What is Staking in Crypto? Everything You Need to Know
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Crypto coins operating on proof-of-stake (PoS) blockchains support ‘staking,’ a passive income tool offering competitive interest rates while coins are locked.
Staking is a great way to increase your crypto holdings – irrespective of broader market prices. Read on to learn how staking crypto works, including its pros and cons and what risks to consider before starting.
What is Crypto Staking?
Let’s start with the basics – what is staking crypto? Staking allows crypto holders to generate passive rewards. The concept is similar to depositing cash into a savings account. Holders typically earn a variable APY while their coins are locked in the staking pool. The APY will vary depending on the coin.
Large-cap coins like Ethereum and Solana often pay APYs of 3-7%. In comparison, new cryptocurrencies can generate double or even triple-digit APYs. Either way, staking is usually offered by PoS blockchains. It keeps the network secure and operational; staked tokens are locked until the staking period ends.
This is often a few days but can be longer, depending on the project. Ultimately, staking is ideal for long-term investors. You’ll earn passive income simply by holding the coins. Otherwise, those same coins will sit idle in a crypto wallet, meaning you’re missing out on free income.
How Does Staking Crypto Work?
Let’s examine crypto staking in more detail using an easy-to-understand, relatable example.
- An investor holds 5 ETH, which they deposit into a staking pool.
- That staking pool offers an APY of 4%.
- The investor keeps that 5 ETH in the staking pool for 12 months.
- 12 months have passed, meaning that the 5 ETH has generated staking rewards of 0.2 ETH
- The investor withdraws their staking balance of 5.2 ETH
So, had the investor held that 5 ETH in a crypto wallet, they would have had an opportunity cost of 0.2 ETH. This is why it makes sense for long-term holders to stake their coins.
It’s important to remember that staking coins rise and fall in value. A positive scenario is the coin’s price increases while it’s being staked.
- For instance, suppose ETH was originally worth $2,000.
- After 12 months of staking, ETH is worth $3,000.
- This means the original 5 ETH increased from $10,000 to $15,000.
- Plus, the 0.2 ETH of earned rewards is worth $600 on withdrawal.
However, a coin’s value can also decline while they’re being staked. This means you could get back less than you originally invested. Therefore, staking isn’t risk-free, as we explore later in this guide.
Proof of Stake Validation
Proof-of-stake, or PoS, is a consensus mechanism that allows blockchains to verify transactions. It keeps blockchain ecosystems decentralized, ensuring no single person or entity has control over the network. Not only are PoS blockchains sustainable and eco-friendly, but they’re ideal for earning passive income.
Anyone can become a staking ‘validator’ simply by locking their coins. Validators are responsible for validating transactions, such as wallet-to-wallet transfers. You, as a validator, ensure the network is honest and legitimate. Acting maliciously means the locked coins can be confiscated by the network, so validators are financially incentivized to act in good faith.
Bitcoin uses the proof-of-work (PoW) consensus mechanism. PoW is not only bad for the environment but is also considered an unfair system. Those with the greatest computational power, which requires huge financial resources, have the best chance of winning rewards. This isn’t the case with PoS staking, as investors can often get started with a few dollars.
What is Liquid Staking Crypto?
A drawback of crypto staking is a lack of liquid funds. After all, the coins can’t be used or redeemed while they’re locked in a staking pool. The solution is ‘liquid’ staking platforms. These platforms allow crypto users to earn staking rewards while still having access to liquidity.
- A popular example is Lido.
- Let’s say you deposit 1.5 ETH into a Lido staking pool.
- That 1 ETH earns APYs of 5%.
- You instantly receive 1.5 stETH, a crypto coin pegged to ETH.
- That 1 stETH can be used in various ways, such as trading, earning yields on DeFi platforms, or sold for cash on an exchange.
However, liquid staking comes with an important clause. The original coins can only be redeemed once the liquid asset is returned. So, in our example, the user would receive their 1.5 ETH back once they redeposit the 1.5 stETH.
