How Crypto Staking Works
Learn what crypto staking is, and exactly how the whole concept works.
As the crypto market has grown in popularity, staking has become a prominent investment option. Like yield farming, crypto staking allows investors to receive interest on their assets.
This article will explain how crypto staking works. Additionally, we will compare staking to other concepts like crypto mining and yield farming. We will also consider staking fees and staking crypto taxes.
What Does "Staking" Mean?
Crypto staking can be described as both a simple and complex idea. The concept is simple if you want to earn interest on your crypto holdings.
However, it can be pretty complicated for crypto enthusiasts who want to understand the systems behind staking. To understand staking, you must first understand its role on blockchain networks that run the proof-of-stake consensus mechanisms (more on this concept later).
Overall, staking has become a popular way for traders and investors to earn rewards on their crypto holdings. Compared with a traditional savings account, staking allows investors to receive interest without selling their digital assets.
Even though they share several similarities, staking cryptocurrency yields greater returns than traditional savings accounts. However, like many other investment opportunities, there are risks attached to crypto staking.
Although staking crypto has become a popular method of earning interest on various digital assets, it only applies to a few select cryptocurrencies.
In general, assets that can be staked are connected to blockchain networks that implement the proof-of-stake consensus mechanism. This includes crypto assets like Solana, Avalanche (AVAX), Ethereum (ETH), and Cardano (ADA), to name a few.
To fully understand crypto staking, we need to know how it works. We will review how staking works in the next section.
How Does Crypto Staking Work?
Staking cryptocurrency works in a variety of ways. Primarily, you can stake crypto to become a validator on a proof-of-stake blockchain network. Additionally, you can stake your digital assets on numerous crypto exchanges by joining staking pools to earn passive income.
While each system allows you to stake your digital assets, their operation modes are different. Let us briefly review three ways you can stake your crypto assets.
Become a Validator on a Proof-Of-Stake Blockchain Network
Staking is synonymous with proof-of-stake blockchain networks, just as crypto mining is with proof-of-work blockchains. Crypto networks that run on a proof of stake model use this consensus mechanism to choose trustworthy participants to act as validators on their blockchain.
Selected participants who act as validators help to verify transactions and add new blocks of data to the network. However, participants who seek to become validators must buy and lock a certain number of crypto assets in a staking pool provided by the network.
In most cases, validators must buy and stake the native cryptocurrency of the blockchain network they wish to validate. The process of locking those crypto assets is done to ensure all validators conduct themselves honestly on the platform.
If a validator acts dishonestly or fails to secure a blockchain network, such actions can cause security breaches. This could result in a fall in the price of the native cryptocurrency attached to the blockchain.
Additionally, validators must purchase and set up their staking infrastructure to be a part of the network. This would require accessing adequate computing equipment and software. It is also necessary for validators to download a copy of the whole history of all transactions on the blockchain.
Although staking via this method is less expensive than crypto mining, the initial cost of setting up your infrastructure can be a little pricey. Generally, this form of staking cryptocurrencies is more expensive than all other options available.
Join a Staking Pool
You can also earn staking rewards by joining a staking pool operated by validators on a blockchain network. Under these circumstances, token holders add their digital assets to staking pools run by validators.
While this system is often adopted to raise the necessary funds to meet the requirement to serve as validators on a proof-of-stake blockchain network, it also helps token holders earn staking rewards without needing to serve as validators.
Instead, operators of the staking pools carry out the responsibilities of validators. To stake using this method, you will need a crypto wallet for connecting and transferring your crypto assets into the validator staking pool. The wallet will also serve as a means for receiving rewards for your staked crypto.
Suppose you are an average crypto investor interested in joining a staking pool. Please consult the official website of your desired proof-of-stake blockchain to learn about its validators. Ensure you conduct careful research before depositing your crypto holdings into a staking pool.
Stake on a Crypto Exchange
Staking on a crypto exchange is the easiest and most effective way to stake and earn. The staking process does not require the purchase of computing equipment or software.
As an additional benefit, crypto exchanges that provide this service offer a wide range of digital assets for users to stake. Some popular crypto platforms like Kraken, Binance, Uphold, and Midas.Investments provide staking opportunities. Additionally, Coinbase supports staking crypto to earn rewards.
Many of these platforms also offer many other investment and rewards programs. Through these opportunities, users can select any particular digital asset available in the investment portfolio of their preferred crypto exchange.
Read this article to learn more about the best crypto staking platforms.
Which Cryptocurrencies can I Stake?
Staking is only compatible with digital currencies that are pegged to proof-of-stake blockchains. Some popular native tokens available for staking include:
Staking vs. Mining
Staking and mining are essential concepts that play critical roles in the operation of blockchain networks. Crypto staking is crucial to proof-of-stake networks, while mining is pivotal to the operation of proof-of-work networks.
Regarding their similarities, both concepts are necessary for validating transactions on blockchains. Additionally, they provide a means for miners and stakers to earn a passive income.
However, regarding their fundamental differences, staking does not require highly specialized equipment, while crypto mining does. Additionally, mining activities consume vast amounts of energy. In contrast, staking does not have high energy demands.
Learn more about staking vs. mining.
Yield Farming vs. Staking
As previously stated, yield farming and staking are investment options that allow investors to earn passive income on their digital assets. However, despite this shared similarity, both concepts are different.
