Staking Explained. Looking for a way to put your crypto to… | by | @blockchain | Sep, 2022

Looking for a way to put your crypto to good use? Staking makes it possible to earn passive income with crypto you already own. Here’s what you need to know about it:

Staking is the act of pledging your crypto to help secure and verify transactions on a blockchain. In return for this, you earn rewards from the network.

There are several benefits to staking your crypto:

  • Passive income. Staking is mostly a passive activity, which means you can earn rewards without having to do much (or any) work.
  • Returns. Staking typically offers a higher return on investment (ROI) than simply holding crypto, especially if the staking wallet compounds your interest.
  • Participation. You can support the network you believe in and help it grow.
  • Low cost. Staking can help you earn rewards more cheaply than mining, as staking requires less computing power and no specialized equipment.

There are a few risks to consider before staking your crypto:

  • Volatility. The value of your staked assets can go up or down, just like any other crypto asset.
  • Loss of control. Once you’ve staked your assets, you won’t be able to access them until you unstake them (which usually takes a set period of time).
  • Slashing. If a validator sends invalid transactions, the network may penalize, or “slash,” parties who would otherwise receive rewards. This is meant to discourage bad behavior on the network.

Staking only happens on cryptocurrency networks that use the proof-of-stake model as their consensus mechanism. A consensus mechanism is the process that a blockchain network uses to process payments, confirm transactions, and add new blocks to the chain.

The two most common consensus mechanisms used by cryptocurrencies are proof-of-work (PoW) and proof-of-stake (PoS).

PoW is the method of choice for early cryptos, including Bitcoin.

In PoW systems, participants compete to solve complex mathematical problems. The first person to solve the problem adds the next block to the chain and receives a reward. PoW is a very energy-intensive process, as it requires miners to run powerful computers 24/7.

Winning the block reward comes down to “outcomputing” others.

PoS is a more eco-friendly way to verify transactions.

In PoS systems, participants pledge their crypto assets to help secure and verify transactions on the network. The more assets you stake, the higher your chances of being chosen to add the next block to the chain.

This process requires neither specialized hardware nor additional computing power.

PoS systems also have different staking rules than PoW systems. For example, some PoS networks require participants to lock up their staking rewards for a set period of time, while others allow stakers to claim their rewards as they earn them.

In sum, staking lets you support a blockchain network — and get passive rewards for doing so — without expending large amounts of energy.

When you stake your crypto, you’re essentially holding it in a wallet that’s connected to the network called a staking wallet.

Once your staking wallet is set up, and you’ve deposited your crypto, a “bonding period” sets in, during which the crypto is locked and ineligible for rewards. After this window, you’re securing the network, so the reward distribution begins.

The size of the rewards will depend on the staking rules of the network you’re helping to stake.

For example, some networks give stakers a fixed reward for each block they add to the chain, while others give stakers a share of the transaction fees associated with the block.

Most staking wallets will let you know how much you can expect to earn in rewards, as well as how long it will take to earn them.

The amount of rewards you earn depends on how much you stake and the token’s specific staking program. Many estimate Ethereum’s rewards at around 5–6% as of a few days before the Merge.

Many cryptos — such as bitcoin, dogecoin, and litecoin — don’t use proof-of-stake to verify their network, meaning you can’t stake them. Those cryptocurrencies get secured through proof-of-work processes like mining.

Many cryptocurrencies support staking, such as:

  • Ethereum — made possible by the Ethereum Merge
  • Avalanche
  • Solana
  • Polkadot
  • And more

In most places, staking rewards are taxed as income. Consult an accountant or other financial professional for the specifics of your region.

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