Staking is a modern method of earning in the cryptocurrency world, serving as an alternative to traditional mining. Unlike the latter, it doesn’t require investments in expensive hardware. The profit you receive varies depending on the specific cryptocurrency and the duration of its storage in the investor’s account.
What Is Staking?
Staking is a method of accumulating passive income through cryptocurrency storage, based on the Proof of Stake (PoS) algorithm. This algorithm ensures the security and integrity of data in the blockchain network.
Participants in the network using blockchains with the PoS algorithm and holding a certain amount of coins in their cryptocurrency wallets receive periodic rewards. Such a system motivates users to actively participate in maintaining the stability and reliability of the blockchain network.
The core idea of PoS is that the probability of generating a new block is directly proportional to the amount of coins held. The more coins you have, the higher the chance of receiving rewards.
Staking is applied in many modern cryptocurrencies, including but not limited to:
- DASH, and many others.
One of the key advantages of this method is that it offers a way to earn in the cryptocurrency space without the need for expensive mining equipment.
Let’s take a closer look at the concepts of mining, Proof of Work (PoW), and Proof of Stake (PoS). This will help us understand how staking works and how it differs from mining.
What Is Mining?
Mining is the process of creating new units (blocks) in a blockchain network and validating transactions within that network. It is most well-known in the context of cryptocurrencies like Bitcoin. Participants in mining, known as miners, use the computational power of their computers or specialized equipment to solve mathematical tasks that secure and operate the blockchain network.
In the case of the Proof of Work (PoW) algorithm, miners compete to solve complex cryptographic puzzles. The first one to solve the puzzle gains the right to add a new block to the chain and receives rewards in the form of cryptocurrency and transaction fees for the transactions included in the block.
Mining serves several important functions:
- Creating New Blocks: Miners confirm and record transactions into new blocks, which are then added to the shared blockchain.
- Security: The work of miners makes the network resistant to attacks and fraud since altering already recorded blocks requires immense computational resources.
- Emission of New Coins: In many networks, miners are rewarded not only with transaction fees but also with newly created coins generated during the mining process. This serves as a form of inflation within the cryptocurrency system.
However, it’s worth noting that mining is an energy-intensive process, requiring specialized equipment and significant electricity costs. These factors have been subjects of criticism and discussion, especially concerning environmental sustainability.
What is Proof of Work (PoW)?
Proof of Work (PoW) is a consensus algorithm used in some blockchain technologies, including Bitcoin. The goal of PoW is to prevent attacks and secure the network by requiring participants to perform complex computational tasks.
In networks using the PoW algorithm, miners compete to solve these tasks in order to create a new block and add it to the blockchain. These tasks are intentionally designed to take a certain amount of time and require a significant amount of computational power to solve. However, verifying the correctness of the solution for other network participants is relatively quick and straightforward.
Once a miner solves the task, they broadcast their solution to the rest of the network for verification (this process is known as “finding” a block). If the solution is correct, a new block is added to the blockchain, and the miner receives a reward in the form of new coins and/or transaction fees included in the block.
This method effectively resists attempts to maliciously interfere with the network because doing so would require a substantial amount of computational power, which would be prohibitively expensive and economically impractical. However, PoW has drawbacks, including high energy consumption and the need for specialized hardware, which raises concerns about its environmental impact and accessibility.
What is Proof of Stake (PoS)?
Proof of Stake (PoS) is a consensus algorithm used in blockchain networks to confirm transactions and create new blocks. Unlike Proof of Work (PoW), where computational power takes precedence, PoS relies on the number of coins a network participant is willing to “stake.”
In PoS systems, participants create new blocks and confirm transactions not based on complex computations but rather on the amount of cryptocurrency they hold and are willing to temporarily lock as a stake. The more coins a participant holds and the longer they are staked, the higher their chances of creating a new block and receiving a reward for it.