Pros of Staking Crypto
We’ve answered the question, ‘What is staking crypto?’ Now, let’s take a closer look at answering, ‘Why stake crypto in the first place?’ by exploring the pros and cons of staking crypto, starting with the core benefits.
Earn Passive Income From Your Crypto
Staking offers an additional income source when investing in cryptocurrencies. This isn’t too dissimilar to buying dividend stocks. Those holding dividend stocks can generate growth in two ways – quarterly dividend payments and an increased share price. This is exactly how the staking process works.
Investors benefit not only when crypto prices rise but also from staking distributions, which are often made daily or weekly. This means investors can compound their returns.
For instance, suppose you receive staking rewards of 0.1 ETH. That 0.1 ETH can be deposited into the same staking pool. This means the 0.1 ETH will also generate staking income. Put otherwise, a compounding staking strategy can amplify your crypto returns much faster. This is like reinvesting dividends back into the stock market.
Contribution to Network Security
Crypto staking isn’t just a passive income tool. It also ensures the respective network remains decentralized and secure. As mentioned, people staking coins become validators. Importantly, validators verify transactions while their coins are locked. This means validators have a financial incentive to remain honest and credible.
Failing to do so can result in ‘slashing.’ Slashing financially penalizes validators when acting maliciously, for instance, by adding fraudulent transactions to the network. Slashing can also happen when validators are unreliable, such as being offline for extended periods. Therefore, this incentivization system keeps blockchain ecosystems safe for everyone.
Staking Term Flexibility and Low Minimums
Coins remain locked while they’re being staked, meaning they can’t be sold or transferred. However, some staking terms are flexible, depending on the coin. This means investors can withdraw their staking coins at any time without financial penalty. What’s more, staking pools often come with low minimums.
For example, while the Ethereum blockchain requires 32 ETH to become a validator, it also offers ‘pooled staking.’ This staking work requires just 0.01 ETH, or about $30, based on current market prices. Therefore, staking is an inclusive income tool that’s suitable for all budgets.
Cons of Staking Crypto
Now let’s move on to the drawbacks of crypto staking.
Lock-Up Periods
Not all staking ecosystems come with flexible terms. On the contrary, minimum staking periods can apply – often for days or weeks. Some staking pools offer enhanced rewards for longer terms, such as 3 or 6 months. This means you can’t access the coins until the term has passed.
For example, suppose you’re staking coins on a 3-month term. The coin has since increased by 400%, but you can’t sell because the staking term is still ongoing. The coin’s value could decline considerably once the 3-month term eventually passes. Similarly, you might need access to emergency cash but can’t withdraw the coins because they’re locked in a staking pool.
Token Inflation
In addition to transaction fees, staking rewards are also generated from newly created coins. For example, according to an MDPI study, approximately 1,600 ETH tokens are minted daily. These coins are distributed to validators, increasing the ETH supply.
As such, staking causes inflation, which can be detrimental to existing holders. That said, the best cryptocurrencies to stake have sensible inflation policies. For example, Solana’s initial inflation rate was 8%. This decreases by 15% annually, with a long-term inflation rate of 1.5%. This means the Solana ecosystem is sustainable for staking yields.
Is Staking Crypto Safe?
In general, crypto staking is safe. For a start, the staked coins are held in a ‘smart contract’. The smart contract’s terms are transparent, and they can’t be amended. This also means the staked crypto coins can’t be withdrawn by the project, as smart contracts are decentralized and immutable.
However, there is an exception. Some staking services and pools are offered by third-party platforms, such as crypto exchanges. Although yields are higher and minimums are more affordable, this presents a counterparty risk. Therefore, investors should ensure they’re using a reputable platform when staking.
The Risks of Crypto Staking Explained
Let’s summarize the main risks of staking crypto:
- Slashing: Those staking coins directly on a PoS network become validators. The risk here is slashing, which is a financial penalty for certain offenses. For example, adding a malicious transaction to the network or being offline for extended periods. Slashing means you’ll lose some or even all of the staked coins.
