What Is Crypto Staking and How Does It Work?
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What Is Crypto Staking and How Does It Work?

What Is Crypto Staking and How Does It Work?

Intermediate
প্রকাশিত হয়েছে Sep 22, 2019আপডেট হয়েছে May 10, 2023
9m

TL;DR

  • Staking cryptocurrency means locking up coins to maintain the security of a blockchain network and earning rewards in return.

  • Staking has become a popular way for crypto investors to grow their holdings without selling their digital assets.

  • Crypto staking involves a unique set of risks that can result in a loss of funds.

What Is Staking?

Staking is a process by which individuals lock their cryptocurrency (their “stake”) to support the security and operation of a blockchain network. When someone stakes their coins, they are essentially helping to secure the chain and validate transactions on the blockchain.

Staking is only possible on blockchains such as Ethereum and Cardano based on a proof-of-stake (PoS) consensus mechanism. PoS differs from the proof-of-work (PoW) used in cryptocurrencies such as Bitcoin, where miners use computing power to validate transactions.

Staking coins makes users' holdings less liquid because the coins are tied up in the staking process. Individuals can usually still access their staked coins but may only be able to use them for other purposes once they are no longer staked.

Proof of Stake Consensus

The PoS algorithm uses a pseudo-random selection process to select validators from a group of nodes. This mechanism can combine various factors, such as the age of the stake, randomization, and the wealth of the node. However, each PoS cryptocurrency has its own set of rules and methods that it has combined to create what it believes to be the best possible combination for the network and its users.

PoS allows blocks to be produced without relying on specialized mining hardware, such as ASICs. While ASIC mining requires a significant investment in hardware, and energy to run mining operations, staking requires an investment in the cryptocurrency itself.

In PoS, blocks are forged rather than mined. When a node is selected to forge the next block, it verifies that the transactions in the block are valid. It then signs the block and adds it to the blockchain. As a reward, the node receives the transaction fees from the block and, on some blockchains, a coin reward.

If a node wants to stop being a forger, its stake and earned rewards are released after a period, giving the network time to verify that no fraudulent blocks have been added to the blockchain by the node.

Some might argue that the production of blocks through staking enables a higher degree of scalability for blockchains. This is one of the reasons the Ethereum network has migrated from PoW to PoS in a set of technical upgrades collectively referred to as ETH 2.0.

How Does Staking Work in Crypto?

Each PoS blockchain network has a specific staking currency used to participate in the staking process. This staking currency is typically the native currency of the blockchain network.

For example, if a PoS blockchain is built on Ethereum, the staking currency would be ether. Similarly, if a new PoS blockchain network is launched, it will likely introduce a new cryptocurrency as the staking currency for that network. Users who want to participate in that network would need to acquire the specific staking currency in order to participate.

There are numerous ways to stake cryptocurrencies. The specific method depends on an investor’s level of technical expertise, the amount of cryptocurrency they want to stake, and their preferred level of control.

One option to get started is to set up and maintain a validator node on the blockchain. This method requires technical knowledge and comes with the most control over the staking process. Therefore, it comes with the most responsibility and potential risk.

Another option is to use staking-as-a-service platforms that allow users to delegate their stake to a third-party service provider who runs a validator node. This method offers a balance of control and convenience, allowing users to retain control over their funds while delegating the responsibility of running the validator node to a trusted service provider. Pooled staking is another option that combines your stake with other users. We’ll get into this method in more detail.

Finally, some cryptocurrency exchanges offer staking services to their users, allowing them to stake their cryptocurrency without running their own node or delegating to a third-party service provider. This method offers the most convenience, but users should carefully consider the exchange's security measures before staking their cryptocurrency on the platform.

What Is a Staking Pool?

A staking pool is a group of cryptocurrency holders who pool their coins to increase their chances of being selected as validators. By combining staking power, users can increase their chances of earning staking rewards, distributed proportionally to each pool member based on their contribution.

Staking pools are beneficial for individual users who may not have the resources or technical expertise to run their own validator nodes. Instead, they can delegate their staking power to a pool and earn rewards without running a node themselves.

Staking pools can also benefit smaller investors with insufficient coins to meet the minimum staking requirements. By pooling their coins together with other users, they can meet the minimum staking requirements and start earning rewards.

However, it's important to note that staking pools typically charge a fee for their services out of the staking rewards earned. In addition, users should carefully research and choose a reputable staking pool with a strong track record of performance and security.

What Are the Benefits of Staking Crypto

1. Earning staking rewards

Nodes that participate in the network's validation process are rewarded with cryptocurrency or transaction fees allowing users to earn passive income. Staking can also increase liquidity as it allows users to put their idle holdings to work without selling them.