For example, crypto staking is vital to the operations of blockchains that operate on proof-of-stake consensus mechanisms. On the other hand, yield farming is only available on DeFi protocols.
Yield farming offers more gains in the short term but comes with more risks in the long run. In contrast, staking crypto provides both short-term and long-term gains. Additionally, staking crypto is safer and more secure compared to yield farming.
Check this out to learn more about yield farming vs. crypto staking.
Staking Crypto Taxes: Everything You Need to Know
There are different types of taxation laws applicable to crypto staking. Generally, the location of stakers will determine the relevant staking laws applicable to them.
Although there are a variety of tax laws for staking, these laws do not apply to specific situations. For example, moving your crypto assets into a staking pool, crypto wallet, or third-party staking wallet is considered a non-taxable event. Such actions are similar to moving your assets from one wallet to another, and such events are tax-free.
In terms of taxes on staking rewards, some countries expect crypto investors to pay income tax on their earnings. These countries also demand capital gains tax from traders who sell, trade, or spend their staking rewards.
However, due to the developing nature of the crypto space, there are still several gray areas regarding taxation laws. Additionally, since there are no laws for cryptocurrencies in several countries, staking rewards are not taxed in such locations.
How Much Money Can You Make Through Staking?
Staking is a sure way to generate modest returns on investment. Although this investment option does not guarantee considerable returns in the short term, users will earn modest returns over a lengthy period.
Crypto stakers can earn up to 19.47% and 15.79% interest for staking their SOL and ADA coins on the Binance exchange for 120 days. An investment of $100,000 in either asset will generate returns worth up to $19,470 or $15,790 in passive income within 120 days.
Read this to learn more about how much money you can earn from staking.
How Staking Fees Work
Several crypto platforms attach fees to their staking programs. As a result, investors using such platforms will be required to pay staking fees on their staked assets. For example, crypto exchange Coinbase charges a 20% commission as fees on staking rewards. Similarly, KuCoin charges a 10% fee on its staking program.
However, other platforms offer staking programs without attaching fees to them. For example, Binance and Kraken exchanges do not charge users for staking crypto on their platforms.
Learn more about how staking fees work.
How Long Do You Have to Stake Crypto For?
There are different periods attached to the staking programs offered by various staking platforms. Investors wishing to earn staking rewards must lock up their crypto assets for a specific time.
During these lock-up periods, investors cannot access nor sell their staked assets. However, some staking programs do not require investors to lock up their assets. If you stake your assets on such platforms, you can withdraw them at any time.
In most cases, staking platforms allow users to stake their digital assets for 30, 60, 90, or 120 days. However, in some cases, users can stake their assets for 6 months or one year.
How Are the Rewards from Staking Calculated?
A staking calculator is the best way to determine the rewards attached to any staking program. With the calculator, you can calculate the value of rewards you will receive based on the interest rate attached to the staking program.
Generally, the higher the value of your coin, the greater the rewards. Similarly, high-interest rates indicate a large reward size. In contrast, rewards will be smaller when interest rates are low.
Crypto Staking Safety
Although crypto staking offers good rewards to investors in the long term, this investment option is not without its risks. Considering the dangers of staking can help you safeguard yourself.
It can also help you select a staking program that fits your circumstances. Some common risks associated with staking include the following:
Generally, most assets that qualify for crypto staking are volatile. Due to this factor, staked cryptocurrencies may experience wild fluctuations in price when the coin market is volatile. This can lead to a significant drop in the value of your staked assets.
Lengthy Lock-up Period
Another common problem with staking is the length of the lock-up period attached to the staking program. Some staking services attach lengthy lock-up periods to their staking programs.
While the lock-up period is in effect, investors cannot access their staked assets. Additionally, in the case of negative price swings in the coin markets, investors are not allowed to unstake and sell their staked tokens.
Risk of Illiquidity
Considering the liquidity of the crypto asset you want to stake is also essential. Although some assets offer huge staking rewards to investors, some of these tokens may not be available on numerous crypto exchanges.
Due to this factor, investors may be unable to sell off their staking rewards due to illiquidity. Therefore, stake crypto assets that have liquidity and are listed on top crypto exchanges.
Many other factors can constitute risks for investors looking to stake and earn passive income on their crypto holdings. Carefully research the potential risks before opting for any staking program.
Read this to learn more about crypto staking safety.
Can You Stake Bitcoin?
The short answer is no. Since Bitcoin runs on a proof-of-work blockchain, crypto investors cannot stake it. As previously stated, investors can only stake crypto assets attached to a proof-of-stake network.
Due to this factor, it is impossible to stake proof-of-work assets like Bitcoin, Dogecoin, Litecoin, Monero, and Bitcoin Cash, to name a few. However, this limitation does not apply to the Ethereum coin.
Initially set up as a proof-of-work blockchain network, the Ethereum network has begun to transition into a proof-of-stake model. As a result, the blockchain now supports both staking and mining activities.
However, crypto mining will be removed entirely from the Ethereum blockchain technology when the transition to a proof of stake model is complete.
Without a doubt, crypto staking offers modest returns in the long term to its users. However, some risks are attached to staking crypto, like many other investment opportunities.
Although some countries have regulations on staking and other crypto investments, these laws are not applied universally. If you wish to join a crypto staking program, carefully research the risks, laws, fees, and rewards attached to your preferred method for staking. Additionally, consider the reputation of several platforms in this space before picking your preferred option.