This method was proposed as an alternative to PoW to address certain issues, such as high energy consumption. Since PoS doesn’t require network participants to have powerful hardware for solving complex mathematical problems, it is considered more environmentally friendly and accessible.
There are variations of the PoS algorithm, such as Delegated Proof of Stake (DPoS), Proof of Stake Time (PoST), and others, which introduce unique elements to the basic PoS model.
Cryptocurrencies using PoS or its variations include Cardano, Polkadot, Algorand, and many others. Each of these networks has its features and nuances in implementing the PoS algorithm.
Difference between Staking and Mining
Staking and mining are two distinct methods of participating in blockchain networks, each with its advantages and disadvantages. Here are the key differences between them:
Mining (Proof of Work, PoW):
- Computational Power: Mining requires significant computational resources and specialized hardware.
- Energy Consumption: The mining process consumes a large amount of electricity, which is an environmental concern.
- Rewards: Miners receive rewards for each new block they create, as well as transaction fees for processed transactions.
- Difficulty: The difficulty level of algorithms is constantly adjusted to maintain a stable block creation time.
- Decentralization: In theory, anyone can become a miner, but in practice, a large portion of computational power is provided by large mining pools.
Staking (Proof of Stake, PoS):
- Capital Investment: Instead of computational power, participants invest their cryptocurrencies by “staking” them in the blockchain for participation in the process.
- Energy Efficiency: Staking is considered more environmentally friendly as it does not require significant computational resources.
- Rewards: Participants receive rewards proportionate to their stakes and the period for which their coins are locked.
- Accessibility: Staking is often more accessible to regular users since it doesn’t require specialized hardware.
- Centralization: In some PoS systems, there is a risk of coin ownership centralization, but this depends on the specific implementation of the algorithm.
In both approaches, the main goal remains the same – to maintain a stable and secure operation of the blockchain network. However, the methods to achieve this goal are different, and each has its advantages and disadvantages in terms of efficiency, security, and accessibility.
Types of Staking
At the core of staking is a concept similar to placing financial deposits in a bank. Users transfer their cryptocurrencies to a special account where they are “frozen” and generate passive income. The more funds that are held in such an account, the greater the chance of earning a higher profit.
In addition to the basic approach, different blockchain platforms may have their own rules and conditions for staking.
In this approach, users are required to specify in advance the duration for which they are locking their assets in an account. Token holders have the option to choose a convenient period, after which it becomes impossible to change. For example, if a quarter (three months) is set, the coins cannot be withdrawn earlier.
With this type of staking, users receive a fixed reward. Typically, contracts of this kind offer a higher interest rate, making it a choice for those who ultimately want to earn more money.
As an example, consider ETH 2.0 staking. To become a validator in it, one needs to deposit a minimum of 32 ETH into the wallet. The annual interest rate can range from 2% to 20%, depending on the total amount of coins locked for staking. This is a case where the entry threshold for staking is significantly higher compared to traditional mining.
This type of staking does not require specifying a fixed duration for the “freezing” of cryptocurrencies. Participants can end their role in network validation whenever they deem it necessary. Interest accrual continues until the user decides to withdraw their tokens or place an order to sell them.
Often, the initial accruals occur within a day after activating the flexible contract, although regular payments are usually made monthly.
This type of staking is ideal for those who prefer not to lock their digital assets for an extended period and value flexibility in managing them. In this case, the deposited funds continue to generate passive income and can be withdrawn at any convenient time.
Decentralized Finance, or DeFi, is a blockchain technology sector that encompasses various financial services, from lending to insurance. These platforms operate based on smart contracts, which enable automation and adherence to predefined transaction parameters.
DeFi staking differs from traditional staking by involving third parties. These parties can be either individual users or organizations that borrow cryptocurrency at a certain interest rate.
The system strictly monitors the execution of transaction conditions. However, as with any smart contract, it’s essential to be cautious of potential vulnerabilities.
