Staking Crypto: How Does It Work and Is It Profitable?

Staking Crypto: How Does It Work and Is It Profitable?

by Andrea Knezovic

If you’re a beginner, but want to understand how staking crypto works and what are its benefits and risks, this article is for you!

Here’s what you need to know about staking crypto.

What Is Staking Crypto and How Does It Work?

On a very basic level, staking refers to locking up your coins so you can’t use them for some time and receiving more coins in the future as a reward.

Staking comes in many forms, but primarily, we’re going to talk about participating in the proof-of-stake process, staking in liquidity pools, and yield farming.

Proof-of-Stake

If you want to earn more of a particular token, you can participate in the proof-of-stake process of that token and get rewards.

It could be compared to putting your cash in a savings account and then getting that cash back after some time, along with interest on top.

However, the two are very different.

With the latter, the bank pays interest for using your money to invest in other things. That’s not what happens when contributing to a proof-of-stake network because you’re not lending your coins to someone else.

With staking, you participate in the blockchain network by taking part in transaction validation. The more people participate, the better, as it’s very important for keeping the blockchain network working properly and protecting its decentralization.

Proof-of-Work vs. Proof-of-Stake

You can stake various coins or fungible and non-fungible tokens that use the proof-of-stake system. Proof-of-stake is a blockchain verification method that is more energy efficient and has a lower barrier to entry than the proof-of-work method, which was the standard.

With the proof-of-work method, miners have to compete to be first to add the new transaction data by solving a complex puzzle. Essentially, it’s a big competition between the most powerful supercomputers, which wastes energy.

In the proof-of-stake system, on the other hand, only one miner is chosen to validate the next block. That’s based on different factors like how many coins they hold or for how long, but there’s also a random element in there to keep things fair. Only the chosen one gets to validate the transaction and get the reward, while other validators double check them.

However, the miner needs to lock up some of their coins as collateral to be chosen. If the information is incorrect, the chosen validator loses the tokens they staked. If everything is accurate, the validator gets a reward.

In other words, you participate in the network by staking your coins and get rewards for it.

Staking in Liquidity Pools

Staking tokens in liquidity pools is one of the most effective ways to earn more crypto. It’s also known as liquidity provider staking and liquidity mining.

It’s a passive income opportunity, as the only thing you need to do is stake tokens and sit back while you reap the rewards. The rewards come in the form of the platforms’ token. For example, DOT, UNISWAP, and CRO. Furthermore, depending on the platform, liquidity providers might get a trading fee or other rewards.

Staking in liquidity pools is also a great way to support a project you really believe in. For example, it can be an awesome blockchain game that you like.

Here’s how it works.

To understand liquidity provider staking, you first need to understand liquidity pools.

Liquidity Pools

Liquidity pools are essential for decentralized finance (DeFi) systems. A liquidity pool consists of digital assets users have staked and locked in a smart contract. Put simply, it’s a pool filled with money.

That enables automated trading of assets, which makes transactions faster. In other words, traders can trade tokens and coins even if there are no buyers and sellers out there. That’s made possible by automated market makers. Thus, liquidity pools remove the need to rely on waiting on buyers and sellers to provide liquidity, which is how traditional stock markets work.

Yield Farming

Yield farming is another way to put your crypto assets to work. However, you don’t need to lock up your tokens to reap the benefits and get rewards.

Most commonly yield farmers use DEXs (decentralized exchanges) to stake tokens and earn interest. Yield farming returns are measured in APY (annual percentage leads).

staking crypto

Is Staking Crypto Worth It?

While it can be risky, in most cases, staking crypto is definitely worth it. It can be very profitable and a great source of passive income. Furthermore, depending on the type of staking you go with and the platform, stakers get additional benefits and perks on top of staking rewards that can range from NFTs to voting rights.

Read more about the benefits of staking crypto in the following section.

The Benefits of Staking Crypto

Here are some of the main reasons why it’s a good idea to stake crypto.

Staking Rewards

The main benefit of staking crypto is getting staking rewards. Whether you’re a liquidity provider or stake crypto on proof-of-stake blockchains, there are incentives for participating. You always get rewarded for staking, usually you get more of the token you staked.

