What is Crypto Staking and How Does it Work?

Staking has emerged as a popular practice in the world of cryptocurrency and blockchain technology. The entire process involves holding and locking up digital assets in a specific wallet in order to support the operations of a blockchain network. In return, you will get rewarded with additional tokens.

Essentially, crypto staking is a way you can generate passive income, in the form of additional crypto. Of course, there are also risks associated with the entire process.

In this article, we will discuss what staking is, the benefits and especially the risks of crypto staking, as well as give some pointers on how to maximize the former and minimize the latter.

What Is Crypto Staking?

Crypto staking is the process of locking up your crypto to help verify transactions on a blockchain network. It’s a key component of proof-of-stake (a consensus mechanism that keeps blockchain networks secure).

At its core, crypto staking is like earning interest on your savings, but instead of money in a bank, you’re using your cryptocurrency. It’s a way to lock up (or “stake”) your crypto assets in a blockchain network for a set period, and in return, you earn rewards. Think of it as putting your crypto to work, helping keep the blockchain running smoothly, and getting paid for doing so.

How Does Crypto Staking Work?

Cryptocurrencies like Bitcoin or Ethereum rely on blockchain technology. This is a decentralised system where transactions are verified by participants across the network. Traditionally, this was done through a process called “mining,” where computers solved complex mathematical problems to confirm transactions.

But in staking, you don’t need massive computing power. Instead, you “stake” your crypto—essentially locking it up for a certain amount of time—so that it helps validate transactions. The more crypto you stake, the higher the chances that the blockchain will use your stake to validate transactions. For doing this, you earn a reward in the form of more cryptocurrency.

Here’s a overview of how it works:

1. You hold a certain cryptocurrency in a staking wallet.
2. You lock it up for a specified amount of time (the staking period).
3. During this time, your staked crypto is used by the network to validate transactions.
4. In return, you earn rewards—typically paid in the same cryptocurrency you’re staking.

The entire process works by having your tokens locked into the blockchain, through the use of a compatible wallet. You can look at these tokens as collateral – they are (usually) not accessible through regular means, for a period specified by their own blockchain.

As far as rewards are concerned, these are usually distributed proportionally among all staking participants, based on the number of tokens they have staked, as well as the duration of said staking. Rewards are generated through several mechanisms, including block rewards, transaction fees, or inflationary issuance.

However, always keep in mind that the manner of reward attainment and distribution varies from blockchain to blockchain, and platform to platform.

There are different methods of staking, including running a full node, using dedicated staking wallets or software, or utilizing centralized platforms. Centralized platforms offer the easiest way to stake, as they simplify the staking process by handling technical complexities on behalf of the users. These best crypto lending platforms allow individuals to stake their tokens with a few simple steps, making staking more accessible to a wider range of participants.

The primary advantage is the passive generation of tokens, which can then be sold or traded. However, many blockchains also give other incentives, like taking part in a community that centers around a specific coin, letting them vote on issues and further development.

The Risks of Staking Crypto

As with any type of investment, and especially when one deals with the cryptosphere, there is an element of risk. Below are some things you need to keep in mind.

Price Volatility

First, as always, is price volatility. The crypto market is famously volatile, and staking is definitely affected by this. To be more specific, whenever you stake a cryptocurrency you run the risk of potentially significant and unpredictable fluctuations in the value of the token. This, then, leads to a potential loss on your investment down the line, even if you generated a substantial amount of additional tokens through staking.

The causes of price volatility can be attributed to various factors, such as market demand, speculation, news events, regulatory developments, and macroeconomic conditions.

A staker can do several things to minimize and mitigate the risk and damages of price volatility. Above all, you should diversify your crypto staking portfolio. Investing in different cryptocurrencies can help you reduce the impact of one crypto having its price drop substantially.

You should also be realistic with your expectations, and as thorough as possible when conducting your research. Always keep an eye on market trends, and try to get as much background information as possible on the people involved in the development of the specific coin you are interested in.

