While traditional finance solutions offer very low or even negative interest on their savings products, the crypto industry is always coming up with new ways to earn money.
In addition to investing and trading, the decentralized finance (DeFi) sector offers an excellent alternative to generating passive income through numerous ways, such as yield farming and cryptocurrency lending.
Today, we will introduce you to staking, a popular activity both in the DeFi and broader digital asset space. Staking crypto not only allows you to put your coins to work and earn rewards but also helps secure the networks of various blockchain solutions.
In this article, we will explore what crypto staking is, how it works, where to get started, as well as the potential risks and revenue you can generate with the activity.
What Is Crypto Staking?
Crypto staking refers to the activity in which a user locks coins in a wallet for a certain period of time to secure the network of a blockchain based on a Proof-of-Stake (PoS) consensus mechanism (or its variant, i.e., Delegated-Proof-of-Stake).
In terms of blockchain security, the network will choose a user who has staked his coins to validate the next block either randomly or by utilizing various factors (e.g., the amount of tokens staked).
In exchange for maintaining the ecosystem, users who stake their coins earn rewards, which is usually the combination of the cryptocurrency included in the block they validated and the fees associated with the transactions they processed for users.
What Is the Difference Between Crypto Staking and Mining?
It’s important to talk about the difference between crypto staking and mining. While both activities have the same purpose – to secure the network, generate new blocks, and validate transactions – they use two distinct approaches to achieve this goal.
Cryptocurrency mining is present mostly in Proof-of-Work (PoW) blockchain networks (e.g., Bitcoin), where validators (called miners) are required to leverage their computational power to solve complex mathematical puzzles to validate blocks.
For this, they purchase specialized hardware (e.g., ASICs and GPUs), which they operate continuously to compete with other miners to secure the reward for each block.
The higher the hash rate (computational power) in a PoW network is, the better it can protect against both internal and external threats, such as 51% attacks and malicious nodes.
As you can see, this is a rather energy-intensive process, which the PoW consensus algorithm has been long criticized for.
On the other hand, PoS blockchains do not require validators to utilize physical hardware or computational hardware to secure the blockchain. Instead, validators lock up their coins in their wallet via staking. Simply put, they guarantee the network’s safety with their money.
While this significantly reduces the energy consumption of the blockchain, staking is a similarly efficient mechanism in protecting users as mining blocks via the PoW algorithm.
In terms of investment, staking can be a more attractive method for users as it doesn’t feature the high upfront costs of mining (where you have to purchase the equipment first to get started) while providing a more predictable revenue stream (in a similar way as a savings account or a government bond).
Furthermore, staking has a well-established infrastructure within the crypto space. As a result, plenty of services offer an easy, flexible way for users to stake their coins. This contrasts with cryptocurrency mining, which requires miners to possess the technical knowledge and skills to maintain their equipment.
How Does Crypto Staking Work?
Now that you know the basics, let’s see how crypto staking works in practice.
First, it’s important to mention that staking is present in the crypto space in two different forms.
We have already taken a look at the first, where validators lock up their coins in their wallets to secure blockchain networks based on the PoS algorithm.
The process works as follows:
- A user deposits cryptocurrency into a supported wallet or staking service.
- The user selects the period (e.g., one month) he/she seeks to stake coins and utilizes the service to lock them up in his or her wallet. Alternatively, some solutions allow flexible staking, where users are free to withdraw their crypto holdings at any time without a mandatory lock-up time.
- After the lock-up period ends (or, in the case of flexible staking, the user is satisfied with the rewards), the staking provider releases the user’s coins and distributes the earnings after deducting the fees for providing the service (usually a percentage rate subtracted from the profits).
- The user is free to withdraw, spend, or re-stake the coins to generate more rewards.
The second type, called DeFi staking, is utilized not for safety purposes, but to offer a desirable user experience on certain decentralized exchanges (DEXs) that feature non-custodial atomic swaps between cryptocurrencies.
Unlike centralized exchanges, these DeFi solutions called automated market makers (AAMs) feature an entirely decentralized process for swapping coins. However, as they lack the order books of centrally-operated services, AAMs have to acquire liquidity from their users to facilitate efficient trading.
For that reason, they incentivize their users to supply both tokens of a trading pair at a 1:1 ratio in a liquidity pool. These rewards are usually offered in the platforms’ native coins after liquidity providers (LPs) have staked a special type of cryptocurrency called LP token.
LP tokens represent the users’ share in a liquidity pool, which they can redeem at any time for the tokens they supplied to the protocol along with their rewards.
By staking LP tokens, users lock the liquidity they provided to a specific platform for a certain period. Since this is a beneficial scenario for the service provider, it makes sense for the protocol to offer staking rewards for LPs.
Now let’s see an example for DeFi staking:
- A user connects his wallet to a DeFi AAM protocol and deposits DAI and ETH at a 1:1 ratio (1 ETH and $3,485 DAI based on October 11 prices) in the DAI/ETH liquidity pool.
- As the next step, the protocol issues the amount of DAI-ETH LP tokens that represent the user’s share in the pool and distributes them to his or her wallet.
- The user locks the DAI-ETH LP tokens on the protocol for 30 days to earn native token rewards from the service provider.
- After 30 days, the user redeems the DAI-ETH LP tokens for his or her original tokens as well as to claim any staking and liquidity provider rewards (e.g., a share of trading fees from the pool).
As you can see, no matter the staking type you choose, the process is similar in both cases and rather straightforward. And, while the mechanism is utilized to achieve different goals for the platforms, it serves the same purpose for stakers: to generate profits.
How Much Staking Rewards Can I Earn?
Besides its simplicity and lack of upfront costs, staking has become so popular in the cryptocurrency industry because it’s an excellent way for users to generate a passive income.
