Crypto Basics

Crypto Staking Overview: How It Works, Benefits, Risks, and Future

A vault with the words "Proof of Stake" written over its entrance and Ether tokens stacked outside and inside.

In 2012, Sunny King and Scott Nadal shared the Proof of Stake (PoS) concept in a paper as a solution to Bitcoin mining’s energy consumption problem. Following that introduction, King launched Peercoin in 2013, making it the first cryptocurrency to employ staking as a means of validating transactions on the blockchain. 

Since that time, staking has exploded in popularity, aided greatly by the Ethereum Merge in September 2022, which converted the network from a Proof of Work (PoW) to PoS consensus mechanism. Today, the market capitalization of Ether (ETH) alone exceeds $380 billion. Crypto staking scales the security and growth of PoS blockchains and can also present a novel opportunity to earn rewards for crypto experts and beginners alike. By incentivizing participants via staking rewards, the PoS model encourages more engagement with the crypto ecosystem, which could spur growth of current and future blockchains.

In those post, we’ll cover:

What is crypto staking?

Generally speaking, crypto staking allows token holders to participate as validators in a Proof of Stake (PoS) consensus mechanism by locking their tokens into a staking contract and running the associated validator software program, though some parts of this process can be automated or outsourced to third parties. The more crypto a validator stakes increases the odds they’ll be randomly chosen to verify and process a new block. In return, they earn the associated staking rewards. Staking ensures the stability and security of a PoS blockchain, as validators risk losing the crypto they’ve locked in the staking contract if they attempt to behave dishonestly and validate false transactions. Though reward structures vary, in return for locking cryptocurrency in an illiquid contract, validators typically receive rewards in proportion to their staked cryptocurrency, and those rewards will generally grow in value if the blockchain successfully scales and becomes more popular.

When it comes to participation in the staking process, there are two key roles. While terminology varies from network to network, we’ll describe them here as validators and delegators, and explain each of their roles in detail. But first, let’s discuss how the PoS mechanism that facilitates the crypto staking process differs from the PoW model.

Proof of Stake (PoS) versus Proof of work (PoW)

Whether a blockchain uses the PoS or PoW consensus mechanisms, both processes provide a way to verify and secure blockchain transactions without the need for an intermediary like a bank or payment processor. Each one just achieves that end in a different way.

In the case of PoS blockchains like Ethereum, in order to verify and process new crypto blocks, validators stake (or lock up) their crypto in a smart contract and are randomly selected to create new blocks as described earlier. In return, once the validator adds a new block to the chain, they earn rewards in the form of newly created cryptocurrency, plus transaction fees. Because validators stake some of their own crypto, they’re incentivized against falsifying blocks which would cause them to lose their staked crypto, adding security to the process.

With the PoW consensus mechanism, which is used predominantly by Bitcoin, “mining” new blocks requires groups or individuals to solve complex, cryptographic puzzles. The miner who does so first wins the right to validate the transaction, then broadcasts it to the network, and receives both the new crypto and transaction fees.

The role of validators and delegators in staking

Individuals or entities that participate in a PoS consensus mechanism broadly fall into two categories:

  1. Validators: node operators that verify transactions and create new blocks. To do so, validators stake some of their crypto as collateral, which incentivizes them to complete the task honestly so as not to risk their stake to slashing, a mechanism coded into PoS blockchains that punishes validators for malicious behavior by taking a percentage of what they’ve staked in the smart contract. Most blockchains have a relatively high minimum staking threshold to become a validator — Ethereum, for instance, requires validators to stake at least 32 ETH.
  2. Delegators: users who lock up a stake of their crypto for a time and delegate it to validators to secure and record new crypto transactions on the blockchain. The delegator role enables users to participate in staking without staking the full amount required to become a validator.

Both parties earn rewards for their successful participation in this process — validators do so once they’ve created a new block and delegators earn a portion of that reward. Having a stake at risk for both parties incentivizes good behavior and makes everyone more engaged in the process and outcome.

How does staking crypto work?

Especially for beginners, getting involved in staking crypto requires a fair amount of research and setup, in addition to acquiring the crypto to be staked. The information below is by no means exhaustive and readers should do their own research when deciding if and how to stake cryptocurrency.

