Generating profits in the crypto space goes beyond the simple strategy of selling assets during market upswings. There are other ways to make profits, and staking is one of them. As an alternative approach, staking lets you generate income without having to sell your cryptocurrency. Consider staking as the crypto equivalent of depositing money into a high-yield savings account.
Like traditional savings, where banks utilize deposited funds for lending, staking involves locking up your digital assets to support blockchain operations. In return for your contribution, you earn a share of the rewards generated by the network.
In this article, we’ll dive into the details of staking, exploring its definition, mechanics, and how it generates passive income. Let’s take a look:
What is Staking?
Staking is a process where cryptocurrency holders willingly participate in validating transactions on the blockchain. The purpose of this is to verify the transactions on the ledger. This validation isn’t carried out by individuals but computers within the blockchain network and is often facilitated by third-party staking services. In return, the crypto holder, who temporarily lets go of the use of their involved cryptocurrencies, receives a share of transaction fees in the form of cryptocurrency.
From a customer’s standpoint, staking becomes a means of earning returns on cryptocurrencies by agreeing to lock them up for a specific period. Staking exclusively occurs on proof-of-stake (PoS) blockchains, such as Ethereum. This differs from the proof-of-work (PoW) mechanism in cryptocurrencies like Bitcoin, where miners deploy computing power for transaction validation.
Staking coins decreases the liquidity of users’ holdings as the coins are tied up in the staking process. While individuals can usually access their staked coins, they will only be able to utilize them properly once they are unstaked.
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How Does Staking Work?
Staking operates exclusively through the proof-of-stake consensus mechanism, which specific blockchains use to choose participants and validate new blocks of data added to the network.
To ensure integrity within the network, participants are required to purchase and lock away a certain number of tokens. This discourages any inclination towards foul actions, as corrupting the blockchain could significantly drop the native token’s value, resulting in financial losses for the wrongdoer.
The stake itself represents the participant’s investment, which is essentially the commitment to acting in the best interest of the network. In return for this commitment, validators receive rewards in the native cryptocurrency. The size of the stake directly influences their likelihood of proposing a new block and collecting rewards.
Stakes don’t need to be exclusively comprised of one person’s coins. Validators often run staking pools, pooling funds from multiple token holders through delegation. This delegation system reduces the entry barrier, allowing more users to participate in staking. Any holder can participate by delegating their coins to stake pool operators, who handle the complex task of validating transactions on the blockchain.
Proof-of-stake (PoS) Consensus Mechanism Explained
The proof-of-stake algorithm utilizes a randomized selection process to choose validators from a node group. This process considers factors like randomization and node wealth. However, each PoS cryptocurrency dictates its own rules and methods to optimize the network and reward users.
Unlike traditional mining setups, PoS eliminates the need for specialized hardware. Your investment is solely in the cryptocurrency itself. In this consensus mechanism, blocks are forged by selected nodes. When chosen, a node verifies the block’s transactions for validity, signs the block, and adds it to the blockchain. As a reward, the node earns transaction fees and, on certain blockchains, a coin reward.
Should a node wish to stop forging, its stake and earned rewards are released after a period. This allows the network to guarantee no fraudulent blocks were added during the node’s forging period.
What Cryptocurrencies Can You Stake?
There are a lot of cryptocurrencies that are established on the proof-of-stake mechanism. Some of the top cryptocurrencies that are available for staking right now include:
- Ethereum (ETH)
- Cardano (ADA)
- Polkadot (DOT)
- Solana (SOL)
- Avalanche (AVAX)
- Polygon (MATIC)
- Algorand (ALGO)
Ethereum is the most popular proof-of-stake cryptocurrency in the world.
How Can You Start Staking?
If you want to explore staking for potential yields, you can begin by following these simple steps.
Choose the Right Token:
Not all cryptocurrencies support staking. Begin by selecting a token that operates on a proof of stake or a similar consensus mechanism, as these generally support staking. It is advised that you do thorough research before choosing the crypto you want to stake.
Acquire Your Chosen Cryptocurrency:
Purchase the selected cryptocurrency through one of the many crypto exchanges available. Not all cryptocurrencies are available on top exchanges like Binance or Bybit. Once you have chosen your cryptocurrency, you find out what exchanges offer that crypto and whether or not you can stake on the exchange.
Select a Staking Platform:
The most critical decision in this process is choosing a staking platform. The platform you pick determines the staking type and whether token storage is custodial or noncustodial. Again, you are advised to do thorough research before choosing a staking platform.
Prepare Your Digital Wallet:
Make sure you have the chosen tokens in your digital wallet, and with the staking platform selected, you’re ready to proceed. The procedure for staking can vary a little depending on the cryptocurrency and the staking platform, so it can vary.
Follow Staking Protocols:
Follow the protocols outlined by the chosen platform to stake your crypto. Staking involves locking the token in a blockchain network for a predetermined period. Once completed, you’re set to earn through staking.
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Risks of Crypto Staking
Just like any investment, especially in crypto markets, it’s important to be aware of the potential risks that come with that venture. Investors should be mindful of the risks given below before staking their cryptocurrencies.
Volatility of Cryptocurrencies:
Cryptocurrencies are known for their price volatility. Significant drops in value can outweigh the rewards earned through staking. Staking is most suitable for those committed to holding their assets for the long term, regardless of market fluctuations. If you like to get in and out of an investment quickly, staking is not ideal for you.
Minimum Lock-Up Period:
Certain coins may require a minimum lock-up period, during which you cannot withdraw your assets from staking. This commitment should align with your investment goals. Once you have staked your cryptocurrency, you cannot withdraw it until the locking period is complete. When withdrawing assets from a staking pool, each blockchain has a specific waiting period before you regain access to your coins. Be prepared for this delay.
Staking pools involve a counterparty risk with the pool operator. You might miss out on expected rewards if the validator fails to perform its duties and incurs penalties. That is why it is vital to choose a reliable staking pool. Don’t just select the first staking pool you come across. Do your research and make sure it’s a trusted pool.
Staking pools are susceptible to hacking, and if a breach occurs, you can end up losing all your stake funds. Since these assets lack insurance protection, the chances of compensation are minimal.
Can You Stake Bitcoin?
Bitcoin operates on the proof-of-work (PoW) consensus mechanism, which means it cannot be staked. Staking is exclusive to cryptocurrencies built on a proof-of-stake (PoS) blockchain consensus mechanism.
In PoS, users validate transactions and secure the network by staking their cryptocurrency holdings. PoW, on the other hand, relies on miners to solve complex mathematical equations and validate transactions in the process. This fundamental difference is why Bitcoin relies on miners, and cryptocurrencies utilizing PoW consensus mechanisms cannot be staked. However, you can stake Ethereum as it is built on the PoS consensus mechanism.
In conclusion, staking offers a viable avenue for investors seeking long-term yields. If you are not unfazed by short-term price fluctuations, staking is worth considering. You must also keep your investment goals in mind before you lean towards staking. Avoid staking if short-term access to funds is critical to you. Also, prioritize thorough research when selecting cryptocurrency and the staking platform. If you make informed decisions, you are less likely to face hurdles in your staking ventures.
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