Cryptos operate without the involvement of third parties. How do they manage to do this? They are able to do this thanks to the mechanisms they use to process and secure transactions on the blockchain. There are several options but the most common are Proof of Work and Proof of Stake. Here’s how Staking in crypto looks like.
“Staking” is part of the Proof of Stake (PoS) mechanism. It allows cryptocurrency transactions to be executed efficiently without duplication or lengthy processing times.
How does crypto staking work
Staking is holding coins for specific periods on a network, in exchange for the right to validate transactions and earn rewards. It usually involves storing crypto in a “staking pool.” Think of these pools as banks that give you interest/rewards for keeping your money with them. The reward is meant to get users to stake their coins and become a validator for transactions.
The following points explain how staking helps validate and add transactions to the crypto network.
- Potential validators stake or commit their tokens to the crypto network.
- Those with larger stakes stand a higher chance of being chosen.
- The next validator is chosen through a pseudo-random process (lottery selection).
- The selected person writes the next block (containing transactions) into the blockchain.
- Successful validators receive a reward (in crypto) for their participation.
Why do only a few projects allow crypto staking?
Most crypto projects don’t use staking because they use a different way of achieving a consensus known as Proof-of-Work (PoW)—a mechanism that Bitcoin popularized.
With PoW, participants known as miners add data about new transactions to the blockchain. Using computational power, miners compete to solve computational problems. The winner gets to validate the transaction.
The PoW model uses high energy and computational power and is considered unsustainable. And as the computational problem becomes more complex over time, PoW also causes a drop in transaction speeds. Yet, cryptos such as Bitcoin or Litecoin continue to use this mechanism. Why? Because proving that a miner expended computational effort is easier with it.
What is Proof of Stake?
Proof of Stake is a built-in consensus mechanism that’s used to prove transactions and to add new blocks to a blockchain network. PoS keeps the database secure by creating a system for validating transactions. All participants in the staking process earn crypto as a reward.
The PoS mechanism works better for larger blockchain networks that select validators to match the current demand for adding new blocks. The selection of validators relies on how long the participants have staked their crypto on the network.
PoS doesn’t require participants to compete—unlike PoW. Instead, it encourages participants to stake their cryptos to earn the privilege of validating new blocks of data. This approach is thus more environmentally-friendly, improves speeds, and reduces transaction processing fees. To avoid the high demands of the POW, some cryptos have shifted to PoS.
The best crypto-staking platforms today are Cardano and Solana. And Ethereum is soon shifting to PoS too.
Is Staking Crypto Safe?
Here are some of the pros and cons of staking your coins. You can decide for yourself
Pros and cons of staking crypto assets
Cryptocurrency staking has several benefits:
- Affordable: When cryptos use staking mechanisms instead of PoW, they eliminate the expense of procuring high-end computers and the energy-related costs.
- Safety: To take over a PoS network, an attacker must control at least 51% of all coins, which is challenging.
- Growth: Staking fuels the growth of the crypto since it prevents panic selling when market prices change. Also, investors with stakes enjoy more profits as market values rise.
- Simplicity: Staking is not as complicated as PoW’s mining process. The only action a participant needs to take is to purchase coins and stake them in their wallets. The cryptocurrency system calculates rewards for the staked amounts in the same way as a bank account.
- Environmentally sustainable: Owning crypto that allows staking is positive for climate change. The PoW mechanism has been blamed for its negative impacts on the environment as it consumes more fossil fuels for energy and creates more waste—from computer parts. The PoS model changes all of that.
Some of the cons of cryptocurrency staking are:
- Illiquidity: Since staking requires users to lock their crypto for specified periods, they won’t be able to access these funds when they need them. The blocking of withdrawals makes staking an inconvenience for crypto holders.
- Low rewards: Staking is an option for all types of investors. But the profits from staking are usually low for those that stake small amounts or use staking pools. Also, if the crypto experiences volatile market shifts, those who have staked their coins can’t do much if their value drops.
- Reduced turnover: Market cap is a good indicator of crypto value. Staking removes coins from circulation—a factor that might affect the turnover of the crypto in question. Indicators can wrongfully interpret low mobility in markets as a sign that the crypto is unpopular or lacks value.
Can you lose money when staking crypto – Risks Involved?
One risk in crypto staking involves the loss of private keys because it requires individuals to lock away their coins for extensive periods. Another risk is that if crypto’s price falls sharply, the investor won’t be able to access it for a quick sell-off.
It is good to be aware of these risks but that need not stop you from choosing to stake your crypto. These risks simply mean staking is better reserved for cryptos with a solid reputation for stability and strong market performance.
When done correctly, crypto staking is a great way to let your crypto generate passive income over time and protect investors from periodic market volatility.
How to Stake Crypto?
Staking bitcoin may appear complicated at first, but it’s a relatively easy process when you get the knack of it. Here’s a step-by-step guide on staking crypto:
- Get a cryptocurrency that employs proof of stake.
- Transfer the coins you want to stake to a crypto wallet
- Join a Staking Pool
Once you’ve identified a pool, stake your coin in it using your wallet. That’s all you have to do to start earning staking rewards.
What is the best crypto to stake?
Staking your crypto on PoS blockchain is an excellent approach to generate passive income and significant profits. These investments are low risk and can offer dividends if you retrieve your profits at the proper time. DYOR before selecting the coin you want to stake.
Is crypto staking worth it?
Crypto staking can be worth it for individuals seeking passive income and long-term investment strategies. It offers potential rewards for participating in the network, but risks such as token price volatility and technical vulnerabilities should be considered before staking.
Is crypto staking safe?
Crypto staking carries risks, including technical vulnerabilities, network security, and token price volatility. However, reputable staking platforms and proper security measures can mitigate some risks. Conduct thorough research and use trusted platforms to enhance the safety of your staking activities.
What is the disadvantage of staking?
Disadvantages of staking include the potential loss of staked tokens due to technical issues or network vulnerabilities, limited liquidity of staked assets, and the possibility of reduced rewards if network participation decreases or the token price declines.
How much will I make staking crypto?
The amount you can make from staking crypto depends on factors like the staking protocol, token rewards, staking duration, and the number of tokens staked. Rewards can vary greatly, ranging from a few percent to double-digit annual returns. Research the specific project’s staking details for more accurate estimates.
Is staking income taxable?
Taxation on staking income varies depending on your jurisdiction’s tax laws. In many countries, staking rewards are considered taxable income. Consult a tax professional or refer to your local tax regulations to understand how staking income is treated in your specific location.
What is the difference between mining and staking?
Mining involves solving complex problems with computational power to secure the network and earn rewards. Staking involves holding and locking tokens to validate transactions and earn rewards.