Selecting a crypto for staking

When getting involved in crypto staking, it’s important to learn more about the token, as well as understand the project(s) it facilitates. For instance, what is the vision and who is behind it? Is the project viable, and what use cases does it fulfill? It’s worth noting that the most successful cryptocurrency projects typically have a robust and active development team behind them, as well as engaged communities that support the user base.

Beyond these fundamentals, it’s key to understand the minimum staking requirements for participating in a given PoS process. For example, to become a solo staker (i.e., a validator) of Ethereum, one must stake at least 32 Ether (ETH). To participate in a staking pool for Polkadot, nominators (Polkadot’s term for delegators) must stake at least 502 DOT, its native token.  

When it comes to staking rewards, it’s important to clearly understand the earning potential, the length of lockup period, and when payouts happen. Information like this can typically be found in a project’s wiki, like this page about Polkadot’s staking rewards.

Crypto staking considerations

Here are some questions potential participants should answer before getting involved in staking:

  • Do I have a comprehensive understanding of the blockchain and its staking process?
  • Does the staking opportunity align with my risk tolerance?
  • Do I want to join a staking pool or stake my crypto individually?
  • How reliable is the validator or staking pool I’m considering?
  • How secure is the platform, protocol, network, or wallet I plan to use?

Staking wallet or platform set up

When it comes to staking, crypto users have the following options:

  • Native staking: This describes the validator’s part in the staking process, so it’s more suitable for those with significant crypto experience, but offers the most control and security because the validator is directly responsible for securing and creating new blocks.
  • Staking through a CEX: In this process, delegators stake their crypto via staking service with exchanges like KuCoin, Gemini, or Coinbase. Widely considered the most suitable option for beginners, staking on a CEX is user-friendly and offers the most support and flexibility when it comes to staking timeframes. Yet, because the CEX custodies the delegator’s crypto, this process also assumes high trust. For instance, hacks can occur or platforms can delist tokens for any number of reasons. The delegator should also have confidence in the service’s staking strategy. Additionally, because the platform performs all aspects of staking for the delegator, staking through a CEX typically offers the lowest staking rewards as compared to staking through a DeFi protocol.

When deciding on a staking wallet or platform, users should explore options that support the coins to be staked and align with their level of technical expertise. Beyond that decision point, security is a paramount consideration, and many users prefer staking crypto on a centralized exchange (CEX) for the reasons described above.

For users who want to custody their own crypto and need to select a hardware wallet, it’s key to confirm compatibility with their phone, computer, or operating system to ensure proper interfacing. Some wallets also have backup and recovery options so that users can regain wallet access or transfer the crypto to a new device, which provides peace of mind. Once the user has acquired their crypto, they can reference the token’s documentation on how to stake it.

Acquiring crypto for staking

There are a few different ways a person can acquire crypto for staking:

  1. Purchase from a CEX: this represents the easiest option for a beginner to buy crypto. The exchange provides the wallet and the buying process is user friendly. 
  2. Purchase from an ATM: While Bitcoin is the most popular token found at crypto ATMs, some provide access to ETH and other cryptos. This option requires having a wallet set up prior to the transaction, whether through an exchange or self custody.
  3. Purchase through a DEX: This option requires that users take the initiative of securing a crypto wallet, so it’s usually a more fitting choice for users with some crypto experience.
  4. Obtain through a peer-to-peer (P2P) service.

Benefits and risks of staking crypto

As discussed, the point of crypto staking is to secure and scale blockchains. In that process, participants benefit by earning rewards and passive income, and can sometimes take part in network governance. Crypto staking also encourages hodling, which can potentially lead to an increase in a token’s value when fewer coins are in circulation. Yet, for all its upsides crypto staking isn’t without risk, which we’ll discuss, too.

Network security and stability

Much like the PoW consensus model used in Bitcoin mining, staking distributes influence amongst stakeholders, making malicious attacks harder to execute and increasing network stability. Staking crypto also has a stabilizing effect on the network because those funds are used to support the operation of validating transactions. Staking allows crypto users to support their favorite blockchains, in addition to earning rewards.

Passive income through staking rewards

Because delegators entrust their crypto to validators, they’re able to earn staking rewards, which represent a portion of the validator’s transaction fees. Typically, rewards are described in terms of annual percentage yield (APY) and each token has its own rewards structure. After validation of a crypto transaction has been completed, the delegator is eligible to earn a reward and the service typically defines the waiting period required to receive it.

