crypto-staking-explained

Crypto Staking will not apply to a non-profit organization whose main goal is to immediately convert digital asset donations into U.S. dollars. This section is only for organizations interested in keeping some donated funds in income generating assets.

You can think of staking as the crypto equivalent of putting money in a high-yield savings account. There are, however, many differences. When you deposit funds in a bank savings account, the bank takes that money and typically lends it out to others. In return for locking up your money with the bank, you receive a portion of the interest earned by the bank for lending out your funds on deposit. 

For example, a bank can make a loan to someone else using your funds on deposit and charge them 5% interest. In turn, the bank will pay you 1% for use of your money and keep 4% as a profit to the bank. With staking crypto, however, you would make 5% for your participation in running the blockchain and securing the cryptocurrency network.

Another difference between bank savings accounts and crypto staking is that when staking crypto there is a potential for the digital asset to increase in value. This is opposed to U.S. Dollars held in a savings account that loses its value on annual basis. As an example, if you make a 5% return in a bank savings account (which is highly unlikely) there will most likely be a debasement of the value of the dollar, which could range between 10 and 15% on an annual basis. Thus, the value of your savings is decreasing on an annual basis.

Staking is a popular way to earn passive income with cryptocurrency investments. In exchange for that, you earn rewards calculated in percentage yields. These returns are typically much higher than any interest rate offered by banks. 

According to Coinbase (a U.S. Cryptocurrency Exchange) “Staking is only possible via the proof-of-stake consensus mechanism, which is a specific method used by certain blockchains to select honest participants and verify new blocks of data being added to the network.”

Stating this in a different way, if you purchase a cryptocurrency like Ethereum (ETH) you can either leave this digital asset on the crypto exchange or send it to a digital cold wallet for storage or safe-keeping. As an alternative, you can “Stake” the ETH to earn a yield on the asset. If you do stake your digital assets, you then lock up the coins in order to participate in running the blockchain and maintaining its security.

When locking up coins by staking on a blockchain, the coin owner(s) become “stakeholders” in the network and this eliminates the tendency to act dishonestly. In other words, network participants who are staking their coins become validators or “stakers” purchasing and locking away a certain amount of network tokens. If the blockchain was corrupted in any way through malicious activity, the native token associated with it would likely plummet in price, and the perpetrator(s) would stand to lose money. Thus, each token holder has a “stake” in the operation of the blockchain. 

For reference, staking is not available for Proof of Work (POW) blockchains like Bitcoin, where “miners” earn rewards for building blocks in the blockchain. 

The stake, then, is the validator’s “skin in the game” to ensure they act honestly with transaction validations and for the good of the network. In exchange for their commitment, validators receive rewards denominated in the native cryptocurrency. The bigger their stake, the higher chance they have to propose a new block and collect the rewards. After all, the more skin in the game, the more likely you are to be an honest participant. 

To keep validators in check, they can be penalized if they commit minor breaches such as going offline for extended periods of time and can even be suspended from the consensus process and have their funds removed. The latter is known as “slashing” and, while rare, has happened across a number of other blockchains.

Risks of Staking Crypto

As with every type of investing, especially in crypto, there are risks you need to consider.

How Profitable is Staking

According to Coinbase, cryptocurrencies that allow staking use a “consensus mechanism” called Proof of Stake. This is the way they ensure that all transactions recorded on the blockchain are verified and secured without a bank or payment processor in the middle. Your crypto, if you choose to stake it, becomes part of that process. In other words, the reason your crypto earns rewards while staked is because the blockchain puts it to work to protect the integrity of the system. 

Staking is a good option for investors interested in generating yields on their long-term investments and aren’t bothered about short-term fluctuations in price. According to data, the average staking reward rate of the top 261 staked assets surpasses 11% annual yield. It’s important to note, though, that rewards can change over time. Fees also affect rewards. Staking pools deduct fees from the rewards for their work, which affects overall percentage yields. This varies greatly from pool to pool, and blockchain to blockchain. You can maximize rewards by choosing a staking pool with low commission fees and a promising track record of validating lots of blocks. The latter also minimizes the risk of the pool getting penalized or suspended from the validation process.

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