Staking is a key feature of blockchain technology and could also earn you passive income.
Every technology evolves. The first blockchain produced Bitcoin in the form of deflationary gold, a store of value. The second type of blockchain produced smart contracts in the form of Ethereum, laying the foundation for decentralized finance.
Both use a Proof-of-Work (PoW) consensus mechanism to verify transactions between network nodes. The latest third-generation blockchains are moving from PoW to Proof-of-Stake (PoS). Instead of using mining as an energy-intensive consensus, PoS blockchains use staking.
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But what is staking and how does it work?
Consensus — the backbone of blockchain
To fully understand what staking is, you must first understand why blockchains depend on consensus. As you may already know, blockchain is a digital ledger distributed over a network of computers. Each computer in this network, called a node, holds the record for the entire ledger.
Therefore, if a node goes down or is attacked, the registry is consulted or compared to other nodes. The way a ledger is verified between nodes is called consensus. As the name suggests, these algorithms check all peers on the network to determine the true state of the ledger, be it cryptocurrencies or smart contracts.
It then logically follows that consensus (as in a general agreement between nodes as to the state of the network) gives the blockchain its reputation as an unassailable, decentralized and trustless network. Thus, when a transaction is made, i.e. a new block is added, all users can be assured that the new state of the blockchain is true.
How does staking work?
After Elon Musk tweeted that Tesla had canceled its Bitcoin payment option, the crypto market suffered a 40% crash. This happened not because of the cancellation itself, but because Musk called Bitcoin not environmentally friendly enough.
Since Bitcoin uses Proof-of-Work consensus to verify transactions and add new blocks, it consumes a lot of energy. The job needs computing power for a node to solve a mathematical puzzle. Therefore, those verifying a PoW network must invest in expensive hardware that consumes a lot of electricity.
In contrast, Proof-of-Stake (PoS) blockchains such as Ethereum, Solana, Polkadot, Algorand, and Cardano use validators instead of miners. Validators become gatekeepers to the network by staking a certain amount of the blockchain’s native cryptocurrency. In other words, they lock crypto assets, which are then used to validate blockchain transactions.
Does Crypto Staking yield a reward?
Depending on the number of staked assets, validators receive rewards. Of course, validators are not real people but computers running validation software. It also contains the complete copy of the blockchain.
Each time a user submits a transaction, such as buying an NFT, a validator adds the transaction to the blockchain. Ethereum hasn’t fully transitioned to PoS yet, but he already has staking, at a minimum level of 32 ETH, for his computer to qualify. Currently, Ethereum is the most decentralized network with 233,734 validators who have staked around 7.2 million ETH worth $24.3 billion.
Other PoS blockchains have different staking thresholds, but Ethereum has by far the largest market share as a smart contract platform.
As you can see, crypto-staking is a passive activity. The staker locks his coins in a wallet, which are then used to add new blockchain blocks, i.e. transactions. The larger the staked holdings, the more likely the stake will be used to validate the blocks.
Staking on crypto exchanges
There is another form of staking that can also be used as a source of income. The largest exchanges, Binance and Coinbase, both offer rewards for staking crypto assets. For example, on Coinbase, you can earn up to 5% APR (annual percentage rate) on ETH staking by locking your crypto wallet funds on the exchange.
Meanwhile, Binance has up to 20% APY (annual percentage return) on ETH 2.0. The difference between APR and APY is that the former does not consider compound interest. Both exchanges allow staking ETH if you have a minimum balance. Then they connect to blockchain protocols to earn rewards.
Few people have 32 ETH ($108,000) on hand to become Ethereum validators, so this is the best solution for passive income with the lowest possible risk. Speaking of which, validators who stake their coins can be punished if they fail to validate blocks or engage in malicious behavior. Then their locked crypto holdings are reduced as a punitive measure.
Is there a way to increase staking rewards?
As noted, the likelihood of staked assets being used for validation is proportional to their size. Accordingly, a group of bettors can create a staking pool to accumulate their holdings. This increases their chances of being frequently used to validate blockchain blocks.
Likewise, it also increases the frequency of rewards. Lido is one of the most popular ETH staking pools. However, one must be prepared to lock up their crypto assets for a set period of time. There are other stipulations depending on each staking pool.
Still, staking pools are the quickest way to proportionately share rewards without having a fortune to stake. Additionally, platforms such as Staked, MyContainer, and Stake Capital have specialized in offering staking as a service (SaaS).
What other cryptos can be staked?
Alongside Ethereum (ETH), one could also stake Cardano (ADA), Solana (SOL), Polygon (MATIC), Algorand (ALGO), Kusama (KSM), Zilliqa (ZIL) and Polkadot (DOT). Each has its own higher APY staking range percentage, so it’s worth considering.
Solana, in particular, has managed to outperform Ethereum by 500% in the past three months, largely due to increased NFT sales and top speed, scalability, and the combination of PoS with Proof-of-History (PoH).
While many see Bitcoin as a better alternative to gold, as a hedge against inflation, you will find that these emerging blockchain products have a better chance of having a 2X or 10X return in a year (no investment advice , don’t invest more than you can afford to lose!).
Finally, these networks pay out staking rewards based on the current inflation rate, as well as validator availability and commission. Since traditional bank savings accounts offer near zero APY, it is worth researching PoS networks to determine the optimal staking pattern.