The cryptocurrency industry continues to evolve, supported by the rising demand for various crypto products and services, such as staking. In this guide, we will explain staking, how it works, and how companies get involved in the process.
What is staking?
Staking is an alternate way for institutions to gain exposure to crypto. It enables investors to earn rewards on purchasing and holding cryptocurrencies. Staking cryptocurrencies involves committing crypto assets to the blockchain and verifying transactions. The process provides a way to validate and add new transactions to the blockchain for cryptocurrencies that support the Proof-of-Stake (PoS) concept.
Before going deeper into the concept of staking, let us familiarize ourselves with theProof-of-Work (PoW) and PoS protocols that are used to validate transactions on a blockchain network.
The PoW model is a consensus mechanism that involves global crypto miners attempting to crack a cryptographic problem. This involves verifying transactions between unknown parties and ensuring that the sums involved aren’t spent twice. Bitcoin is a cryptocurrency that follows the PoW model and does not allow cryptocurrency staking.
The PoS model is another consensus mechanism that ensures all transactions on the blockchain are secured and validated without a middleman, such as a payments processor or a financial institution. In the process, the investor-staked cryptocurrency becomes part of the blockchain. This model does not require miners to work through complex math problems, thereby considerably reducing the required processing power. Instead, transactions on the blockchain are validated by the entities, called validators, who have a stake in the blockchain. As a result, the PoS protocol processes transactions faster and more efficiently; it also reduces costs.
How does staking work?
Staking is available with only a handful of cryptocurrencies (Ethereum, Cardano, Solana, Polkadot, Cosmos, Celo, and Tezos) that support the PoS model. Staking can be done individually or through a crypto exchange that offers the service.
Individual staking requires a lot of expertise because it needs the setting up and running of a node. The validator also needs to maintain a deposit of supported coins on the network. The staked coins function as a guarantee of the legitimacy of a new transaction added to the blockchain. For every successful block added, validators receive rewards in the form of fees or new cryptocurrency coins.
If staking programs are available at the exchange where the crypto was purchased, then the entity can directly stake the crypto it owns on that exchange. A few exchanges also allow investors to choose their desired validator. Some of the crypto exchanges offering staking services are Binance, Kraken, and Coinbase. Kraken offers staking in over 15 coins, with an annual reward rate of up to 23%. Rewards are credited twice a week.
If crypto staking programs are unavailable at the exchange, the cryptocurrency must be transferred to a crypto or blockchain wallet. Some of the popular wallets are Coinbase Wallet, Metamask, ZenGo, Trust Wallet, and Trezor Wallet.
While individual staking offers higher yields, it involves significant investments and expertise. Long-term crypto investors looking for a passive income with little effort can simply opt for a staking service from a crypto exchange.
What are the advantages and disadvantages of staking?
Staking allows investors to earn higher returns on assets than yields (i.e., interest from savings accounts). Staking cryptocurrencies does not require huge amounts of processing power, making the process environmentally friendly. Staking also helps improve the efficiency and security of the blockchain.
Despite these benefits, cryptocurrency staking has some disadvantages. Cryptocurrencies can be highly volatile; sometimes, a drop in the value of cryptocurrencies can outweigh any rewards received, leading to a loss for the investor. Staking may also have a lock-in period, unlike publicly traded stocks and bonds. This liquidity — or lack thereof — differs across crypto projects, and it’s wise to read the fine print before investing.