What Is Crypto Staking?

The cryptocurrency market has experienced substantial growth in recent years, and staking has emerged as a fundamental mechanism fueling this expansion. In May 2024, a total of 32.5 million (approx. US$99 billion) Ethereum (ETH) were staked. This represents a 78% increase in staked ETH following the Ethereum Shanghai Upgrade in April 2023, highlighting the growing interest in staking as a way to earn passive income and participate in network governance.

In a market dominated by volatility and rapid innovation, it’s common for crypto investors to seek innovative strategies to navigate market fluctuations. Staking addresses this need. With the rise of various staking options, each with unique features, understanding how crypto staking works and what you should note before staking your crypto is crucial for novice and experienced crypto enthusiasts.

What Is Staking?

Staking is the process of actively participating in transaction validation on a blockchain network, typically a Proof of Stake (PoS) blockchain. Instead of using computational power to solve complex puzzles, as in Proof of Work (PoW) systems, staking involves holding (or locking up) funds in a crypto wallet to support the network's operations. In return, participants are rewarded with additional cryptocurrency.

Key Concepts in Staking

• Proof of Stake (PoS): A consensus mechanism where validators are chosen based on the amount of crypto they hold and are willing to "stake" as collateral. These validators are responsible for validating transactions on the blockchain and securing the network. 

• Delegated Proof-of-Stake (DPoS): A variation of PoS where users vote for delegates to validate transactions. Delegates are required to lock up a large amount of their own cryptocurrency as a kind of deposit. The deposit ensures that the delegates act honestly and in the best interests of the network, as they risk losing their deposit if they behave badly.

• Staking Rewards: Incentives given to validators and delegators for participating in the staking process. These rewards can come as newly minted crypto or transaction fees from the network.

• Lock-Up Period: The length of time that your staked crypto is inaccessible and cannot be transferred or withdrawn. The lock-up period can range from a few days to several months, depending on the specific blockchain network. Lock-up periods are a crucial factor to consider when staking, as they affect your liquidity and flexibility. If you need access to your funds during the lock-up period, you won't be able to withdraw them, even if the market price changes significantly.

• Slashing: A penalty mechanism where a portion of a validator's staked crypto is forfeited if they engage in malicious activity or fail to perform their duties, such as going offline for extended periods.

• Finality: The point at which a transaction is considered irreversible and fully confirmed on the blockchain network. Achieving finality can be affected by technical issues such as software bugs.

How Does Crypto Staking Work?

Staking, in essence, is like earning interest on your crypto holdings by contributing to the network's security. You lock up a portion of your cryptocurrency in a wallet, and in return, you earn a reward proportional to the amount you stake and the duration of the stake.

Not all cryptocurrencies can be staked because staking is intrinsically linked to how a particular blockchain verifies transactions and maintains security. Only cryptocurrencies built on blockchains that employ Proof of Stake (PoS) or Delegated Proof of Stake (DPoS) consensus mechanisms can be staked. Other cryptocurrencies, particularly those utilizing the older Proof of Work (PoW) mechanism, rely on energy-intensive mining processes for validation and thus do not offer staking opportunities.

The Staking Process

1. Choose a Staking Platform: Research and select a reputable staking platform (e.g., an exchange, a dedicated staking service, or a wallet that supports staking) offering a staking service for your crypto.

2. Transfer your coins: Transfer your chosen crypto to the staking platform.

3. Select a Staking Pool (Optional): Some platforms allow you to pool your stake with others.

4. Choose Staking Options: Select your lock-up period or the validator you want to delegate to (if applicable).

5. Start Staking: The platform will proceed to stake your crypto based on the chosen staking option and the blockchain network's protocol.

Note: This is a simplified example. The actual staking process may vary depending on the platform and chosen blockchain.

Considerations Before Staking Your Crypto

• Fees: Some platforms may charge fees for staking services. These fees vary depending on the platform and the specific cryptocurrency being staked.

• Staking Period: The duration for which the staked assets are locked up can vary. Some platforms offer fixed staking options with predetermined lock-up periods and potentially higher rewards, while others provide flexible staking with no fixed terms and the ability to unstake at any time, usually with lower rewards. Consider your liquidity needs and risk tolerance when choosing between these options.

• Different Blockchains: Each blockchain network has its own set of rules and reward structures for staking. It's important to research the specific blockchain and platform before you start staking your crypto with them.

• Risks: Understand the potential risks, including price volatility, slashing, and counterparty risk (if using a third-party platform).

Types of Staking

1. Proof of Stake (PoS)

What it is: As aforementioned, PoS is a consensus mechanism that replaces the energy-intensive Proof of Work (PoW) system. Instead of miners competing to solve complex puzzles, validators are chosen to verify transactions based on the amount of cryptocurrency they "stake" or lock up.

Why people use it: PoS staking allows crypto holders to earn passive income on their holdings by participating in network validation. It's seen as a more environmentally friendly option compared to PoW mining.

