What is Crypto Staking: A Beginner's Guide
The concept of crypto staking, how it works, benefits and disadvantages.
Almost all crypto platforms rely on blockchain technology to perform their core functions. By integrating blockchain technology into their services, these platforms are better placed to deliver crypto-related products to their users.
Since crypto staking is an integral part of blockchain technology, many platforms in this space rely on this feature to secure and improve the security of their blockchains. So what is crypto staking?
Cryptocurrency staking involves locking up crypto assets for a specific period on a blockchain network. This action aims to enhance the performance and increase the safety of such blockchains. However, there is more. Crypto investors who lock up their digital assets can earn staking rewards for their activities.
This article will carefully review the concept of crypto staking in its entirety. Among other things, we will discuss how crypto staking works, its benefits, and its disadvantages. This article will also discuss other blockchain features like crypto mining and yield farming.
How Was Crypto Staking Created And Why?
As previously outlined, crypto staking involves locking up digital assets for a specific period on a blockchain network. By engaging in this process, validators on a crypto project help increase the safety of blockchain networks attached to that project. Additionally, this practice helps to enhance the performance of a blockchain network.
Crypto assets are staked as an investment that offers interest to depositors. In this way, crypto traders can earn passive income on their staked assets. As a rule, crypto staking provides opportunities to earn a greater interest rate than those offered by traditional financial institutions such as banks.
We must clearly state that crypto staking is not an independent concept. Instead, this concept is a by-product of the Proof-of-Stake (PoS) consensus mechanism. Therefore, to understand how and why crypto staking was created, we need to first examine the origins of the Proof-of-Stake (PoS) consensus mechanism.
A proof-of-stake system is a popular consensus mechanism used by several crypto projects for operating transactions on their platform. POS is also central to creating new blockchain networks on these platforms.
If you are new to the crypto space, consensus mechanisms refer to means adopted by crypto projects to validate entries into their distributed databases. Apart from logging in data in their database and helping to verify transactions, the selected consensus mechanism must also protect and secure the database for the blockchain.
The Proof-of-work model is the first consensus mechanism applied by crypto projects for validating transactions and adding new blocks of data to a blockchain. Proof-of-Stake blockchains were developed to perform their functions in response to the POW system's flaws.
Some of these flaws include high energy usage due to the activities of crypto miners. Additionally, the POW system requires specialized equipment, which is very expensive. Furthermore, POW systems are famous for their slow transaction speed and costly fees.
The challenges facing the Proof-of-work system led to the development of the Proof-of-stake consensus. Crypto staking is essential to the Proof-of-stake consensus mechanism.
The Proof-of-work (POW) system relies on crypto mining for validating transactions. Crypto mining will be discussed later in this article. Unlike the POW consensus, the Proof-of-stake model adopts the use of cryptocurrency staking to validate transactions. Let us briefly consider how crypto staking works.
How Does Crypto Staking work?
The crypto staking process requires investors to lock up their digital assets to operate and safeguard transactions on a proof-of-stake blockchain.
Generally, participants lock up their assets in a staking pool to indicate their desire to serve as validators or stakers on a POS blockchain. An investor who locks a significant number of digital assets in the staking pool is usually more likely to be selected for a role as a blockchain validator.
The blockchain then selects participants to serve as validators and verify transactions on this network. By ensuring that validators stake their crypto assets, crypto projects limit the possibility of dishonest and fraudulent conduct. Participants are also aware of the need to maintain and safeguard the blockchain.
Any form of malicious conduct can lead to the corruption of the blockchain. In most cases, unethical and fraudulent activities will cause tokens associated with a crypto project to drop in value, and network validators will suffer losses on their staked crypto assets. Therefore, stakers must pay close attention to enhancing the performance of their blockchains to prevent loss of funds.
Validators are typically rewarded for each new block they add to the blockchain. When this occurs, new crypto coins will be minted and distributed to the validator of the new block. Generally, rewards are issued using the particular digital asset staked by nodes or validators. However, staking rewards are often paid using a different form of digital currency on some blockchains.
Staking Crypto: Advantages And Disadvantages
This section of our guide will list some of the advantages and disadvantages of staking digital assets.
Advantages Of Crypto Staking
Investors can earn passive income on their idle assets by staking crypto. Some crypto projects offer up to 10% APY for staking your crypto assets on their platform. Apart from earning staking rewards, many other benefits are attached to the staking process. For example
Compared to crypto mining, validators do not need to purchase specialized equipment to participate in the staking process.
Crypto staking is more environmentally friendly and consumes lesser amounts of energy.
Crypto staking allows investors to operate and safeguard a blockchain network without any hassles.
Disadvantages Of Crypto Staking
There are very few cons attached to staking your digital assets. However, one major issue with this practice is the vesting or lock-up periods attached to the staking process.
