What is Staking in Crypto? What You Need to Know

While buying and holding crypto coins is one way to make money with cryptocurrencies, there are other ways to put your digital assets to work for you. One of these options is a process known as staking.

Crypto staking is a way of earning rewards for holding specific cryptocurrencies. Let’s take a closer look at how staking crypto works and how you could use it to earn more on your digital assets.

What is staking crypto?

The idea behind staking crypto is pretty simple. You let an exchange or a blockchain project use your cryptocurrency coins to validate transactions. In return, you receive a reward, usually in the form of the coin you’re staking. So, if you stake tezos (XTZ), you receive more XTZ in return for letting the project use what you staked.

Staking crypto is one way to learn how to invest money and earn a return by putting your assets to work. Staking coins lets you earn extra passive income on top of any appreciation the coin might experience.

With staking, you agree to put up your coins for a chance of being selected to validate a block on the blockchain. When it’s time to validate a transaction, you could be randomly selected to help create the new block as a validator. This takes less energy than crypto mining, and you don’t need to buy special computing hardware to increase your chances of being chosen to help with the transaction.

Staking crypto can also work as a way to provide liquidity to an exchange. For example, you might put up your coins on an exchange. The exchange can then use your coins to validate trading transactions and then offers you a reward.

How does staking work?

When you stake your crypto assets, you basically agree to hold your coins up so they can be used to validate transactions. It’s similar to putting your cash in a certificate of deposit (CD) in that you agree to keep the money locked up for a set period of time. In return, you receive an interest yield on the money.

Crypto staking works similarly. In return for letting someone else use your crypto coins, you receive a reward. This can be in the form of a regular interest yield (paid out at regular intervals in the coin you’re staking), a share of the fees earned, or some other mechanism designed to reward you for staking your cryptocurrencies.

Some of the altcoins you can stake include tezos (XTZ), cardano (ADA), polkadot (DOT), solana (SOL), and algorand (ALGO). Additionally, as Ethereum 2.0 rolls out its proof-of-stake (PoS) protocol, it will be possible to stake a soon-to-be-merged version of ethereum (ETH) and ethereum 2 (ETH2) and earn.

What cryptocurrencies don’t allow staking?

Not every cryptocurrency allows staking. For example, bitcoin (BTC) doesn’t allow staking and continues to work off a proof-of-work (PoW) protocol.

You can only stake cryptocurrencies that use a proof-of-stake (PoS) protocol. Basically, these are two different ways to validate transactions and create new data blocks to be added to the chain.

Proof-of-work

With PoW, computer processing power matters. The blockchain network requires a large amount of processing power. Those who validate transactions and add blocks to the chain are rewarded for the “work” they do by lending computing power to the network to keep the blockchain secure. When cryptographic puzzles are solved, those who get to the finish line first receive coins in exchange for the work done.

PoW was pioneered by the bitcoin blockchain, and you still can’t stake your bitcoin. Ethereum started with a PoW protocol but has been shifting to a PoS protocol for several years. Until that happens, you cannot stake ether (ETH). Other PoW coins that you can’t stake include dogecoin (DOGE), litecoin (LTC), and monero (XMR).

Proof-of-stake

Rather than work, PoS takes a look at how many coins you have staked to determine who is validating transactions and adding blocks to the chain. When you stake your coins, the protocol may choose you as a validator. You can increase your chances of being chosen (and rewarded with the coin) by staking a larger number of coins or by agreeing to hold your coins for a longer period of time.

What are the benefits of staking crypto?

When you decide to stake crypto, you have access to potential staking rewards that can benefit you down the road, especially if the coin you stake becomes popular.

• Receive additional coins as a reward: One of the biggest reasons to stake crypto is to receive additional coins. It’s a way of putting your crypto assets to work, rather than having them sit in your crypto wallet or on the exchange, providing you with no ongoing value.
• Increased security: When you stake, you are helping a blockchain project improve its security. The more people who are involved as validators, the harder the chain is to attack.
• More efficiency: Additionally, you help create more efficiency and scalability in the blockchain. One reason that PoS is becoming so popular is that it helps blockchain projects scale. This is especially important for chains that support decentralized finance applications, metaverses, and other applications.
• Voting rights: Depending on how the consensus mechanism works in a blockchain, staking might provide you with additional voting rights and the ability to participate meaningfully in the direction of the blockchain project.

What are the risks of staking crypto?

As with any investment or speculation, cryptocurrency staking has some risks. Before you decide to participate, make sure you understand the potential downsides.

• Lockup periods: Some blockchains or exchanges will allow you to withdraw your crypto and your earnings anytime, but others require you to commit to a set number of weeks or months. You can’t access your crypto during this time.
• Volatility: Cryptocurrencies are alternative assets and very volatile. As a result, your crypto coins could lose value while they’re held, and you wouldn’t be able to limit those losses. Additionally, there’s no real way to tell whether the crypto will catch on and be viable in the future.
• Impermanent loss: This is the concept that you would have made more by selling your cryptocurrency and taking your capital gains instead of staking your coins. This is closely tied to volatility. For example, if a coin shoots up in price, but you don’t sell it, and then the price drops, you could have made more money. While you don’t actually “lose” anything, you could be missing out on bigger gains.

FAQs

How to start staking crypto

There are different ways to start staking crypto, including using an exchange, joining a staking pool, or becoming a validator.

One of the easiest ways to do so is through a staking service. Some of the best cryptocurrency exchanges — such as Coinbase, Binance.US, and Kraken — make it easy to stake your crypto, although you might not get the same return going through a crypto exchange as you would using other methods. On an exchange, you simply indicate that you want to stake a coin, and then buy and hold it on the exchange.

You can also contribute your coins to a staking pool. In some cases, this happens on an exchange such as Coinbase. However, you might be able to earn more as part of a liquidity pool. Every time a transaction is validated through the coins in the pool, you receive a share of the fees in return for providing liquidity.

Finally, you can become a validator. However, you will need to make sure you have a computer with the necessary requirements. Each blockchain has its own requirements, so check those ahead of time.

You’ll also need to make sure you have the minimum amount of the coin available to stake. For example, you might need 32 ether (currently valued at over $100,000 as of April 2022) to become a validator on the Ethereum 2.0 blockchain. That can be a fairly substantial amount of money to participate at this level.

Bottom line

Staking crypto can be a way to earn an extra return from your crypto assets. By staking, you hold up some of your coins and let a project or exchange use them to validate transactions. In return, you’re rewarded with additional coins regularly. You can then stake those coins or withdraw them.

However, before you decide to get involved with staking, make sure that you can afford to hold your assets and that you understand the risks. If you’re a novice to crypto assets, it might make sense to learn how to buy cryptocurrency first. You can then add staking when you’re more comfortable with how assets work on the blockchain.

Disclosure: The author owns all of the coins mentioned in this article.

FinanceBuzz is not an investment advisor. This content is for informational purposes only, you should not construe any such information as legal, tax, investment, financial, or other advice.