Staking rewards vary by the coin, which can range from anywhere from 1-2% to as high as 150% annually, especially if we take compound interest into account (when you maximize your gains by continuously re-staking or reinvesting your profits along with the principal sum).
In most cases, cryptocurrencies with larger market caps offer lower annual percentage yields (APYs) than smaller coins.
For example, while Ethereum (ETH) and Cardano (ADA) features 5-6% APYs, smaller-cap digital assets like DefiChain (DFI) or the Mirror Protocol (MIR) allow stakers to earn a yearly 70-75% after their coins.
Furthermore, rewards can also vary by the platform or service you utilize for staking. For example, while Binance and Everstake offer a 5.54% APY on ADA, some pools only feature a 3-4% ratio.
The reason for the variance in rewards may be due to two factors.
First, all of these services operate staking pools where they combine the locked coins of users to increase their chances to become validators and gain rewards.
At the same time, many PoS-based blockchains choose a validator for a block based on the amount of staked cryptocurrency. This means that the larger the pool, the greater chance it has to produce blocks and the better rewards it can generate for users.
Second, the commission service providers deduct from user profits can greatly impact one’s staking rewards. While some pools operate without fees, others charge 3-12%, and there are also platforms with extraordinarily high rates (30-50%).
For that reason, it’s crucial to research both the coins and the staking providers to generate the best staking rewards.
Is Staking Crypto Safe?
In general, crypto staking can be considered a safe activity within the digital asset space. However, it definitely comes with certain risks.
Unlike crypto lending, where lenders mostly earn revenue on stablecoins – digital assets pegged to one or a basket of other financial instruments (e.g., USD, EUR) to stabilize its price movements – staking predominantly involves locking up “standard,” non-stablecoin cryptocurrencies.
For that reason, the coins you dedicate to staking are subject to the high volatility associated with the cryptocurrency asset class (especially if you stake small-cap coins). As they can increase and decrease in value in short periods, this increases the risks of stakers.
These risks increase if you choose a staking service where users must lock up their coins for a specific period as you won’t be able to liquidate your crypto holdings in the case of a sudden market crash or another price movement (even if it’s favorable).
However, if you choose a flexible staking provider with no mandatory lock-up periods, you can mitigate your risks.
That said, volatility is not the only risk that comes with staking. For that reason, you should also be aware of the following factors:
- Counterparty risks: You can choose to stake your coins either on a centralized service where the provider stores your crypto holdings on your behalf or via a decentralized, non-custodial solution. If you choose the former, you should know that the platform is in custody of your private keys, which provide access to your coins. For that reason, you face increased risks of a loss in case of a successful hacker attack or an “internal” exit scam, unless the provider features the necessary security measures and guarantees.
- Smart contract bugs: If you stake coins as a liquidity provider on a DeFi protocol, you should be aware of the risks of smart contract bugs. Since these platforms use smart contracts to operate, a small issue in the code can lead to grave consequences for users. Therefore, you should always ensure that you use a reputable platform that features audited smart contracts.
- Slashing: Staking services handle all the technical parts of staking for you, including operating a blockchain node and validating blocks. However, suppose the provider is dishonest or fails to maintain a 100% uptime. In that case, some networks punish it by refusing to distribute rewards for a block or even slashing all its cryptocurrency stake. In the latter case, all users who have staked crypto via the service would lose their locked-up tokens.
Based on the above information, staking can be a high-risk activity. However, that is only true if you fail to do your own due diligence.
For example, you can significantly decrease your risks by staking your coins via a secure wallet through a reputable provider that features a long-standing history of continuous uptime and honest activity as part of a non-custodial solution.
Where to Start Staking Coins
Earlier on, we discussed the process you have to follow to stake your coins.
Now, you only need to choose the platform and method you will use to generate rewards after your cryptocurrency holdings.
For this, you can select between four different solutions:
- Cryptocurrency exchanges: Crypto exchanges provide one of the most convenient ways to stake crypto as you don’t have to move your holdings to other wallets or platforms to generate rewards. While this can come in handy when network transaction fees are high, this is a custodial solution that involves increased counterparty risks.
- Staking service providers:Like crypto exchanges, staking-as-a-service providers offer easy access to staking across numerous blockchains. However, these also involve custody over users’ funds.
- Crypto wallets: Many cryptocurrency wallet providers allow their users to stake their coins directly from their wallets without an intermediary. As a result, they don’t face the counterparty risks of custodial services while offering the same level of convenience (and similar reward rates).
- Manual staking: This is maybe the most complex method to start staking, which is a possibility for advanced users. Here, you operate your own node and stake your coins on your own. While this offers you the most freedom, it requires the necessary time and technical expertise to run your machine as well as a higher upfront investment for many blockchains (as there is usually a minimum amount validators have to meet).
It is also important to mention cold staking, where you generate a passive income via a wallet (e.g., a hardware wallet) that is not connected to the internet. For that reason, it’s probably one of the safest ways to earn revenue with the activity.
Staking: An Easy Way to Earn Rewards on Your Crypto Holdings
Crypto staking is a widely popular activity, where you can easily generate extra revenue on your digital assets without significant upfront investments.
As it only takes an initial deposit and a few clicks to get started, staking is a great way for both beginners and advanced crypto users to earn coin rewards.
At the same time, long-term investors can utilize staking to put the cryptocurrency they hold to work to maximize their profits.
In terms of risks, staking is generally a safe way to earn crypto. However, users must do their own due diligence as well as select reputable (ideally non-custodial) providers and coins with larger market capitalizations to minimize their risks.
If you are looking for more ways to earn crypto, we highly recommend checking out our articles about stacking sats, Bitcoin faucets, as well as the best free methods to generate revenue in the digital asset world.