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Cryptocurrency is an extremely high-risk and complex investment. Don’t invest unless you’re prepared to lose all the money you invest. You are unlikely to be protected if something goes wrong.
Forbes Advisor has provided this content for educational reasons only and not to help you decide whether or not to invest in cryptocurrency. Should you decide to invest in cryptocurrency or in any other investment, you should always obtain appropriate financial advice and only invest what you can afford to lose.
With cryptocurrency, one way to make a profit is to sell your investment when the market price increases. There are other ways to make money in crypto, like staking. With staking, you can put your digital assets to work and earn passive income without selling them.
In some ways, staking is similar to depositing cash in a high-yield savings account. Banks lend out your deposits, and you earn interest on your account balance.
In theory, staking isn’t too different from the bank deposit model, but the analogy only goes so far. Here’s what you need to know about crypto staking.
What is ‘staking’?
Staking is when you lock crypto assets for a set period of time to help support the operation of a blockchain. In return for staking your crypto, you earn more cryptocurrency.
Many blockchains use a proof of stake consensus mechanism. Under this system, network participants who want to support the blockchain by validating new transactions and adding new blocks must “stake” set sums of cryptocurrency.
Staking helps ensure that only legitimate data and transactions are added to a blockchain. Participants trying to earn a chance to validate new transactions offer to lock up sums of cryptocurrency in staking as a form of insurance.
If they improperly validate flawed or fraudulent data, they may lose some or all of their stake as a penalty. But if they validate correct, legitimate transactions and data, they earn more crypto as a reward.
Popular cryptocurrencies Solana (SOL) and Ethereum (ETH) use staking as part of their consensus mechanisms.
Proof-of-stake validation
Staking is how proof of stake cryptocurrencies cultivate a functioning ecosystem on their networks. Typically, the bigger the stake, the greater chance validators get to add new blocks and earn rewards.
As validators amass larger amounts of stake delegations from multiple holders, this acts as proof to the network that the validator’s consensus votes are trustworthy, and their votes are therefore weighted proportionally to the amount of stake the validator has attracted.
Plus, a stake doesn’t have to consist of just one person’s tokens. For example, a holder can participate in a staking pool, and stake pool operators can do all the heavy lifting in validating the transactions on the blockchain.
Each blockchain has its set of rules for validators. For example, Ethereum requires each validator to hold at least 32 ETH. At the time of this writing, that’s about $38,965. A staking pool allows you to collaborate with others and use less than that hefty amount to stake. But one thing to note is that these pools are typically built through third-party solutions.
How does staking work?
If you own a cryptocurrency that uses a proof of stake blockchain, you are eligible to stake your tokens. Staking locks up your assets to participate and help maintain the security of that network’s blockchain. In exchange for locking up your assets and participating in the network validation, validators receive rewards in that cryptocurrency known as staking rewards.
You can also set up a cryptocurrency wallet that supports staking.
Read More: The Best Staking Platforms
If you have your tokens in one of these wallets, you can delegate how much of your portfolio you want to put up for staking. You pick from different staking pools to find a validator. They combine your tokens with others to help your chances of generating blocks and receiving rewards.
How to stake crypto
When you choose a program, it will tell you what it offers for staking rewards. As of December 2022, the crypto exchange CoinDCX offers a 5%-20% annual percentage yield (APY) for Ethereum 2.0 staking.
Users must stake at least 0.1 ETH in the pool to get started.
Once you’ve committed to staking crypto, you will receive the promised return according to the schedule. The program will pay you the return in the staked cryptocurrency, which you can then hold as an investment, put up for staking, or trade for cash and other cryptocurrencies.
What are the potential benefits of staking crypto?
- Potentially earn passive income If you don’t plan on selling your cryptocurrency tokens in the immediate future, staking lets you earn passive income. Without staking, you would not have generated this income from your cryptocurrency investment.
- Straightforward You can get started staking quickly with an exchange or crypto wallet.
- Support crypto projects you like Tanim Rasul, chief operating officer and co-founder of National Digital Asset Exchange, a cryptocurrency trading platform in Canada, says: “Staking has the added benefit of contributing to the security and efficiency of the blockchain projects you support. By staking some of your funds, you make the blockchain more resistant to attacks and strengthen its ability to process transactions.”
What are the risks of staking crypto?
When you stake your tokens, you may have to commit them for weeks or months depending on the program. During this time, you wouldn’t be able to cash out or trade your tokens.
Still, since you’re selling on a secondary market, you need to find a willing buyer or lender. Plus, there’s no guarantee you’ll be able to do so or get all your money back early.
Cryptocurrencies are also extremely volatile investments, where double-digit price swings are common during market crashes. If you’re staking your cryptocurrency in a program that locks you in, you wouldn’t be able to sell during a downturn. The staking platform you choose could offer lucrative annual returns, but if the price of your staked token falls, you could still incur losses.
Many proof of stake networks use “slashing” to punish validators who take improper actions, destroying some of the stake they put up on the network. If you stake with a dishonest validator, you could lose part of your investment for this reason.
Should you stake crypto?
Staking can be a good option for investors interested in generating yields on their long-term investments who aren’t bothered about short-term fluctuations in price. If you might need your money back in the short term before the staking period ends, you should avoid locking it up for staking.
You should carefully review the terms of the staking period to see how long it lasts and how long it would take to get your money back at the end when you decide to withdraw.
And it is important to identify and work with companies with a positive reputation and high-security standards.
If the interest rates seem too high to be true, you should approach cautiously.
Lastly, staking, like any cryptocurrency investment, carries a high risk of losses. Only stake money you can afford to lose.