How it works: Validators are randomly selected to create new blocks and verify transactions. The more coins a validator stakes, the higher their chances of being chosen. If a validator acts maliciously, they risk losing a portion of their stake.

Example: ADA is a popular native cryptocurrency of Cardano, a blockchain that uses a Proof of Stake (PoS) consensus mechanism. Cardano's unique Ouroboros protocol allows ADA holders to delegate their stake to stake pools, earning rewards while supporting network decentralization and security.

2. Delegated Proof of Stake (DPoS) System

What it is: DPoS is a variation of PoS where token holders don't directly validate transactions. Instead, they vote for a smaller group of delegates who perform this task on their behalf.

Why people use it: DPoS offers a more accessible way for investors to participate in staking, as they don't need to run their own validator nodes. They can simply delegate their stake to a trusted delegate and share in the rewards.

How it works: Token holders stake their coins to gain voting power. They then use this power to elect delegates who are responsible for maintaining the blockchain and validating transactions. Delegates earn rewards for their work, and in some cases, these rewards are shared with the token holders who voted for them.

Example: EOS (EOS) is a well-known example of a DPoS blockchain. EOS token holders can actively participate in network governance by voting for block producers (delegates) who, in turn, earn EOS tokens as rewards for their role in maintaining the network.

3. Liquid Staking

What it is: Liquid staking offers the benefits of staking (earning rewards) while maintaining the liquidity of your assets. When you stake your crypto through a liquid staking platform, you receive derivative tokens representing your staked amount.

Why people use it: Liquid staking appeals to investors who want to earn staking rewards but don't want to lock up their digital assets for a fixed period. The derivative tokens can be traded or used in DeFi applications, providing flexibility and potential for additional gains.

How it works: Users deposit their tokens into a smart contract on a liquid staking platform. In return, they receive derivative tokens (e.g., stETH for staked ETH) that represent their staked amount plus accrued rewards. These derivative tokens can be traded or used as collateral in DeFi.

Example: Lido Finance is a popular platform offering liquid staking services for various crypto like Ethereum (ETH). 

4. Restaking

What it is: Restaking involves taking your staked assets (or the derivative tokens representing them) and staking them again on another platform or protocol.

Why people use it: Restaking is an advanced strategy for investors seeking to maximize their yield from staking. By redeploying their staked assets, they can potentially earn rewards from multiple platforms and protocols.

How it works: Restaking can involve multiple steps and platforms. For instance, you might stake ETH on Lido to get stETH, then stake that stETH on Rocket Pool to earn additional rewards. The increased complexity of restaking comes with certain implications:

• Technical Knowledge: Restaking often requires a deeper understanding of DeFi protocols, blockchain layers, and the associated risks. Users need to research and evaluate different platforms, understand the mechanics of each protocol, and manage their assets across multiple platforms.

• Smart Contract Risks: Restaking involves interacting with multiple smart contracts, which can expose users to potential vulnerabilities and security risks. It's crucial to choose reputable platforms and protocols with a strong track record of security.

• Impermanent Loss: When restaking assets in liquidity pools, there's a risk of impermanent loss if the price ratio of the assets in the pool changes significantly. This can result in a lower overall value of the staked assets compared to simply holding them.

Example: Restaking ETH with Lido and Rocket Pool

Imagine you've staked ETH with Lido and received stETH (Lido staked ETH) in return. With restaking, you could then deposit your stETH into Rocket Pool, a decentralized Ethereum staking pool. Doing this would allow you to earn additional rewards from Rocket Pool on top of the rewards you're already earning from Lido. However, it would require interacting with both the Lido and Rocket Pool platforms and understanding the potential risks involved, such as smart contract vulnerabilities and impermanent loss.

Benefits and Risks of Staking

Just because staking is popular doesn't mean it's risk-free. Let's explore the potential upsides and downsides you may experience by staking your cryptocurrency to understand all sides of the coin.

Benefits

• Passive Returns: One of the primary benefits of staking your crypto is the potential to earn rewards in the form of additional crypto. By participating in the staking process, you can earn interest on your holdings, which may be an option for long-term crypto investors who prefer to let their assets work for them rather than just holding them in the crypto wallet​.

• Network Security: Staking contributes to the overall security and efficiency of the blockchain network. By locking up their digital assets, crypto investors help maintain the network's operations, making it more robust against attacks. The added layer of security supports the blockchain network's infrastructure and deters malicious activities.

• Energy Efficiency: Compared to PoW systems, PoS is more energy-efficient. It reduces the environmental impact associated with high energy consumption used in mining activities, making PoS a greener alternative which contributes to the sustainability of blockchain technology​.

• Participation in Governance: Some staking mechanisms allow crypto investors to participate in network governance, giving them a say in important decisions such as protocol upgrades and policy changes. Involvement can influence the future direction of the blockchain project and ensures that stakers have a voice in the network.

• Access to Early Projects: Staking can also provide early access to new crypto projects and associated perks. This could include early airdrops, participation in initial staking offers (ISOs), or other incentives designed to attract and reward early supporters.

