Crypto Staking - What it is And How it Works

Crypto traders can consider becoming crypto stakers to earn passive income and actively participate in securing blockchain networks. Staking allows them to grow their holdings through rewards while supporting decentralized ecosystems.

In this article, we will discuss all about crypt staking and how it works. 

What is crypto staking?

Crypto staking refers to participating in a cryptocurrency network by holding and locking up a specific amount of cryptocurrency to support network operations, like securing the blockchain and validating transactions. Participants, known as stakers, earn rewards in return in the form of additional cryptocurrency. The cryptocurrency staking process works in three steps –

1. Stakers lock up funds in a digital wallet or staking platform

2. In a proof-of-stake system, stakers are chosen to validate crypto transactions and create new blocks based on the amount of crypto staked 

3. Stakers chosen receive rewards in the same crypto they staked
   
   

How staking differs from traditional mining?

Consensus mechanism and validity

Staking uses a proof-of-stake (PoS) or variations like the Delegated proof-of-stake consensus mechanism, whereas traditional mining uses Proof-of-Work (PoW). Mechanism. Stakers validate transactions as discussed above, whereas miners solve complicated cryptographic puzzles to validate transactions. The first miner to solve the puzzle adds the block to the blockchain and receives rewards. 

Energy-efficiency

Staking crypto is more energy-efficient since it does not require extensive computational work. On the other hand, traditional mining requires heavy computational power and energy to solve puzzles, such as specialized hardware that consumes a lot of electricity. 

Entry barriers

The more cryptocurrency a staker stakes, the higher the chance of them becoming a validator with low entry barriers. Conversely, a miner needs to invest high initial costs in equipment and has higher entry barriers due to the complexity of setting up and maintaining mining rigs. 

Funds liquidity

In staking crypto, funds are locked up for a specific time frame, depending on the protocol. This limits liquid staking. On the other hand, mining does not involve locking up funds but requires continuous investment in hardware and energy.

Benefits of and risks of staking crypto

Benefits

• Increased staked token utility: Staking encourages active use within the token's ecosystem, boosting adoption and utility

• Lower transaction costs: Some networks offer reduced fees for stakers, leading to savings on transactions

• Earn passive income: Stakers/token holders earn rewards by holding and locking their crypto

• Reduced potential volatility: Staking locks up tokens, stabilizing and potentially increasing the cryptocurrency's value
  
  

Risks

• Staking penalties: Non-compliance or poor performance can lead to financial penalties or loss of rewards in some proof-of-stake systems

• Uncertain regulations: Regulatory changes or legal issues could impact the legality, gains, or mechanics of staking

• Slashing risk: Stakers risk losing part of their crypto if they don't maintain uptime

• Market risk: A drop in cryptocurrency prices can reduce the value of staked assets
  
  
  

Staking process: How staking works in crypto

Choose a cryptocurrency that supports staking

Select a cryptocurrency that uses a proof-of-stake or similar consensus mechanism. Some cryptocurrencies that use this are Ethereum, Solana, and Cardano. Each cryptocurrency has its own staking requirements and protocol. 

Acquire the cryptocurrency

After choosing the cryptocurrency, acquire the crypto through a crypto exchange where the chosen token is listed. 

Select a staking method

Then, select from different staking methods to start staking the cryptocurrency. Different staking methods and platforms are available, including –

• Direct staking, where a staker runs a validator node and directly participates in the network's consensus process

• Staking pools, where the staker joins a pool of other stakers and stakes smaller amounts

• Centralized platforms, where an exchange or staking platforms handle the technical aspects for the staker
  
  

Set up a staking wallet

A staking wallet is required to hold and manage the staked crypto. These wallets can be digital wallets installed on one's computer, mobile device, or platform wallets provided by crypto exchanges. 

Delegate or lock up cryptocurrency

Depending on the chosen staking method, lock up or delegate the cryptocurrency as the staking protocol requires. For example, to directly stake crypto such as Ethereum 2.0 –

1. Configure the server to run an Ethereum 2.0 validator node.

2. Transfer the required ETH to the ETH 2.0 deposit contract from the wallet.

3. The validator node participates in consensus, validating transactions, and proposing new blocks.

4. Earn staking rewards directly added to the staking wallet for participation.
   
   

Earn staking rewards

After staking, the staker begins earning rewards based on the amount staked. Stakers can collect these staking rewards periodically.

Unstake cryptocurrency (optional)

If a staker decides to withdraw funds or stop staking, they need to unstake the cryptocurrency. Based on their staking method, a staker can follow the network's procedure. 

Crypto staking strategies

Diversification and risk management 

Diversifying staked cryptocurrencies across multiple currencies and platforms reduces the risk associated with a single network, technical failure, regulatory changes, and market volatility. 

Monitoring each staked crypto's performance and regularly rebalancing the portfolio improves risk management. This ensures that stakers do not heavily rely on a single crypto, protecting their overall investment from sudden downturns or platform-related issues.

Long-term vs short-term staking

Long-term staking involves locking up funds for a long staking period. Due to the extended commitment, it offers higher rewards and suits stakers who believe in a crypto's long-term potential. Conversely, short-term staking involves locking up funds for a short period of time with lower rewards. However, it also minimizes the risk of crypto prices declining in the long run. 

Staking on a cryptocurrency exchange 

Staking on a crypto exchange allows traders to take advantage of the platform managing technical staking aspects, making it easier for them to earn rewards without running a validator node or joining a staking pool. 

This strategy involves the staker's trust in the exchange, which might also lead to counterparty risk in case of operational failures or security breaches. Hence, stakers need to choose the cryptocurrency exchange after thorough research.

Staking's important role in crypto's future

Over $18 million worth of cryptocurrencies are now staked, and as blockchain technology advances, staking becomes increasingly vital in decentralized ecosystems. It provides crypto investors with opportunities for long-term growth and involvement in the future of digital finance.

Crypto staking offers passive income but comes with risks like penalties, slashing, and market volatility. Stakers must stay informed on regulations and manage the potential loss of liquidity due to lock-up periods. A well-diversified staking strategy is crucial to minimize risks and maximize rewards in the evolving crypto landscape.