As a decentralised entity, cryptocurrencies have no single control authority. This can come with the risk of double-spending and other financial irregularities. To avoid such concerns, cryptos depend on mining. It involves various computers working in the network to verify transactions and introduce new blocks on the network.
In the earlier crypto days, Proof-of-Work was the most common mining option. This is where various computers compete in solving arithmetic puzzles. The first computer to solve the puzzle gets rewarded. However, with time, there has been the need for more computing power hence more energy is needed. This has an impact on the environment. Instead of the PoW, the current range of cryptos is using the Proof-of-Stake protocol consensus.
That is where staking in crypto comes in.
What is Proof of Stake (PoS)?
To understand crypto staking, we must first understand how Proof of Stake (PoS) works. PoS is a consensus mechanism that allows blockchains to run more efficiently while preserving a reasonable level of decentralization (at least, in theory).
If you understand how Bitcoin works, you probably heard of Proof of Work (PoW). It is the mechanism that permits transactions to be grouped into blocks. The blocks are then connected to form the blockchain. Miners compete to solve a complicated mathematical puzzle, and the first person to answer it can add the next block to the blockchain.
Proof of Work has shown to be a robust approach for facilitating decentralised consensus. The issue is that it requires a lot of arbitrary computation. The puzzle the miners solve serves no purpose other than keeping the network safe. One may argue that this justifies the excess of computation. At this point, you may be asking if there are any alternative ways to preserve decentralised consensus without incurring such enormous processing costs.
The basic feature of Proof of Stake is that participants can lock funds (their “stake”), and the protocol will randomly allocate one of them the authority to validate the next block. The possibility of being chosen usually depends on the number of coins locked up – the more coins locked up, the better the chances.
For the Proof of Stake mechanism, what determines which participants construct a block is not based on their ability to solve hash problems. Instead, it is determined by the number of staking coins they have.
Some may claim that the production of blocks through staking allows blockchains to be more scalable. This is among the reasons why the Ethereum network is expected to transition from PoW to PoS as part of a package of technical upgrades known as ETH 2.0.
What is crypto staking?
Staking cryptocurrencies involves buying then setting aside a certain amount of tokens which are then used as nodes in the network to validate transactions. The network uses these tokens in the verification process while the token holder gets rewarded accordingly.
The rates of the rewards for the staked tokens differ depending on the given network. Some factors that impact the rewards include the market demand and supply dynamics.
For the longest time, staking was only possible on a token’s mainnet. However, as PoS-based cryptos become more common, crypto staking facilities become more available. You can opt to stake on the staking pools from crypto exchanges and cold staking. These options seek to allow even those who hold fewer tokens to stake. Something that was not possible in the earlier days.
Some of the cryptos that currently allow staking include Ethereum 2.0, Cardano, Polkadot, Trezor and Solana.
Staking explained. Source: CoinCulture
How does crypto staking work?
The first step to staking crypto is by ensuring you are operating in a crypto platform that uses the proof-of-stake protocol consensus. The next step is to buy the tokens which you will then set aside for staking. Every crypto project provides for a staking procedure on the network. Otherwise, if you have fewer tokens you can transfer them to the staking pools on the crypto exchanges.
Tokens that are part of the staking process operate as nodes that validate transactions. You are entitled to rewards depending on your network activity. That is why the more nodes you have, the higher compensation you receive.
You can either opt for fixed staking where you hold tokens for a specific period or flexible staking where you can withdraw the tokens at any time.
What are some of the crypto staking advantages?
Staking comes with various benefits such as;
- Provides an easy way to earn interest on tokens.
- There is no need for any special machines like in the case of mining.
- More environmentally friendly compared to mining.
- It is a way to ensure the security and efficiency of the blockchain network.
What are some of the crypto staking risks?
At the same time, staking comes with various risks. These include;
- The volatile nature of cryptos means your tokens can lose value over time.
- With fixed staking, you cannot use your cryptos in any other way until the stipulated time.
Still, these concerns are manageable and should not stop you from staking.
How are staking rewards calculated?
There is no simple answer here. Each blockchain network may have its method of calculating staking rewards. Some are changed block by block, based on a variety of criteria. These are some examples:
- The number of coins the validator stakes
- The period that the validator has been actively staking
- The total number of staked coins on the network
- The inflation rate
- Other factors
Staking rewards on several other networks are established at a predetermined percentage. As a kind of inflation compensation, these payments are provided to validators. This encourages users to spend their coins rather than save them, which increases bitcoin adoption.
However, using this model, validators may determine the precise staking reward they expect. Some may prefer a fixed payout schedule to a probabilistic chance of earning a block reward. As this is public knowledge, it motivates more people to participate in staking.
What is a staking pool?
As a group of crypto holders, a staking pool merges their resources to improve their chances of validating blocks and getting rewards. They combine their staking power and split the profits based on their contributions to the pool.