- Volatility: Even the best cryptocurrencies to buy are volatile. While staking ensures a passive income stream during volatile market conditions, you could get back less than what you originally started with, at least in dollar terms. After all, the coin’s value could decline significantly while they’re being staked.
- Counterparty Risk: Using a third-party staking platform means there’s counterparty risk. This is because you’re trusting the platform to act responsibly and ethically. At some stage, you’ll request a withdrawal from the platform. This means you won’t receive the staked coins until the withdrawal is approved.
How to Start Staking Crypto
We’ll now explain how to get started with a staking strategy. This is a generalized walkthrough that covers the key points.
Step 1: Choose a Platform
First, choose a reputable staking service or staking platform. The top crypto staking platforms are not only secure, but they offer competitive APYs and flexible terms.
Be sure to check which staking coins are supported and whether account minimums apply.
Step 2: Select Crypto and Lock-Up Period
Next, choose the best crypto to stake and deposit the coins. This is done via a wallet-to-wallet transfer, and the platform will provide a unique wallet address for the deposit.
Alternatively, some staking platforms allow you to connect a private wallet and automatically stake the coins. You might also need to select the lock-up period. Longer terms typically offer the highest APYs.
Step 3: Earn Rewards
Most providers offer staking rewards that are distributed automatically – often daily or weekly. This means the rewards are transferred to your wallet. This continues until the coins are unstaked and withdrawn.
That said, some staking agreements work differently. You might need to manually claim the rewards. This means the rewards and original deposit are claimed collectively once you unstake the coins.
Should You Stake Your Crypto?
Most experts say that staking is a no-brainer – especially if you’re a long-term investor. It’s a simple way to generate passive income, allowing you to compound your crypto earnings and assets. After all, the coins would otherwise sit idle in a private wallet. Meaning – if you don’t stake your coins, there’s an opportunity cost. What’s more, staking keeps the respective network secure.
Credibility and reputation are crucial in the crypto space, so broader security and safety can help your investment over time. All that said, staking isn’t a risk-free investment vehicle. The value of the coin can decline. Plus, you won’t be able to withdraw the coins until the staking term has passed. There are also counterparty risks when using a third-party platform.
Conclusion
We’ve explained everything there is to know about crypto staking. Overall, it’s a solid way to amplify your crypto earnings. In addition to price increases, you’ll also generate passive income.
No prior experience is needed, and minimum requirements are often low. Just make sure you consider the risks – especially when using third-party platforms.
FAQs
What does staking crypto mean?
Staking requires crypto holders to deposit their coins into the network, often for a few days or weeks. The holder earns interest, paid in the respective coin, until the staking term ends.
Is staking crypto better than just holding?
Staking is better than just holding, as you’ll generate passive rewards. This means you’ll earn extra coins, which isn’t possible when keeping them in a standard digital wallet.
Is crypto staking worth it?
Yes, crypto staking is generally worth it – as you can benefit from passive income and price appreciation. However, staking also comes with risks, such as slashing and market volatility.
How much can you earn with crypto staking?
Staking rewards are not only variable, but they depend on the network and coin. Generally, smaller-cap coins pay much higher APYs than established projects like Ethereum and Solana.
What are the best coins to stake?
Stablecoins like Tether and USD Coin are ideal assets for staking, as investors can mitigate the risks of volatility. Alternatively, those also targeting price appreciation might consider ETH, SOL, or AVAX.
Is crypto staking taxable?
Yes, crypto staking is taxable in most countries, including the US. The crypto staking rewards are typically added to your overall income and based on the value of the coins when received.
References
- Proof of Stake: A process used to validate crypto transactions through staking (Business Insider)
- Earn rewards while securing Ethereum (Ethereum)
- Proposed Inflation Schedule (Solana)
- Kapengut, E.; Mizrach, B. An Event Study of the Ethereum Transition to Proof-of-Stake. Commodities 2023, 2, 96-110 (MDPI)
Eric Huffman 
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