2. Supporting network security

Staking helps secure the network by incentivizing validators to act in the network’s best interest. Validators who act maliciously or violate the rules of the network risk having their stakes confiscated, which helps deter bad actors from attempting to compromise the network.

3. Decentralization

Staking also helps decentralize the network by allowing anyone to participate in the validation process. This decentralization helps reduce the risk of a single entity controlling the network, which can harm its security.

4. Energy efficiency

Staking is considered a more energy-efficient and environmentally friendly alternative to PoW mining. It requires significantly less computing power to validate transactions and create new blocks.

5. Network governance

Some blockchain networks allow users who stake their crypto to have voting rights and influence the governance of the network. This gives stakeholders a voice in proposing and deciding on protocol upgrades, changes, and improvements, allowing them to shape the future direction of the network.

What Are the Risks of Staking Crypto?

Validators must carefully research the specific cryptocurrency they plan to participate in, understand the risks involved, and clearly understand the technical requirements and procedures involved in staking. Following are some of the risks associated with crypto staking:

1. Volatility risk

The value of cryptocurrencies can fluctuate wildly, which means that the value of the staked cryptocurrency can decrease rapidly, potentially resulting in significant losses.

2. Slashing risk

In PoS networks, validators can be penalized for various types of behavior that violate network rules, such as double-signing or going offline for extended periods of time. These penalties can result in the loss of some or all of the staked coins.

3. Centralization risk

In some PoS networks, a small number of validators may hold a significant portion of the staked coins. This can create centralization risks, as these validators may have disproportionate power and influence over the network.

4. Technical risk

Staking requires users to keep their coins locked in a wallet or validator node for an extended period. Technical failures, such as software bugs, can result in the loss of staked coins.

5. Lock-up periods 

Users typically need to immobilize their coins for a predetermined period when staking their crypto. Immediate access to these coins may be restricted during this time, preventing them from selling their holdings as quickly as they normally would if they weren’t stakes. There’s a possibility of forfeiting potential investment opportunities or encountering an inability to respond promptly to price fluctuations.

How to Stake Your Crypto

Get PoS crypto

Make sure to choose a cryptocurrency that supports staking. Then obtain the required number of coins to stake. Some blockchains have minimum staking amounts, which may vary depending on the network.

Transfer the crypto to a wallet

Set up a wallet that supports staking. It’s safest to use the wallets recommended on the blockchain's official website.

Transfer your staking coins to your wallet. Follow the network-specific instructions for transferring coins.

Begin staking

Follow the network-specific instructions for staking, which may involve delegating coins to a validator node or running a validator node yourself. This information can be found on the chosen blockchain’s official website.

How Are Staking Rewards Calculated?

Each blockchain network may use a different way of calculating staking rewards. Some are adjusted on a block-by-block basis, considering many different factors. There’s no short answer, but the reward calculation may include the following:

  • The number of coins the validator is staking 

  • The length of time the validator has been actively staking

  • The validator’s ability to fulfill their responsibilities

  • The total number of coins staked on the network

  • The network's transaction fees 

  • The inflation rate of the coin

For some networks, staking rewards are determined as a fixed percentage. These rewards are distributed to validators as compensation for inflation. Inflation encourages users to spend their coins rather than hold them, which may increase their use as a cryptocurrency. But with this model, validators can calculate exactly what staking reward they can expect.

A predictable reward schedule may look more favorable than a probabilistic chance of receiving a block reward to some. And since this is public information, it might incentivize more participants to get involved in staking.

Why Can’t You Stake All Cryptocurrencies

Only cryptocurrencies built on a PoS blockchain consensus mechanism can be staked. PoS allows users to validate transactions and secure the network by staking their cryptocurrency holdings rather than solving complex mathematical equations, as is the case with PoW consensus mechanisms. Cryptocurrencies built on PoW blockchain consensus mechanisms can’t be staked.

Not all PoS cryptocurrencies support staking. Some PoS cryptocurrencies may have other mechanisms to incentivize users to maintain and support the network, such as delegated proof-of-stake (DPoS), which may not involve staking in the traditional sense.

Researching the specific cryptocurrency and network you are considering staking in and understanding the staking requirements and rewards is vital.

Closing Thoughts

Staking crypto opens up more avenues for anyone wishing to participate in the maintenance and governance of blockchains. It’s also an easy way to earn rewards by simply holding digital assets. The barriers to entry to the blockchain ecosystem are getting lower as staking becomes easier.

It’s worth keeping in mind that staking isn’t risk-free. Smart contracts used to lock up funds can be prone to bugs, so it’s always important to do your own research and use highly secure wallets.

Further Reading

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