Risks

• Price Volatility: The value of the staked assets can fluctuate significantly, potentially leading to losses. The crypto market is known for its volatility, and staked assets are not immune to these price swings. For instance, the balance of Ethereum across crypto exchanges dropped to its lowest in eight years on 14 June 2024, indicating significant market movement and potential volatility impacts on staked assets. Even if you earn staking rewards, a substantial drop in the value of the crypto can offset these gains​. 

• Lock-Up Periods: When staking your crypto, your digital assets are often locked up for a certain period, during which they cannot be traded or withdrawn. Lack of liquidity can be a risk if the market conditions change suddenly and you need to access your funds​.

• Counterparty Risk: Staking through crypto exchanges or staking platforms introduces counterparty risk, meaning that the security and reliability of the platform holding your digital assets should be a crucial consideration factor. In the event of a security breach or technical malfunction on the platform, your staked assets could potentially be lost or become inaccessible.

• Slashing Risk: Validators in PoS networks can be penalized for misbehavior, such as double-signing or going offline for extended periods. These penalties, known as slashing, can result in the loss of some or all of the staked crypto. Although slashing events are relatively rare, they can still pose a significant risk if they occur.

• Software Bugs: Blockchains that frequently undergo upgrades may experience issues with their client software. These bugs can disrupt staking operations. Ethereum, for example, has experienced issues achieving finality due to client software bugs. 

Ways to Stake Your Crypto

There are several methods available for staking your cryptocurrency, each catering to different levels of technical expertise and risk tolerance.

Native Staking

Native staking means you are directly participating in the blockchain's consensus mechanism by locking up your cryptocurrency in your own wallet. Your wallet must be compatible with staking for that specific cryptocurrency. Think of it like becoming a mini-validator on the network.

In simple terms, when you stake your coins natively, you're essentially saying, "I trust this blockchain and want to help keep it secure."  In return for your help, the network rewards you with more coins. The more you stake, the more likely you are to be chosen to validate transactions and earn these rewards.

Native staking typically offers the highest potential rewards compared to other staking methods because there are no intermediaries taking a cut. However, it requires more technical know-how. You'll need to set up and maintain your own staking node, which involves running special software and ensuring your internet connection is reliable.

Example: On the Ethereum network, you can become a validator by staking a minimum of 32 Ethereum (ETH). The process requires running a validator node, which involves setting up specific hardware and software to participate in their network operations.

Staking Through CEXs, DEXs, or Staking Services

You can participate in crypto staking through various platforms, including centralized exchanges (CEXs), dedicated staking services, and some decentralized exchanges (DEXs). These platforms simplify the staking process by handling the technical aspects of validator selection and reward distribution.

Example:

• Centralized Exchanges (CEXs): Allow users to stake their crypto without needing to manage the technical requirements. These exchanges handle the validator nodes and distribute rewards to users, usually in exchange for a small fee.

• Decentralized Exchanges (DEXs): DEXs offer staking services as well, allowing users to participate in staking directly from their crypto wallets while maintaining control over their private keys. These platforms use smart contracts to manage the staking process.

• Dedicated Staking Services: There are also specialized staking services that focus solely on providing staking solutions. They often offer unique advantages for new and experienced users alike:

  • User-Friendly Interfaces: Many dedicated staking services prioritize making staking accessible, with intuitive interfaces and clear instructions.

  • Wider Range of Cryptocurrencies: These services typically support staking for a wider variety of cryptocurrencies than CEXs or DEXs, giving you more options to choose from.

  • Additional Features: Some services offer advanced features like automatic restaking, yield optimization strategies, and educational resources to help you get the most out of your staking experience.

  • Strong Security Measures: Reputable staking services implement robust security measures to protect your staked assets, such as insurance funds and multi-signature wallets.

Pooled Staking

Staking pools allow multiple crypto holders to combine their resources, increasing their chances of validating transactions on the blockchain and earning rewards. It often works by using smart contracts to manage the distribution of rewards among participants, providing flexibility and lower barriers to entry. This method is beneficial for those who have smaller amounts of crypto and want to participate in staking, as they don't have to meet the high minimum requirements of some networks. 

Example: Solana’s (SOL) stake pools allow users to delegate their SOL across multiple validators, enhancing network security and decentralization.

Stake It Until You Make It? Don’t Put Your Crypto At Stake.

Now that you have grasped the basics of staking, you're equipped to make informed decisions about utilizing your digital assets. There's no one-size-fits-all approach — native staking, crypto exchange staking, and staking pools each offer unique benefits and drawbacks. The key takeaway is you should carefully evaluate your risk tolerance, investment goals, and the specifics of each method before staking your crypto.

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Disclaimer: This material is for information purposes only and does not constitute financial advice. Flipster makes no recommendations or guarantees in respect of any digital asset, product, or service. Trading digital assets and digital asset derivatives comes with significant risk of loss due to its high price volatility, and is not suitable for all investors.