All platforms that offer crypto staking require investors to lock up their assets for an extended period. During this period, users can not transfer or sell their staked tokens. This is a significant disadvantage since crypto assets may lose value during the vesting period.
If you are interested in staking your crypto assets, carefully consider the requirement and rules attached to the staking platform you wish to join. Here is another piece of investment advice, consider the staking criteria of numerous platforms before settling on one.
Is Crypto Staking Safe?
The short answer is yes, crypto staking is safe and reliable. However, the volatility of cryptocurrencies may be a major drawback for many potential investors looking to stake crypto assets.
Generally, most digital currencies are highly volatile. As a result, these assets experience massive fluctuations in price. Crypto investors who select lengthy lock-up periods may suffer significant losses due to a crash in the price of the staked crypto. Investors are urged to choose staking platforms with a reasonable vesting period when staking their digital assets.
Best Platforms For Staking
Several popular platforms in the crypto space offer crypto staking as a part of their investment portfolio. Additionally, users can stake their digital assets using a cold wallet. This section will identify five of the best staking platforms currently available in the crypto space.
Binance – Offers excellent Staking for investors living outside of the U.S.
Coinbase – Crypto exchange with the best crypto staking services in the US.
Kraken – Offers both on-chain and off-chain staking opportunities
Ledger – Best cold wallet for staking crypto assets
Trust Wallet – A top crypto wallet for staking and receiving rewards
Popular crypto exchange Binance currently offers the best staking program. Currently ranked as the largest crypto exchange by trading volume, the Binance staking program provides an opportunity to earn interest on several Proof-of-stake tokens.
Investors can also earn rewards from staking stablecoins like Tether (USDT), Binance USD (BUSD), and DAI. The DeFi staking page allows investors to stake on the decentralized finance tokens.
Coinbase delivers staking opportunities on several governance tokens attached to different Proof-of-stake blockchain networks. some of these tokens include Cosmos (ATOM), Tezos (XTZ), and Ethereum 2.0 (ETH2.) Additionally, there are staking opportunities available on stablecoins like DAI.
Coinbase offers a lower interest rate for its staking program compared to other staking platforms in this space. However, this platform makes our list due to its extensive security features and availability to users based in the US. Currently, investors can earn up to 5.75% APY on the Coinbase staking program.
Kraken is another excellent crypto exchange that offers staking opportunities to its users. This platform provides both on-chain and off-chain staking opportunities to its investors.
Leveraging on the on-chain staking option, investors can stake on proof-of-stake tokens available on this platform. These POS tokens include Tezos, Cosmos, Cardano, and Ethereum 2.0.
The off-chain staking option allows investors to stake their assets on digital currencies in Kraken's internal programs. However, this staking option is only available in a few select countries.
Due to cold staking, investors can now earn rewards for staking assets in their cold and private wallets. However, stakers must store their staked coins in the same wallet address throughout the lock-up period to benefit from this program.
Moving staked cryptocurrencies before the end of a vesting period means a loss of the rewards attached to the staking process.
Ledger is rated as the best cold wallet for staking digital assets globally due to its excellent security features. A significant benefit attached to staking with Ledger is that users can maintain complete control over their assets during the staking period.
However, staked coins must remain in their address during the vesting period for users to receive interest on their assets. Currently, Ledger supports staking for up to seven tokens at once. Some of which include ATOM, ALGO, and Tron (TRX)
Known for its versatility, Trust Wallet is a private wallet that supports crypto staking. Owned by popular crypto exchange Binance, Trust Wallet supports staking on digital tokens like ATOM, Callisto (CLO), VeChain (VET), TRX, XTZ, ALGO, IoTeX, and TomoChain.
Best Coins For Staking
Generally, crypto staking should only be available on crypto projects with blockchains that operate on the proof of stake system. However, several platforms in this space now deliver staking opportunities on a wide range of crypto assets. Below, we list some of the best coins for staking.
Although Ethereum was built to operate on a Proof-of-work consensus, the devs team behind the project has begun to migrate to a Proof-of-stake model. As a result, users can now stake their Ethereum tokens on various platforms. These include crypto exchanges and investment platforms. Currently, most platforms offer between 4% to 7% APR to investors who stake Ethereum.
Currently, many crypto platforms provide users with a chance to stake the SOL token. The interest rates for staking this digital asset vary from one platform to another. However, users can expect to earn between 5.8% to 8% APY for staking this token.
Several platforms offer investors opportunities to earn interest for staking the Cardano token. Generally, the interest rates attached to staking the ADA token range from 4% to 8% APR. However, the lock-up period varies depending on the platform you select
Much like many other digital assets in this category, the AVAX token also provides rewards for staking. In most cases, users can earn between 3% to 21.63% APR depending on the duration of the vesting period.