Challenges and risks of crypto staking

Though staking has benefits for the crypto ecosystem and individual investors, it’s not without challenges, one of which is illiquidity. If, due to unforeseen circumstances, a user needs to access their investment during the lockup period, that could pose financial difficulty or missed economic opportunity for them elsewhere. By contrast, another form of staking typically leveraged by more advanced crypto users — liquid staking — allows a person to stake their token(s) on a PoS network while maintaining liquidity of the asset. In this process, a smart contract or platform programmatically generates a liquid staking token (LST) which is essentially an on-chain receipt proving ownership of the staked asset. Much like a home equity line of credit that allows a person to borrow money against the value of their home, an LST lets people take advantage of the equity in their staked tokens in order to make other investments. Liquid staking may however raise other risks, for example, in relation to contagion and levels of leverage.

Educational barriers pose another challenge to getting involved in crypto staking. Without the requisite knowledge, both validators and delegators could make uninformed decisions that lead to poor outcomes. As for risks, token devaluation is a distinct possibility. If the price of a staked asset drops while it’s locked up, the user could lose value in their holdings if it doesn’t recover before the staking period ends. Counterparty involvement poses additional risks. If a user decides to stake via pool, they’re beholden to the decision-making process of its operator. In addition, the regulatory status of staking remains unclear in many countries. Last, network vulnerabilities like attacks or bugs can prevent the staking process from completing.

Popular staking cryptocurrencies

While many types of tokens can be staked, ETH is the most popular. The chart below shows the top 10 PoS tokens by market capitalization as of this publication.

Top 10 PoS tokens by market capitalization, according to Coinmarketcap
Ethereum (ETH) $381.98 billion
Solana (SOL) $68.66 billion
Toncoin (TON) $20.60 billion
Cardano (ADA) $18.36 billion
Polygon (MATIC) $7.28 billion
Injective (INJ) $2.66 billion
Algorand (ALGO) $1.57 billion
MultiversX (EGLD) $1.20 billion
Tezos (XTZ) $1.02 billion
Mina (MINA) $969.11 million

For the purpose of comparing some popular tokens for staking, we’ll discuss Ethereum, Cardano, and Polkadot.

Ethereum, Cardano, Polkadot

As the second largest crypto by market capitalization, it makes sense that ETH is the most-staked form of crypto given Bitcoin doesn’t use the PoS model. The Ethereum blockchain facilitates smart contract creation and provides the scaffolding for many decentralized applications (dApps) and protocols. The Cardano blockchain launched in 2017 and its processing speed of 1,000 transactions per second makes it an attractive option for staking its native token, ADA. The Polkadot blockchain’s token is DOT, and the network places heavy focus on scalability and interoperability, both of which are areas for opportunity when it comes to PoS tokens.

Comparing staking rewards

Staking rewards vary depending on the staker’s role in the process, the method used, or the platform chosen. Validators earn a larger reward than delegators who are awarded a portion of the transaction fees a validator collects after creating a new block.

As of this publication, ETH validators typically earn 3.6% for staking crypto. The earlier report referenced on the state of staking found that ETH alone generates $1.8 billion in annual staking rewards. Delegators staking Cardano typically earn 4.6083% in rewards and its site provides a calculator to estimate reward potential. Polkadot has a 14.88% historical rewards rate.

Staking methods and platforms

It’s possible to stake crypto through a variety of methods and platforms, and choosing how to do it depends on the user’s goals and level of sophistication.

Staking methods

Here are the different methods available for crypto staking:

  • Solo or self-staking: The validator stakes their own crypto, which gives them full control.
  • Delegated staking: Involves entrusting a validator to stake on their behalf, which requires a level of trust in that person.
  • Pooled staking: Users delegate the task to a staking pool, which also requires trust that the operator will make the right decisions.
  • Staking as a service: Users can stake their crypto via a CEX, which requires trust given the exchange formulates the staking strategy and custodies their crypto.

Popular staking platforms

Today, most prominent CEXes offer staking services. Here are some popular examples:

Future of crypto staking

Given staking incentivizes network participation through rewards, it holds promise for growing the crypto ecosystem. The more crypto users involved, the more decentralized these networks will become, making them more difficult to hijack. Continued improvements on staking rewards and incentives will further refine tokenomics, and as governance mechanisms evolve, new models and voting structures could make staking even more inclusive across the crypto user base, providing new opportunities to more users, as well as completely new blockchains in which to invest.  

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