against various cryptocurrencies. DAI is the principal stablecoin on the network. Therefore, yield farmers deposit DAI which is then lent to borrowers, who receive rewards from the interest charged on loans.
- Synthetix (SNX) – Synthetix provides exposure to a wide array of crypto and non-crypto assets in a decentralized, permissionless, and censorship-resistant way, enabling participation in the DeFi ecosystem despite not holding those assets. The platform issues synthetic assets, known as Synths. Synths are synthetic assets, minted against the value of crypto assets staked as collateral.
- Yearn Finance (YFI) – Yearn Finance is a suite of products in Decentralized Finance (DeFi) that provides lending aggregation, yield generation, and insurance on the Ethereum blockchain. The protocol is maintained by various independent developers and is governed by YFI holders. Instead of facilitating lending and borrowing, it distributes deposited funds into platforms with the best yields and lower risk profiles.
- Compound (COMP) – Compound is a DeFi protocol that hosts lending pools to earn interest on a suite of selected cryptocurrencies, such as USD Coin (USDC), Basic Attention Token (BAT), Ethereum (ETH) and DAI. These pools allow token holders to supply their tokens to others who borrow those tokens at algorithmically set interest rates based on supply and demand. For collateral, the protocol requires borrowers to deposit a given amount of supported coins.
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DeFi staking on Bitcoin sidechains
There is clearly a disconnect between where the money is and where the majority of the staking solutions are presently. The majority of the funds of-course are locked up in Bitcoin, yet staking is almost exclusively located on Ethereum; using ERC-20 tokens.
Although there is a quasi Bitcoin staking solution on the Ethereum blockchain called Wrapped Bitcoin (wBTC); which gives Bitcoin holders access to DeFi via a 1:1 relationship Bitcoin backed token.
But what if the Bitcoin community had access to staking without needing to switch to Ethereum? DeFi staking on Bitcoin side-chains is now available and it looks promising to say the least. Below is a list of the leaders in this space.
- Sovryn – Sovryn is a permissionless & non-custodial smart contract system for Bitcoin lending, borrowing and margin trading. The Sovryn team is building a DeFi ecosystem natively on Bitcoin, hosted on the RSK sidechain, which is secured by the Bitcoin Network. In layman’s terms, it is the decentralized alternative to platforms such as BlockFi, Celsius and many of the centralized exchanges today.
- Cake DeFi – Cake DeFi is a fully transparent platform that allows users to generate cash flow through pooled masternode staking and options lending.
- Stacks – Stacks is an open-source network of decentralized apps and smart contracts built on Bitcoin. Stacks utilises Bitcoin’s full potential as a programmable base layer. The Stacks network uses the proof-of-transfer (PoX) mining protocol, which runs in parallel to Bitcoin and uses the BTC network as a reliable broadcast medium for its block headers. Our in-depth guide on Stacks elaborates on many of these concepts.
- Badger DAO – Badger is a decentralized autonomous organization (DAO) with a single purpose: build the products and infrastructure necessary to accelerate Bitcoin as collateral across other blockchains. Badger DAO has two main products, Sett and DIGG. Sett is an automated DeFi aggregator focused on tokenized BTC assets, while DIGG is a non-custodial synthetic Bitcoin on Ethereum.
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- Atomic Finance – Atomic Finance offers a transparent non custodial way to earn yield on your bitcoin without giving up custody.
Considering these side-chains use tokens with a 1:1 relationship with Bitcoin, many Bitcoiners may still not be interested in parting with their hard earned coins and that’s OK. For those however who wish to put their profits to work – without losing the value of their Bitcoin, then staking on Bitcoin side-chains could be a viable solution to earning passive income.
Staking can be a straightforward way to put cryptocurrency holdings to work. By depositing coins into a Proof-of-Stake mechanism, users can help to secure a blockchain and deter malicious activity.
For this contribution, those staking are rewarded with more coins, similar to earning dividends on stock holdings. For those of you who love and believe in these cryptocurrencies, it offers the opportunity to help the industry maintain its break-neck innovation speed. Staking isn’t without risk. Locking up funds in a smart contract is prone to bugs, so it’s important to be thorough in your research, and safeguard your coins at all times.
Although it can appear daunting, the reality is quite different as many crypto wallets and crypto exchanges now make the process remarkably simple.
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