Setting up and managing a staking pool requires significant effort and expertise. Staking pools are the most effective on networks if the entrance barrier (technical or financial) is reasonably high. As a result, many pool operators deduct a fee from the staking incentives provided to players.
Aside from that, pools offer further freedom to individual stakeholders. The stake is typically locked for a specified amount of time and has a withdrawal or unbinding time determined by the protocol. Furthermore, a significant minimum balance is necessary to disincentivise malevolent action.
Most staking pools have a low minimum balance and no extra withdrawal delays. As a result, joining a staking pool rather than staking solo may be conducive to beginners.
How to stake crypto?
Staking bitcoin may appear complicated at first, but it’s a straightforward procedure once you get the hang of it. Here’s a step-by-step guide on staking cryptocurrency:
1. Buy a coin that uses PoS.
Staking is not available in all cryptocurrencies. You need a crypto that uses PoS to validate transactions. Here are some major cryptocurrencies you can stake:
- Ethereum (ETH) is the first cryptocurrency to have a programmable blockchain on which developers could build apps. Ethereum began with a PoW mechanism but is now shifting to a PoS mechanism.
- Cardano (ADA) is a cryptocurrency that is beneficial to the environment. It is based on peer-reviewed research and was created using evidence-based procedures.
- Polkadot (DOT) is a protocol that enables multiple blockchains to interact and collaborate.
- Solana (SOL) is a scalable blockchain that delivers rapid transactions with cheap costs.
Begin by studying more about any PoS cryptos that pique your interest, such as how they function, their staking rewards, and the staking method for each one. Then you can opt for the cryptocurrency to purchase on crypto exchanges.
2. Transfer crypto to a wallet.
After you acquire your cryptocurrency, it will be available on the exchange from which you purchased it. Some exchanges provide staking programs with specific coins. For instance, CoinSpot allows you to stake an amount you can afford to earn attractive staking rewards. You can learn more about how to stake crypto on CoinSpot here.
Otherwise, you must transfer your funds to a blockchain wallet, often known as a cryptocurrency wallet. Wallets are often the most secure method of storing bitcoin. You can use a free software wallet, but hardware wallets are more secure, but you need to purchase one.
When you have your wallet, choose to deposit crypto and the type of cryptocurrency you prefer. This generates a wallet address. Navigate to your exchange account and select the option to withdraw your cryptocurrency. To move your cryptocurrency from your exchange account to your wallet, copy and paste that address.
3. Join a staking pool.
While staking might vary based on the coin, most employ staking pools. To increase the chances of receiving staking rewards, crypto traders pool their funds in these staking pools.
Investigate the staking pools that are accessible for your cryptocurrency. There are a few things to keep an eye out for:
- Reliability: You do not get rewards while the servers of your staking pool are down. Choose one with uptime as close to 100% as feasible.
- Reasonable fees: Most staking pools take a tiny percentage of the staking earnings. The amount is fair depending on the coin, but it’s typically 2% to 5%.
- Size: Smaller pools are less likely to be selected to validate blocks, but when they are, they give more significant rewards since they do not need to share prizes as evenly. You don’t want a pool that is too tiny and may fail. However, as some cryptocurrencies limit a pool’s rewards, the largest pools may become oversaturated. Mid-size pools are ideal for the majority of investors.
Once you’ve identified a pool, stake your cryptocurrency in it to earn incentives.
Why not all cryptocurrencies have staking
Cryptocurrencies must employ the proof-of-stake consensus to be staked. Many do not, and these cryptocurrencies cannot be staked.
Proof of stake isn’t the first or only consensus available to cryptocurrencies. Proof of work was the first because it began with Bitcoin. Other early cryptocurrencies followed suit until 2012 when Peercoin (PPC) introduced proof of stake.
There is disagreement on which consensus technique is more secure. Although proof of work requires a significant amount of processing power, it also makes proof-of-work blockchains hard to attack. For this reason, several cryptocurrencies use proof of work.
Proof of burn is a less prevalent consensus process in which miners must burn (destroy) crypto to confirm transactions. No solution is ideal, and bitcoin developers select the one that best suits their needs.
When to stake crypto?
If you have coins using PoS and don’t intend to exchange them anytime soon, you can stake them. You don’t need to do anything else to earn more coins.
What if you don’t currently have any crypto to stake? Given the potential profits, it’s worthwhile to try staking cryptos. However, buying crypto to stake only makes sense if you also feel it is a solid long-term investment.
The proof-of-stake mechanism has benefited both cryptocurrencies and investors. Cryptocurrencies use proof of stake to execute vast numbers of transactions at little cost. Crypto investors can also generate passive income from their investments.
Proof of Stake and crypto staking provide opportunities for everyone interested in participating in the consensus and governance of blockchains. Furthermore, merely holding coins is a simple way to create passive income. The barrier to entry into the blockchain ecosystem reduces when it becomes easier to stake.
It’s important to remember that staking isn’t without risk. Since storing funds in a smart contract is vulnerable to faults and attacks, it’s recommended to stake coins on highly secure platforms.