You can stake the DOT token on several popular crypto exchanges and investment platforms. Generally, validators on this blockchain network can earn up to 10% APY from staking DOT. It is typical for fees to be deducted from a validator's commission rate.
Apart from the tokens listed above, investors can also stake and earn rewards on a wide range of stable coins. Some of which include assets like Tether (USDT), Binance USD (BUSD), USDC, and DAI. Currently, investors can earn up to 18.05% APY for staking USDT and USDC stablecoins on some crypto platforms.
Staking Vs. Mining
Crypto staking and mining are very similar concepts. Both concepts are used to validate transactions on a blockchain network. Additionally, they both offer rewards to stakers and miners.
In terms of their differences, crypto staking is only available on a Proof-of-stake consensus mechanism. On the other hand, crypto mining is attached to a Proof-of-work system.
Crypto projects like Bitcoin make use of a Proof-of-work system. As a result, crypto miners in that ecosystem are responsible for maintaining and securing transactions on that network. Similarly, platforms like Tezos and Cosmos operate a Proof-of-stake model and require validators to stake their assets to manage and validate transactions.
Mode Of Operation
Another difference between crypto mining and staking is their method of operation. In crypto mining, miners are required to solve tedious mathematical problems. For staking, nodes simply lock their assets for a fixed period to validate new blocks on the network.
Equipment & Energy Consumption
In crypto mining, miners use specialized equipment to carry out their mining operations. These mining equipment consume a lot of energy and are considered unstable for the environment. Compared with mining, staking does not require any form of specialized equipment. Additionally, its energy consumption is low.
Miners looking to earn rewards from their mining activities must use equipment with high computational power. Such equipment increases their chances of quickly adding new blocks and receiving rewards. Stakers can increase their chance of earning rewards by increasing the number of tokens they stake. Engaging in this practice increases their prospects of serving as validators.
Yield Farming vs. Staking
Staking and yield farming share several similarities, and they both offer investors opportunities to earn passive income on their digital assets. Staking and yield farming differ due to the platforms they employ.
Although crypto staking is available on several crypto exchanges, this concept is used for managing and securing blockchain networks that run on a proof-of-stake model. On the other hand, yield farming is only available in the decentralized finance (DeFi) space.
Apart from this crucial difference, both concepts differ in many other areas. For example, the interest rates for staking a crypto asset are usually fixed, often starting at 5% or higher.
Yield farming can reward users with over 100% interest or more, as rewards attached to this practice are prone to fluctuations. However, investors in this space must invest smartly or risk losing a significant portion of their funds.
The crypto staking system offers greater security since investors act as validators tasked with securing the blockchain network. Yield farming operates on DeFi protocols, and these platforms may be susceptible to hacks or thefts.
It is also vital to state that yield farmers can suffer permanent losses if their assets are locked in a liquidity pool with an uneven ratio of tokens. Although validators can experience losses during staking, they will continue to receive rewards during the vesting period.
To become a validator on any blockchain that operates on a proof-of-stake system, investors must lock up their assets for a specified period. During this period, validators can not withdraw their funds. In contrast to staking, yield farming has no vesting period. As a result, users are not expected to lock up their assets to earn rewards.
Staking NFTs: How It Works
In addition to staking crypto assets, many crypto platforms now allow users to stake their NFTs to earn rewards. To benefit from NFT staking, investors must lock their non-fungible tokens on a DeFi protocol that supports this service. However, these platforms must function on blockchains networks managed by a Proof-of-stake system.
An advantage of NFT staking is that it allows its holders to profit from NFTs without selling them. In terms of the rewards, NFT stakers are rewarded based on the number of non-fungible tokens they stake and a fixed annual percentage yield (APY).
Staking Crypto Taxes: Everything You Need To Know
The Internal Revenue Service (IRS) has not yet provided specific guidelines for taxing crypto staking. However, the common view among tax experts is that staking rewards will be viewed using income tax laws.
These experts also believe that taxes shall be applicable from the time an investor receives his staking rewards. This belief stems from guidelines issued by the IRS on taxing crypto mining.
Due to the aforementioned factors, any rewards earned from crypto staking are usually taxed under the income tax law. However, before these taxes can be deducted from investor earnings, they must be disposed of or sold off. This practice is also applied to cryptocurrencies.
Crypto staking is essential to the operation of Proof-of-stake blockchains. Additionally, staking crypto provides a means for investors to earn passive income. Although staking shares several similarities with yield farming and crypto mining, these concepts are entirely different.
Several platforms offer staking opportunities on a wide range of crypto assets. However, the interest rates offered by these platforms vary. Additionally, the vesting period on each platform differs significantly.
If you wish to stake your digital assets, ensure you select a secure crypto platform that offers attractive interest rates. Additionally, choose a lock-up period that is favorable to you.