Staking: the new way to earn from cryptocurrencies

July 9, 2021
Staking the new way to earn from cryptocurrencies

Crypto staking is a trend that has emerged in response to the growing energy demand resulting from Proof-of-Work (PoW) protocols such as the one used by the bitcoin (BTC) blockchain to validate transactions. In essence, staking cryptocurrency involves acquiring and setting aside a certain number of tokens that will be used to validate the transactions made through the blockchain. This innovative protocol, known as Proof-of-Stake (PoS), is less energy-intensive as it eliminates, or at least reduces, the need for using a lot of mining equipment to keep the blockchain secure. Many blockchains, including ethereum (ETH), have now adopted PoS protocols to power their networks to respond to growing environmental concerns over the increased adoption of cryptocurrencies.

Staking income is offered in the form of interest paid to the holder, while rates vary from one network to the other depending on several factors including supply and demand dynamics. As the number of PoS-based networks continues to grow, new alternatives to stake crypto have emerged including the launch of group staking, also known as staking pools, staking providers, and cold staking. These initiatives aim to democratise access to opportunities in the staking space to retail investors who hold a small number of tokens of a certain blockchain.

The process of staking starts by buying a certain number of tokens in the network. It is important to note that staking can only be done in a network that supports a PoS protocol. After the purchase is completed, the user now has to lock the holdings by following the procedure indicated by the developers of each particular network. In most cases, a staking transaction can be performed in a few minutes by following your wallet’s instructions. On the other hand, cryptocurrency exchanges have facilitated the process of staking tokens by introducing features such as staking pools. These aim to increase the compensation obtained from staking the tokens of a certain network by upping the number of coins staked at a given point in time. In most cases, the higher the number of staked coins, the higher the number of transactions a given node will be assigned to validate. Nodes are ranked, in most cases, based on the number of tokens they hold. As a result, the nodes that hold the largest number of tokens will often receive higher compensation, which is the reason why staking pools have become so popular these days.

On the other hand, a user can stake tokens for a certain period – known as fixed staking. Some providers are also offering the possibility of entering a more flexible scheme in which the user can withdraw their tokens at any given point – known as flexible staking. The rigid nature of fixed staking results in higher interest rates offered to the holder, while flexible staking tends to offer less attractive terms.

Crypto staking has grown in popularity lately due to the attractive rewards crypto holders receive from this activity. At the moment this is written, interest rates offered by staking can go from 6% per year offered by well-reputed networks like ethereum (ETH) and Cardano (ADA) to as much as 100% offered by smaller networks, for example, PancakeSwap (CAKE) and Kava (KAVA). However, these high crypto staking returns don’t come without risks as multiple factors could affect the performance and security of your staked tokens.

The first risk to mention is the possibility of a cybersecurity incident that could result in the loss of your tokens held within a certain exchange or online wallet. To eliminate this threat, some crypto investors have resorted to cold staking – an activity that involves storing your tokens on a piece of hardware like a hard drive. Cold storing your crypto assets protects your holding from a cyber attack, as the hardware will not be connected to the internet. However, the loss or damage of the hardware remains a risk when using this form of staking. Another risk of staking results from potential downturns in the price of the crypto asset during the staking period. Since staking works by locking your coins, you will be unable to liquidate your holdings in case the market goes sideways and, therefore, you are exposed to the risk of losing a portion of your principal without being able to trim those losses by selling your coins. Finally, there is a risk associated with the uptime of the validator node that is holding your staked tokens. In most cases, networks penalise a validator if its ability to process transactions is affected, which means that your staking income could be diminished by any disruptions in the validator up time.

Crypto staking has become an attractive resource for investors seeking to earn income from holding cryptocurrencies – similar to how a bond or high-dividend stock would work. The attractive APRs offered by some tokens nowadays have attracted billions of dollars to this activity and the PoS protocol has also relieved some networks from the environmental concerns resulting from the energy-intensive nature of the traditional PoW protocol. However, like any other form of investing, crypto staking comes with risks including the possibility of losing the coins held within your online wallet in case of a cybersecurity breach or a loss in principal resulting from a sharp downturn in the price of the token during the lockup period. Thus, like every other investment, the risks and benefits need to be evaluated before making an investment decision.