Earning rewards for staking is a way to earn passive income on the crypto assets you hold. In a way, it’s similar to earning interest on your cash in a bank account or a dividend on your stock holdings. In this article, we cover everything you need to know to understand staking rewards, including how staking works and its pros and cons.
What Is Staking?
Staking involves using your crypto holdings to validate transactions on a blockchain network. The term comes from putting something (in this case, your coins) at stake for a set period. In return for staking your coins, you get a reward.
Note that staking isn’t possible with every cryptocurrency. This option is only available with currencies that use the proof-of-stake (PoS) model to process payments. Before looking at examples of such currencies, let’s quickly understand PoS, which differs from the more energy-intensive proof-of-work model used by a currency like Bitcoin.
The Proof-of-Stake Model
Since cryptocurrencies are not controlled by a financial institution, they require a method to verify transactions. PoS is one such method involving a consensus mechanism where crypto owners stake their coins for a right to check new blocks of transactions and add them to the blockchain.
The participants staking their coins can be validators, computer nodes in the peer-to-peer network that confirm transactions. Participants can also be delegators who trust existing validating nodes and form a stake pool through the delegation of their staked assets. Validators are selected at random. The number of coins you have to stake to participate in the validation process differs from one network to another. Each block is verified by multiple validators; when a certain number of validators have verified the block’s accuracy, it is finalized.
How Do Staking Rewards Work?
So, we have established that staking is how new transactions get added to a blockchain. The process begins with participants pledging their coins to a particular cryptocurrency protocol. The protocol chooses validators from these participants. While the selection process has a component of randomness built in, your likelihood of being chosen increases with the more coins you stake.
When a new block gets added to the blockchain after successful validation, new coins get minted and distributed to the validators (and indirectly to the delegators). These reward coins are usually in the same cryptocurrency being staked. However, in some cases, the protocol may use a different type of currency for rewards.
Getting validators to stake their coins incentivizes them to play by the rules, minimizing the chance of fraud. Therefore, the more you stake, the better your chance of earning rewards. At the same time, if your verified block is found to have inaccurate information, you can be penalized part of your stake.
Remember that you still own the coins you are staking. The coins are being used in the validation process, but you can “unstake” them later. Depending on the currency, the unstaking may be immediate or, more commonly, involve a lock-in period.
Coins for Staking and Typical Returns
Quite a few cryptocurrencies use the PoS model, so you aren’t short of viable staking options. Some well-known among these are Ethereum (which relied on proof of work earlier), Cardano, Solana, and Tezos.
The average annual yields on networks that allow staking can even be over 40%. However, the more popular (and reliable) currencies will have a narrower range of 4% to 20%. For example, according to StakingRewards.com, the estimated annual reward on Ethereum in October 2022 was 4.88%; on Polkadot, it was 13.97%.
The above yields are not adjusted for inflation. Please also note that these returns change over time, so it’s vital to do your own research.
How to Stake Cryptocurrency
There are a few ways to stake your cryptocurrency, requiring varying degrees of commitment. The simplest way is to do it through an exchange. Staking is a service provided by some top crypto exchanges, such as Coinbase and Binance.US. These exchanges charge a commission in return. Some other exchanges allow users to earn rewards in a manner similar to staking.
A much more complicated way is to become a validator. This requires a substantial financial investment and your own staking infrastructure, either of which is more commitment than what most crypto investors want. Plus, you also need to go through the blockchain’s entire transaction history, which is time-consuming.
Staking Pool
The most common method to participate in staking is through a pool operated by a validator. Crypto investors can combine their assets in these pools, giving them and the validator a better chance of being selected and earning rewards. You can follow these steps to earn staking rewards through a pool:
Research PoS Currencies
Once you have identified a handful of currencies that allow staking, research them. Factors worth understanding include the currency’s history, the staking process, and the rewards offered. Your preferences may differ from someone else, so it helps to consider these factors carefully before zeroing in on your currency of choice.
Buy and Transfer to a Wallet
After selecting the currency of interest, you must buy it to stake it. There are several ways to buy crypto, including through an exchange or app. If the exchange doesn’t offer a staking service, you will need to transfer your coins to a crypto wallet.
Join a Staking Pool
The final step is to research staking pools and join one. A useful resource is the set of information often shared by the official websites of PoS blockchains. Several factors must be considered before finalizing a pool. Reliability is critical, so look for pools where servers have as close to 100% uptime as possible.
Staking pools charge a small commission (usually 2% to 5% of the staking rewards), so you would want pools where the fee seems reasonable for the currency. The size of the pool is another vital consideration. Very small pools have a lower probability of being selected for validation, thus offering a poorer chance of earning rewards. However, if selected, your share of the rewards can be bigger than in a large pool.
On the other hand, larger pools can get oversaturated because some currencies limit the rewards going to a pool. Moreover, in the interest of decentralization, some networks prevent the largest pools from becoming too influential.
Having selected a pool to stake with, you will need to connect your wallet with that pool.
Pros and Cons of Staking
Like most aspects of investing, the decision to stake crypto requires careful evaluation of its advantages and disadvantages. Only then will you be in a position to decide if staking is the right option for you.
- Additional income _ The greatest benefit of staking is the possible increase in your holdings. If you or your pool is selected for validation, you can earn staking rewards that can add to your stash of crypto assets.
- Passive growth _ Unlike trading, staking doesn’t require you to be actively involved. Thus, it’s a particularly useful option if you can’t afford the time or research required for frequent trading.
- Greater participation _ Staking is a bit like owning stock in a company. Stakers are more involved in the ecosystem of a blockchain network, giving them a greater say in some of the operational aspects.
- Saving of resources _ Compared to crypto mining, staking takes up far less electricity and computing resources. Thus, your wealth creation is much less harmful to the environment.
- Lock-up period _ The funds you have staked remain locked up for a specific period, during which you can’t use them for any other purpose. Of course, the lock-up period and the time it takes to unstake varies across networks.
- Volatility _ The crypto market is highly volatile, and the consequent price swings impact everyone investing in this market. However, in the case of staking, it is coupled with the fact that you don’t have immediate access to staked assets to adapt your investing strategy to changing market conditions quickly.
- Slashing _ Poor or dishonest performance from validators can result in a penalty of a specific portion of the staked assets. This also affects those who have delegated assets to that validator.
- Fees _ Whether staking through a pool or an exchange, you will have to incur a fee. The fee is typically not large relative to the interest you earn, but it still helps to know that there is some expense along with the rewards.
Final Thoughts
Staking rewards can prove a great way to earn some passive income with your crypto assets. However, before staking your crypto assets, ensure you have considered all aspects, especially whether you can afford to commit the assets for a set period. There are also other means of earning passive income, such as bonds, which are less risky. After careful consideration, if you have decided in favor of staking, we are sure the points covered here will help you get started.
