Staking has become one of the most intriguing concepts of cryptocurrencies, especially since you are able to earn rewards just by locking up your funds.
How does staking give you rewards, and is it really safe?
Here’s everything you need to know.
What is crypto staking?
Staking refers to the action of locking up your crypto assets with a validator on a Proof-of-Stake blockchain network, and receiving staking rewards in return.
Validators are similar to miners in a Proof-of-Work blockchain, where they will get the chance to process transactions on the network.
If they correctly process a block, they will be issued staking rewards by the network.
After taking their commission, the remaining amount will be distributed to you as staking rewards.
While only one validator will be selected to process a transaction, there will be other validators that are selected to double-check if the selected validator processed transactions correctly.
To ensure that validators are operating in the best interests of the network, they are required to lock up some collateral on the network. This will usually be in the form of the network’s token.
In the event that a validator misbehaves or acts maliciously, some of the collateral will be taken away, which is also known as slashing.
Since the validator would not want to lose the collateral that they locked up, they are incentivised to behave in the best interests of the blockchain network.
This is only for PoS networks
Staking is only possible if a blockchain network utilises the Proof-of-Stake (PoS) consensus mechanism.
For example, you are unable to stake BTC on its network, as it uses Proof-of-Work (PoW) and not PoS.
The PoS consensus will nominate a validator to validate a block of transactions on the blockchain.
In most cases, the higher the number of crypto assets that are staked, the greater the chance of being selected to validate the block.
There are different ways that a validator will be nominated, and this will depend on how the network operates.
- Randomised Block Selection (validators are selected based on having the lowest hash value and the highest stake)
- Coin Age Selection (the longer the tokens have been staked, the higher the chance of being selected)
Which blockchain networks utilise PoS?
Here are some well-known examples of cryptocurrencies that use the PoS consensus mechanism:
In fact, the Ethereum network is in the midst of transitioning to a PoS consensus mechanism, and you can find out more about it here.
How can I stake my tokens?
These are the 2 main ways to stake your crypto assets:
#1 Becoming a validator
The first way to stake is by becoming a validator of your own.
However, for most networks with PoS, being a validator may require some technical expertise.
Here are some of the documentation for the different networks:
You will need to run some code, which can be rather complicated!
#2 Delegating to a validator
Instead of fussing with the code required to be a validator, it may be better to delegate your stake to a validator who’s already up and running.
This will save you the hassle of setting up a node, but the validator may take a commission from the staking rewards that are distributed to them.
Nevertheless, it will help to save you a LOT of trouble!
How are the staking rewards generated?
For most cryptocurrencies, you will receive staking rewards in the same coin or token.
Here are some ways the staking rewards are generated:
#1 Transaction fees
When a user performs any transaction on the blockchain, they will need to pay a small transaction fee to process it.
This is sometimes called gas fees.
As a validator processes the transactions in that particular block, they will receive all the transaction fees involved as their reward.
#2 Inflationary rewards
Apart from just the transaction fees themselves, some networks will issue new tokens for every block that has been generated.
This would mean that for every new block being generated, there will be new tokens that have entered the circulating supply.
Since the supply of the token increases, the price of each token may decrease.
This is similar to how the printing of US dollars has resulted in one of the worst inflation rates that we have had in 4 decades.
JUST IN: CPI YoY hits 9.1%
— Blockworks (@Blockworks_) July 13, 2022
While the staking APY may seem quite high for certain cryptocurrencies, it will be good to consider the inflationary rate of the token.
Solana has a high initial inflation rate (8%), before it reduces to 1.5% as the long-term rate.
Furthermore, what determines the staking yield for Solana is the amount of SOL staked divided by the total amount of SOL.
Since the supply of SOL tokens continues to increase,
the staking yields will eventually decrease.
With this increase in supply of SOL tokens, there could be a decrease in the value of each SOL token since the supply is diluted.
As such, the high staking yields may not be sustainable in the long run!
Another example is the Cronos token (CRO), where there has been 5 billion CRO that is set aside for staking rewards.
Interestingly, the supply in this wallet has been frozen until 7th November 2022.
— Crypto.com (@cryptocom) November 7, 2019
What are the risks associated with staking?
There are 3 main risks of staking cryptocurrencies on a blockchain network.
#1 Validators getting slashed
To ensure that all validators are behaving properly, they may get penalised if they do not behave properly.
In such an event, some of the staked cryptocurrencies by that validator will get slashed, or taken away.