Advantages of DeFi Staking:
Quick Access to Funds: You can withdraw your accumulated interest within one day, rather than waiting for monthly payouts.
- High Returns: DeFi staking often offers higher interest rates compared to what you could get on traditional PoS platforms. Returns can go as high as 100% annually or even more, depending on the choice of cryptocurrency and conditions.
- Reliability and Security: For instance, in the case of Binance BNB Staking, trust is bolstered not only through smart contracts but also by the platform’s reputation.
- Staking continues to gain popularity as a method of passive income with relatively low levels of risk.
Depending on the chosen coin, the duration of its “lockup,” and the type of staking, returns can vary significantly among users. However, regardless of these factors, DeFi staking provides a stable income that often surpasses the possibilities of mining.
In certain DeFi projects, only specific users with significant deposits can become validators. However, there are alternative approaches: users can pool their resources to collectively become validators. In this case, the rewards earned are distributed proportionally to the funds invested.
In cryptocurrency staking, there are various risks to consider:
- Price Volatility: One of the main risks is the instability of the cryptocurrency’s value. If the asset’s price decreases, the fiat value of your rewards will also drop, even if the percentage-based rewards remain the same.
- Cryptocurrency Choice: For this reason, it’s essential to choose an asset with relative stability and low volatility, especially if you’re engaged in fixed staking and can’t easily liquidate your coins.
- Account Security: The risk of losing access to your staking platform or cryptocurrency exchange account is also crucial to consider. You should apply all security measures, such as two-factor authentication and secure storage of login credentials.
- Scams: If someone posing as a validator asks you to send funds directly to them, this is a likely sign of a scam. Such requests should be ignored.
- Technical Risks: Technical glitches in the platform or blockchain network are not out of the question and can result in the loss of funds.
- Regulatory Risks: Cryptocurrencies and staking may be subject to new laws and regulations that could have a negative impact on your activities.
- Complexity and Uncertainty: Insufficient understanding of staking mechanisms and the specific features of a blockchain can also pose risks for inexperienced users.
Therefore, before engaging in staking, it’s crucial to carefully analyze all potential risks and be prepared for them.
How to Start and Choose a Coin for Staking
Choosing a coin and starting staking is a process that requires careful analysis and planning. Here are a few steps that can help you get started:
- Market Analysis: Research the fundamentals of the coin, including its roadmap, team, and community. Assess the potential returns from staking.
- Cryptocurrency Analysis: Research various cryptocurrencies that support staking. Examine their stability, growth prospects, and reputation within the community.
- Volatility Level: It’s preferable to select coins with relatively low volatility if you’re new to staking.
- Current Yield: Pay attention to the current annual yield (APY or APR) for staking this coin.
- Terms and Conditions: Find out what staking periods are offered and what the conditions are for receiving rewards.
- Staking Wallet: Choose a suitable wallet for staking. Some platforms offer staking directly within their official wallets.
- Platform Overview: Apart from the official wallet, there are staking platforms and pools that offer different terms and levels of profitability.
- Security: Ensure that your computer and internet connection are secure. Use two-factor authentication and other security measures.
- Starting Staking:
- Purchase Coins: Once you’ve chosen a coin, buy it on an exchange that supports it or through other available methods.
- Transfer to Wallet: Transfer the coins to your chosen wallet or staking platform.
- Staking Activation: Follow the instructions to activate staking on your wallet or platform.
- Monitoring: Regularly check the status of your staking, reward levels, and network events for the chosen coin.
- Income Withdrawal: Familiarize yourself with the terms and fees for withdrawing staking rewards.
- Be cautious of promises of extraordinarily high returns; this could be a sign of fraud or high risk.
- Keep all login credentials for your wallet and staking platforms in a secure and safe place.
- Stay informed about the latest news and changes related to your coin and staking in general.
- Also, research potential tax obligations that may arise from earning income through staking.
- By following these recommendations, you can start staking with minimal risks and earn a stable income.