How much you’ll get varies based on the token, as some give out higher rewards than others. For example, ETH, SOL, and ADA are known to pay the most for staking.

However, keep in mind that higher rewards usually mean that the entry barrier is higher and you’re required to stake your tokens for longer periods.

Voting Rights

On many platforms, staking tokens also grants voting rights and the ability to participate in a platform’s governance.

For example, people who stake MANA get to participate in Decentraland’s DAO and vote on various proposals regarding the game.

Additional Perks

Along with staking rewards and voting rights, many platforms also offer additional benefits for staking. For example, access to exclusive NFT drops, special offers, the ability to participate in governance, the right to claim land in the metaverse, etc.

Contribute to the Platform

Staking crypto is a cost-effective way to support a platform and help validate its transactions or provide liquidity.

Not only that, staking in things like GameFi supports a game’s economy and aids the play-to-earn system.

Increase Token Value

Another benefit of staking tokens is that it tends to make them less volatile, as people are incentivized to invest in the platform. Furthermore, if many people keep a certain token, its value can increase due to supply and demand.

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The Risks of Staking Crypto

The Crypto Market is Volatile

If we know anything about the crypto market, it is that it’s unpredictable. That makes staking risky, as the value of the token you staked can easily go down. That goes for any type of staking.

Because of that, staking is recommended for those who are fine with holding tokens for longer periods of time, regardless of price fluctuations.

You Need to Pay Fees

This one refers to people who participate in proof-of-stake.

If you don’t know how to set up a validation process yourself or simply don’t want to, you can have somebody else do it. However, you need to pay fees to these platforms, which may put a dent into your earnings.

Lock-up and Waiting Periods

When you stake your coins in liquidity pools, there are lock-up periods during which you can’t use your coins. The amount of time required depends on the specific coin or token, it can be a month or even a year.

Impermanent Loss

This is a risk if you’re a liquidity provider.

This happens when the value of the token you staked changes compared to when you deposited it. In other words, the price of that asset in the pool changes.

However, if you’re also earning trading fees, those can sometimes compensate for the losses.

How to Stake Tokens

There isn’t a one size fits all explanation on how to stake tokens, as there are different ways to do it. Furthermore, each token may have different rules, returns, barriers for entry, and staking length.

But here’s an example of staking Ethereum.

Ethereum has three different options for staking to fit everybody’s needs – solo staking, staking as a service, and pooled staking.

For the first two, there’s a 32 ETH stake minimum, which is around $50,000 as of writing this article. People can also stake less with Ethereum’s pool staking. It’s the perfect option for those who are not whales and want a simple staking option.

Exchanges

If you’re looking for a simple way to stake your tokens, I recommend that you go through exchanges like Binance and Coinbase, as they make the process much simpler.

Essentially, an exchange does all the backend blockchain stuff for you so the only thing you need to do is decide which token you want to stake, how much of it, and for how long.

However, keep in mind that exchanges take a small fee.

Staking in Blockchain Games

Staking is also popular in blockchain games and it goes hand in hand with digital assets like NFTs and the play-to-earn model. Most commonly, players can stake the game’s native token or NFTs and get rewards for it, along with voting rights.

Furthermore, in such games, staking usually means that you become a liquidity provider and power the game’s economy.

The staking rewards can include getting more of that token, NFTs, or additional perks like voting rights, exclusive offers, NFT drops, metaverse land, merchandise, etc.

Most blockchain projects make it very simple for users to stake game tokens.

For example, The Sandbox has various staking programs on Polygon that players can access directly from their account. From this dashboard, players can earn the minimum amount of SAND tokens that need to be staked for each program, as well as the rewards for each.

Top Staking Tokens by Market Capitalization

If you’re wondering which tokens to stake, here’s a list of top staking tokens by market capitalization.

Data source: CoinMarketCap

  1. Cardano (ADA)
  2. NEAR Protocol (NEAR)
  3. BitTorrent New (BTT)
  4. Mina (MINA)
  5. Ankr (ANKR)
  6. Serum (SMR)
  7. SKALE Network (SKL)
  8. SwissBorg (CHSB)
  9. Injective (INJ)
  10. Conflux (CFX)
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