Staking, like many other concepts in cryptocurrencies, can be either a complex or a simple concept, depending on how many layers of comprehension you want to reach. The main lesson for many traders and investors is that staking is a means to receive rewards for holding particular cryptocurrencies. However, even if all you’re after is some crypto staking benefits, it’s still helpful to know at least a little bit about how and why the system functions the way it does.
How does staking work?
You can “stake” some of your cryptocurrency holdings in exchange for a percentage-rate reward over time if the cryptocurrency you own permits it (current alternatives include Tezos, Cosmos, and now Ethereum thanks to the recent ETH2 update). Typically, a “staking pool,” which is analogous to an interest-bearing savings account, is used to do this.
Your cryptocurrency generates dividends while being staked because the blockchain uses it. Staking-enabled cryptocurrencies use a “consensus technique” called Proof of Stake to guarantee that all transactions are secure and confirmed without the involvement of a bank or payment processor. If you decide to stake your cryptocurrency, it joins that operation.
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Why do only some cryptocurrencies have staking?
It starts to become more technical at this point. Staking is prohibited when using Bitcoin, for instance. You need a little bit of backstory to comprehend why.
- Decentralization, or the absence of a centralized authority, is a characteristic of cryptocurrencies. How therefore, without having the solution provided to them by a centralized entity like a bank or credit card firm, do all the computers in a decentralized network come to the right conclusion? A “consensus mechanism” is employed.
- A consensus technique known as Proof of Work is used by many cryptocurrencies, including Bitcoin and Ethereum 1.0. The network uses Proof of Work to solve issues like authenticating transactions between strangers on different sides of the world and ensuring that no one is attempting to spend the same amount of money twice. “Miners” from all around the world compete to be the first to solve a cryptographic puzzle as part of the process. The winner receives some cryptocurrency in addition to the right to add the most recent “block” of validated transactions to the blockchain.
Proof of Work is a scalable method for a relatively simple blockchain like Bitcoin’s, which tracks incoming and departing transactions much like a bank’s ledger. However, Proof of Work can lead to bottlenecks when there is too much activity for something more complex like Ethereum, which has a wide range of apps running on top of the blockchain, including the entire world of DeFi. Transaction times may lengthen as a result, and costs may increase.
What is Proof of Stake?
Proof of Stake, a more recent consensus technique, has surfaced with the goal of boosting speed and efficiency while decreasing fees. By removing the need for all those miners to do energy-intensive arithmetic operations, Proof of Stake significantly lowers prices. Transactions are instead verified by users who have staked actual money into the blockchain.
- Staking performs a similar role to mining in that it selects a network participant to add the most recent batch of transactions to the blockchain and rewards them with cryptocurrency in return.
- Users risk their tokens for the opportunity to add a new block to the blockchain in exchange for a payout. The specific implementations differ from project to project. Any new transaction they make to the blockchain will be legitimately supported by their staked tokens.
- Based on the value of their investment and how long they’ve held it, the network selects validators (as they’re often known). As a result, those who invested the most are rewarded. In what is referred to as a “slashing event,” users may have a portion of their stake burnt by the network if transactions in a fresh block are found to be incorrect.
What are the advantages of crypto staking?
Many long-term cryptocurrency owners view staking as a means to put their holdings to use by producing rewards rather than letting them sit dormant in their wallets.
Staking also helps the blockchain projects you support by enhancing their effectiveness and security. You can increase the blockchain’s security and transaction processing capacity by staking some of your funds. (Some projects additionally distribute “governance tokens” to staking participants, which allow holders to vote on upcoming protocol updates.)
What are some crypto staking risks?
Staking frequently necessitates a lockup or “vesting” period during which your cryptocurrency cannot be transferred. This can be a disadvantage because even if prices change, you won’t be able to swap staked tokens during this time. It is crucial to familiarize yourself with the individual staking standards and regulations for each project you are considering participating in before staking.
How do I start crypto staking?
In general, anyone who wants to participate in stakes is welcome. Nevertheless, turning into a full validator may involve a substantial minimum investment (ETH2 requires a minimum of 32 ETH), technical expertise, and a dedicated computer that can carry out validations around-the-clock. Participating at this level involves security concerns and carries a heavy responsibility because downtime can result in a validator’s stake being reduced.
However, there is a more straightforward approach to participate for the vast majority of individuals. You can fund a staking pool with as much as you can afford using an exchange like FunexCoin. As a result, there is a lower entrance barrier and investors can begin receiving returns without having to manage their own validator hardware.
The financial takeaway
Staking is a viable option for cryptocurrency holders who want to put their investments to work and earn interest and prizes. Additionally, it might involve you in the blockchain networks’ governance and validation aspects, which may be of interest to some investors.
Consideration of staking as owning stock and receiving dividends, or even as depositing money in a bank account and receiving interest, may be helpful. It might be a pretty low-lift method of account growth, but do your research and understand the hazards of staking before you begin.
