How Crypto Staking Works

As the cryptocurrency market has become more popular, staking has become a popular way to invest. Like yield farming, crypto staking allows investors to receive interest on their assets.

This article will explain how cryptographic staking works. We'll also compare staking to other ideas, 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 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. Unlike a normal savings account, staking lets investors earn interest without having to sell their digital assets.

Even though staking cryptocurrencies and traditional savings accounts have a lot in common, staking cryptocurrencies gives you a better return on your money. However, like many other investment opportunities, there are risks attached to crypto staking.

Staking crypto has become a popular way to earn interest on different digital assets, but it can only be done with a small number of cryptocurrencies.

In general, proof-of-stake consensus is used to connect assets that can be staked to blockchain networks. This includes crypto assets like Solana (SOL), 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. Also, you can earn passive income by staking your digital assets on a number of crypto exchanges and joining staking pools.

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 and proof-of-stake blockchain networks are the same thing, just like crypto mining and proof-of-work blockchains are the same thing. 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.

Validators are members of the network who are chosen to help check transactions and add new blocks of data to the network. To become a validator, however, a participant must buy and lock a certain number of crypto assets in a staking pool that the network provides.

In most cases, validators must buy and stake the native cryptocurrency of the blockchain network they wish to validate. Locking those crypto assets is done to make sure that all validators on the platform act in an honest way.

If a validator is dishonest or doesn't do their job to keep a blockchain network safe, this can lead to security holes. This could cause the price of the cryptocurrency that is tied to the blockchain to go down.

To be a part of the network, validators must also buy and set up their own staking infrastructure. This would require access to 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. In general, this method of staking cryptocurrencies is more expensive than all other options.

Join a Staking Pool

Joining a staking pool run by validators on a blockchain network is another way to earn staking rewards. Under these circumstances, token holders add their digital assets to staking pools run by validators.

On a proof-of-stake blockchain network, this system is often used to raise the money needed to pay the validators, but it also lets token holders earn staking rewards without having to be validators.

Instead, operators of the staking pools carry out the responsibilities of validators. To use this method, you will need a crypto wallet to connect to the validator staking pool and move your crypto assets there. The wallet will also be a way for you to get rewards for the crypto you staked.

Suppose you are an average crypto investor interested in joining a staking pool. Please visit the official website of the proof-of-stake blockchain you are interested in to find out about its validators. Before depositing your crypto holdings into a staking pool, make sure you do your homework.

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 added bonus, crypto exchanges that offer this service let users bet on a wide range of digital assets. Some popular crypto platforms like Kraken, Binance, and Uphold provide staking opportunities. Additionally, Coinbase supports staking crypto to earn rewards.

Many of these platforms also offer many other investment and reward programs. Through these options, users can pick any digital asset in the investment portfolio of their favorite cryptocurrency 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:

• Solana (SOL)

• Ethereum (ETH)

• Cardano (ADA)

• Polkadot (DOT)

• Avalanche (AVAX)

• Algorand (ALGO)

• Tezos (XTZ)

Staking vs. Mining

Staking and mining are important ideas that are essential to the way blockchain networks work. 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.

But staking and crypto mining are fundamentally different in that staking doesn't need a lot of special 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 was already said, yield farming and staking are two ways to invest in digital assets that let investors make money without doing anything. However, despite this shared similarity, both concepts are different.

For example, crypto staking is essential to the way proof-of-stake consensus mechanisms work on blockchains. 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 various tax laws that apply to cryptocurrency staking. Generally, the location of the 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 not a 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.

But because the crypto space is still developing, there are still a lot of gray areas when it comes to tax 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. Even though this investment option doesn't promise big returns in the short term, people who use it will make small profits over a long time.

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. So, investors who use these platforms will have to pay staking fees on the assets they stake. For example, the cryptocurrency exchange Coinbase charges a 20% commission on staking rewards. Similarly, KuCoin charges a 10% fee for 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?

There are different periods attached to the staking programs offered by various staking platforms. To get staking rewards, investors must lock up their crypto assets for a certain amount of time.

During these lock-up periods, investors are unable to access or sell their 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 six months or one year.

How Are the Rewards from Staking Calculated?

The best way to figure out the rewards of any staking program is to use a staking calculator. With the calculator, you can calculate the value of the 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. In contrast, rewards will be smaller when interest rates are low.

Crypto Staking Safety

Even though crypto staking is a good long-term investment, it does come with some 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:

Market Risk

In general, most assets that qualify for crypto staking are volatile. Because of this, when the coin market is volatile, the price of cryptocurrencies that have been staked may go up and down in crazy ways. This can lead to a significant drop in the value of your underlying assets.

Lengthy Lock-up Period

The length of the lock-up period is another problem that often comes up with staking. Some staking services attach lengthy lock-up periods to their staking programs.

Investors cannot access their assets while the lock-up period is in effect. Also, investors can't take their staked tokens off the market and sell them if the price of the coin goes down.

Risk of Illiquidity

It's also important to consider the liquidity of the cryptocurrency asset you want to stake. Even though some assets have huge staking rewards for investors, some of these tokens may not be available on many crypto exchanges.

Because of this, investors may not be able to sell their staking rewards because the market is not liquid. As a result, invest in crypto assets that are liquid and listed on top cryptocurrency exchanges.

There are many other things that can pose risks for investors who want to bet on their crypto holdings and earn passive income from them. Carefully research the potential risks before opting for any staking program.

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.

The Ethereum network was first set up as a proof-of-work blockchain network, but it has begun to change to a proof-of-stake model. As a result, the blockchain now supports both staking and mining activities.

But when the switch to a proof-of-stake model is complete, crypto mining will no longer be possible on the Ethereum blockchain.

Conclusion

Without a doubt, crypto staking gives its users a small return over time. 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 universally applied. If you want to join a crypto staking program, you should carefully look into the risks, laws, fees, and benefits of the method you want to use. Also, think about the reputation of several platforms in this space before choosing the one you like best.

Disclosures

The content is only provided for informational purposes. It is not meant to be tax or financial advice, and it does not recommend any particular investment plan. Every investment has risk, including the possibility of a cash loss. Past performance does not guarantee future results.

Bitcompare does not guarantee good investment outcomes. The way a security or financial instrument performed in the past does not show how it will perform in the future. Before investing in options, clients should carefully assess their financial goals and risk tolerance. Due to how important tax issues are in all staking transactions, a customer who is thinking about buying options should talk to a tax expert to find out how taxes affect the outcome of any staking strategy.