For a long time since the inception of cryptocurrencies, the only way to earn new coins was to participate in the mining process. This usually required much-enhanced computing power, as well as a huge power outlay. Due to the sheer cost of this process and its detrimental effects on the environment, most crypto enthusiasts were turned off from it. However, there are now several crypto coins that allow users to stake their coins on their blockchain network, which consequently earns them staking rewards.
Staking defined
There are a few cryptocurrencies that allow staking. They include the likes of Cardano, Solana, Polkadot, and now Ethereum, too, after the Ethereum 2.0 update. If you own any of these coins, you can opt to stake some or all of your holdings and earn interest on them over time. This works similarly to opening a fixed savings account with your bank.
The rewards doled out for staking are because the crypto network puts your coins to work. Staking is only possible for crypto coins that use the proof-of-stake method of transaction validation, as opposed to the proof-of-work model common with Bitcoin. The coins you stake are used as collateral to allow you to verify a new block of transactions on the network. In case of any errors in the block you verify, a penalty is charged on your stake.
Why can’t all crypto coins be staked?
If you have read anything about crypto, you know that they are typically decentralized. This means that there is no central authority that has total control over a cryptocurrency’s network, which is called a blockchain. So how do all the computers (nodes) on the blockchain solve the equation that allows them to verify new blocks on the network?
They do this via a consensus mechanism. Most crypto coins such as BTC and ETH 1.0 use the proof-of-work mechanism. This means that miners will use advanced computing power to try and solve a cryptographic equation on the network. The first to solve it gets to verify a new block of transactions and gets rewarded with crypto coins in return.
The proof-of-work model is not feasible for large blockchains such as the Ethereum network, which has several applications running on it. This is because the increased traffic may overload the network, increasing transaction periods and, consequently, transaction fees.
Proof-of-stake
PoS is a consensus mechanism meant to increase the speed of transactions and reduce fees on the blockchain. Instead of miners competing to solve complex mathematical problems, people who are heavily invested in the network are selected to validate transactions.
In this method, users stake their coins, essentially putting them on the line, so they can get a chance to validate these transactions. Their stake acts as a guarantee that they will act in good faith. Therefore, the more they stake, the higher their chances of getting to verify the next transaction block, and receive rewards for it. If there are found to be erratic transactions in the block they verify, a section of their stake is burned by the network, a phenomenon known as slashing.
Staking pros
- You can earn interest on the cryptocurrencies you hold instead of them just sitting idly in your wallet. This interest may reach up to 10% or 20% annually, which is higher than most banks’ interest on savings accounts.
- Staking doesn’t necessitate complex equipment, unlike mining.
- You participate in ensuring the security and efficiency of the blockchain you’re invested in. This way, you ensure your blockchain is running smoothly, thus securing your investment.
- Staking is not as harmful to the environment as mining.
Staking cons
- Cryptocurrency prices tend to be volatile. This means they can drop sharply, which, if the drop is large enough, could negate any profits gained from staking rewards.
- Staking involves locking away your assets for a specified period of time. During this time, you cannot trade or otherwise move your coins, which is a risk on its own, especially when their price drops steadily.
- If for any reason, you choose to unstake your coins, the process is not instant. In some cases, it could take as long as a week or more.
For these reasons, before staking your coins, do your research and find out how long the lockup period is and how long it takes to unstake your coins from the network.
How to stake
Staking has little to no barriers to entry, and anyone holding stakable coins is welcome to do so. However, to become a fully-fledged validator, you may need suitable computing equipment and software with no downtime, as well as a copy of the blockchain’s entire transaction records. You also need a minimum investment to stake. For the Ethereum network, this is capped at 32 ETH.
However, an easier method would be to use an exchange. Using exchanges like Coinbase, eToro, or Binance.US, you can stake your coins through them since they have access to the best validator hardware and software. In return, they charge a fee which is usually a percentage of the returns, so you’re still in profit.
Alternatively, you could join a staking pool run by another user. To do this, you will need to do extensive research on the policies of potential pools and their history of penalties for mistakes. Also, you may not want to join the biggest pool, as blockchains are usually against any one group wielding too much power over the network.
Conclusion
Staking involves putting your crypto holdings on the line so as to get a chance to verify a block of transactions on the blockchain. Once you successfully verify a new block, you are rewarded with new coins. Staking only works for coins that use the proof-of-stake consensus model. You may also stake through exchanges like Coinbase and Binance at a fee or join a staking pool.