If you have staked your crypto with a slashed validator, some of your funds may be lost!
As such, it will be good to spend some time finding a good validator. One indicator of a good validator is one with a high uptime, which is the time that the validator is online and can process transactions.
A validator with a high uptime would mean that there is a lower risk of getting slashed.
An alternative way is to spread your staked amount across multiple validators. This helps to diversify your risk, as only a portion of your funds will be affected if one validator gets slashed.
Interestingly, not all networks use slashing to penalise validators. One such example is Cardano.
In fact, Cardano does this the other way around. Instead of taking a portion of the staked funds, the malicious validator will not be able to receive any staking rewards when a new block is formed.
As result, users who delegated their stake to this malicious validator will no longer be able to earn staking rewards, and they may redelegate their stake to another validator.
The malicious validator will become less relevant as the amount staked with it decreases. Since there are some costs incurred in running a node, it is not economically viable to act against the interests of the network.
#2 Time taken to receive staking rewards
For some networks, you may not be able to receive your staking rewards immediately after staking your tokens.
In the case of Cardano, you will need to wait a few days before you can receive your staking rewards, as shown in this timeline here.
You will need to wait at least 15–20 days to receive the first rewards when you first stake your ADA tokens.
This is in contrast to staking CRO or OSMO tokens, where you can start to receive staking rewards immediately.
These cryptocurrencies with instant staking rewards may have a lockup period, and this comes with its own risks too!
#3 Lockup period
The Terra crash has been a huge disaster, resulting in one of the worst crypto crashes.
If you had staked LUNA on the Terra Station wallet, you would have needed to wait 21 days before you could receive the LUNA tokens back in your wallet!
In the event that a sudden price crash happens, you may not be able to unstake your cryptocurrencies in time to sell them off.
As such, it will be good to check if the crypto that you’re staking has a lockup period, especially if the price is rather volatile.
How can I stake my crypto?
Here are the 3 main ways that you can use to stake your cryptocurrencies:
#1 Non-custodial wallets
For each PoS network, there will be some non-custodial wallets that provide staking services directly from their wallet.
Some of these include:
- Phantom (SOL)
- Keplr (ATOM, OSMO, etc.)
- Exodus (ADA, ATOM, SOL, ALGO)
- Yoroi (ADA)
Non-custodial wallets give you the greatest control over your assets. You will be able to have full custody of them, and will not face the risk of having any of them withdrawn.
However, this would also mean that you will need to keep your wallet secure. If anyone gets a hold of your seed phrase or private key, they are able to access all of your funds!
As such, it is important to keep this seed phrase secure, and to be careful of which DeFi protocols you are interacting with.
#2 Centralised platforms
There are some centralised crypto exchanges that allow you to stake cryptocurrencies on their platform.
Some of them include:
One of the main concerns with centralised platforms is that you do not have full custody of your crypto assets.
This is because the platform owns the private keys of your account, which differs from a non-custodial wallet.
Self-custody has become a hot topic, especially after the crash of centralised lending platforms.
Some of these platforms even halted withdrawals, which shows the need for self-custody!
⏸ Why are so many crypto platforms pausing withdrawals?
💸 Here’s a deep dive on why some platforms stopped withdrawals, while others still survived
— Krystal DeFi (@KrystalDefi) July 7, 2022
You can find out some of the key lessons we can learn from this crash here.
#3 Liquid staking platforms
With the advent of staking, a brand new concept has been released, known as liquid staking.
While staking locks up your assets, liquid staking allows you to continue utilising your staked assets with other protocols.
When you stake your crypto assets with a liquid staking platform, you are given another token which represents your staked assets.
For example, staking ETH on Lido Finance will give you stETH (or staked ETH).
You are able to use this liquid staking token in different DeFi protocols to earn even more yield.
What’s more, your staked crypto assets will still continue to generate staking rewards!
Some liquid staking platforms include:
While this adds a lot of functionalities to your locked tokens, there are certain risks, such as the increased centralisation of the network.
Lido Finance has raised some concerns about the centralisation of Ethereum after The Merge, which you can find out more here.
Staking cryptocurrencies can be a good way to earn passive income on your idle assets.
However, here are some things you can consider before leaving your cryptocurrencies staked for the long term:
- What is the lockup period?
- Will my validator get slashed if they behave maliciously?
- Am I staking with a centralised entity or do I have full control over my assets?
- Is the cryptocurrency I’m staking inflationary in nature?
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