Staking Crypto: Everything to Know

By  Beluga Research September 5, 2023

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Summary

  • Cryptocurrency staking is the action of locking up a set amount of coins in a digital wallet for a set period, to support the network's security and earn financial rewards
  • Users who stake coins have the opportunity to earn income passively, just as investors with traditional accounts earn interest and investors with stocks receive dividends
  • The practice of crypto staking began in 2012, when Peercoin offered users this option
  • Disadvantages include market volatility, technical risks and centralization concerns

Overview

Cryptocurrency staking is the action of locking up a set amount of coins in a digital wallet for a set period, to support the network's security and earn financial rewards. Staking is an integral part of the proof-of-stake (PoS) consensus mechanism. A network utilizes this mechanism by giving investors opportunities to stake coins by locking them up in a compatible wallet or in the platform itself.

The users contribute to network security and efficiency by ensuring there are a certain amount of the coins in the system. The platform typically rewards the users with additional coins. The number of coins that a user stakes determines how quickly they can expect to see a transaction validated and how high a reward they can earn.

A Brief History

The practice of staking crypto began when Peercoin introduced PoS in 2012. Peercoin's purpose for introducing this consensus mechanism was to address environmental concerns, namely the high use of electricity. Gradually, more cryptocurrencies decided to rely on PoS or offer staking options from that point forward. Currently, Cardano, Solana and Shiba Inu are among the cryptocurrencies that rely on PoS. Ethereum also transitioned from using a proof-of-work (PoW) consensus mechanism to a PoS consensus mechanism with the launch of Ethereum 2.0 in September 2022.

Staking Crypto: Everything to Know

  • Choose a Staking Coin. Research and select a cryptocurrency that supports staking.
  • Staking Wallets and Platforms. Use a reputable wallet or platform that offers security, user-friendly features and competitive rewards.
  • Minimum Staking Requirements. Some cryptocurrencies have minimum staking requirements, like a specific number of coins or a set staking period.
  • Staking Rewards. Participants earn additional cryptocurrency as rewards, influenced by factors like staked amount, duration and network performance. Rewards are subject to market volatility.
  • Network Security and Consensus. Staking enhances network security by making it difficult for malicious actors to manipulate the network. Participants must follow network rules to avoid penalties and maintain rewards. Increasing financial literacy, making staking rules less complex and welcoming new groups of users can help a network get more users involved in staking.

Getting Started

  • Choose a blockchain network that supports staking. These include Ethereum, Cardano and Polkadot. Gain familiarity with the network's specific requirements and rules.
  • Acquire the desired cryptocurrency. The user can accomplish this by purchasing the coin through an exchange, receiving it as a gift, like through an air drop or participating in an Initial Coin Offering (ICO) or token sale. They should transfer the cryptocurrency to a secure and reputable staking wallet.
  • Initiate the staking process. The user should determine the amount of cryptocurrency to stake and confirm the transaction. The staked funds will be locked for a predetermined period. This will contribute to the network's consensus mechanism and secure the blockchain.

Unique Aspects

  • Reliance on a proof-of-stake (PoS) consensus mechanism. Validators create blocks based on the number of coins they hold and stake. The creation of blocks reduces energy consumption. It also develops a more scalable and environmentally friendly blockchain.
  • Offers the potential to earn rewards. Participants receive additional tokens proportional to the amount staked. More staked tokens mean higher potential rewards. Staking can provide a passive income stream and enhance a user's return on investment.
  • Can grant governance rights. Some platforms allow stakers to vote on protocol upgrades, parameter changes and fund allocations. This gives users who stake influence over the network's development. Staking also allows users to influence the platform so that the platform considers and factors in user interests.
  • Includes penalties for malicious behavior. Validators acting against the network may have their staked funds slashed or confiscated. Penalties discourage dishonest behavior. They ensure the blockchain remains integrated and secure.

Advantages

  • Passive Income Generation. Staking allows individuals to earn passive income by holding and staking their cryptocurrencies. This opportunity appeals to users who want to diversify their income streams.
  • Network Security. Staking contributes to the overall security and stability of the blockchain network. It helps to deter malicious actors and enhance resilience against attacks.
  • Inflation Hedge. Staking serves as a hedge against inflation. Stakers can offset the impact of inflation on their holdings by receiving new coins as staking rewards.
  • Voting Rights. Stakers in certain blockchain networks have voting rights proportional to their staked cryptocurrency. This enables participation in governance decisions like protocol upgrades and parameter changes.
  • Lowers Barriers to Entry. Staking has lower entry barriers compared to PoW, or mining. Mining requires specialized hardware and technical expertise. Staking allows a broader range of individuals to validate the network and earn rewards.
  • Reduced Energy Consumption. Staking consumes significantly less energy than PoW. This makes it a more environmentally friendly option.
  • Fewer Other Negative Environmental Impacts. PoW consensus mechanisms can lead to issues beyond high electricity use, such as carbon emissions or the dumping of heated water into lakes and waterways. Staking does not cause these environmental impacts.

Disadvantages

  • Lock-up Period . Typically, staking involves a lock-up period where staked funds cannot be freely accessed or traded. This lack of liquidity restricts flexibility for individuals needing immediate access to their funds. This is not true in all cases, because some platforms allow users to trade staked coins.
  • Market Volatility . Staking exposes individuals to price fluctuations in cryptocurrency markets. If the value of the staked cryptocurrency significantly decreases, the rewards earned through staking may not compensate for the loss.
  • Technical Risks. Staking requires individuals to properly set up and manage their staking infrastructure. Aspects of staking infrastructure include wallet security, network connectivity and software updates. Neglecting one or more of these aspects is likely to result in financial losses and missed rewards.
  • Centralization Concerns . Staking can concentrate power in the hands of a few large stakeholders. This can lead to centralization and concerns associated with it, like censorship and the exclusion of users with less capital.
  • Slashing Risks . Some staking protocols implement slashing mechanisms to deter malicious behavior. Violating network rules or behaving dishonestly typically leads to penalties. These include a loss of a portion or all of the staked funds. A network will also typically restrict a user who acts maliciously from sharing input about the future of the platform.
  • Dependency on Network Health . Staking rewards depend on the overall health and performance of the blockchain network. Technical issues or low participation usually result in reduced rewards as well as operational challenges.