Slashing

Slashing is a risk specific to Proof of Stake (PoS) blockchains that involves the potential penalty or confiscation of staked tokens due to certain protocol violations. These violations boil down to:

• Validator double signing – This occurs when a validator, accidentally or intentionally, signs two blocks at the same time.

• Validator downtime – When the validator, who is in charge of a significant part of the staking process, is offline and thus fails to fulfill their duties to the chain.

• Network manipulation – Any dishonest behavior within the network.

The consequences of slashing can range from a partial reduction in staked tokens to the complete confiscation of the stake, depending on the severity of the violation. Its main purpose is to incentivize stakers to act honestly and maintain the network’s security.

The best way to mitigate the risk of slashing is for stakers to be very mindful of the rules of their chosen network. Obviously, they should always strive to act honestly, but accidents can happen.

Validators need to be certain that their entire validator setup is stable and that it fulfills more than the minimal hardware and software requirements related to staking. If you’re delegating your tokens, you should research the credentials of prospective validators and consider delegating to multiple validators to spread the risk.

We should mention that some blockchains, like Cardano (ADA) and Avalanche (AVAX), do not employ slashing.

Lock-up Periods

Lock-up periods are unique aspects of crypto staking. It refers to the duration during which a staked token is inaccessible and cannot be freely traded or transferred. This risk arises from the requirement of many staking protocols to lock the tokens for a specific period to participate in staking and earn rewards.

The obvious risk here is the temporary removal of liquidity of your staked tokens. Simply put, you will not be able to sell and trade them, which can prevent you from accessing unique trading opportunities, or from reacting optimally to price changes.

In order to minimize this risk, good long-term planning is needed. You need to carefully consider your investment horizon and in general be very aware of your short-term and long-term plans when it comes to investing.

Another option is choosing platforms and tokens that have flexible staking options, or that offer liquid staking (partially unlocked tokens that can still be traded).

Counterparty Risk

Counterparty risk in staking refers to the potential for losses or negative outcomes arising from the actions or failures of the staking platform or service provider. This risk includes the platform getting hacked, going bankrupt, lacking proper security measures, or not having adequate insurance coverage. If the staking platform experiences any of these issues, stakers may face financial losses or lose access to their staked assets.

The solution behind minimizing this risk boils down to the staker doing their research. You should select reputable and reliable platforms and service providers. Practice due diligence, read online reviews, check out forums and even Reddit, and see what people have to say.

We also suggest you distribute your assets over multiple platforms, along with using self-custody wallets. This greatly helps with reducing exposure to a single counterparty risk.

Lack of Regulation

This risk has some connection with the previous one. Namely, one common criticism directed against the cryptosphere (which many consider a benefit) is a lack of regulation.

The lack of regulation in the staking space poses risks related to investor protection, transparency, and market integrity. The absence of clear regulatory frameworks can result in potential scams, fraudulent projects, market manipulation, and inadequate investor safeguards. This lack of regulation can also lead to financial losses, fraudulent activities, and a lack of legal recourse for affected stakers.

One solution is lobbying for the development of further regulations, if not of the industry, then definitely of platforms and crypto exchanges.

The other, more immediate, action is similar to the previous point. Namely, to exercise caution and to do thorough research before investing with a specific blockchain and platform. Staying informed about regulatory developments and seeking platforms or projects that adhere to recognized industry standards and compliance measures can help mitigate the risks associated with the lack of regulation. However, if you’re looking to lean towards passive income you should consider staking crypto and discover the best coins to stake, ensuring steady returns on your investments while actively supporting the network’s security and growth.

What Is the Safest Staking Platform?

There are several ways one can stake crypto, and one of the easiest ways is to use a platform. In the section below we have reviewed the safety of four platforms, but also one high-quality wallet, as well as a specific Decentralised Autonomous Organization.

Examples of Coins That Can Be Staked

Not all cryptocurrencies use staking—only those that run on a Proof of Stake mechanism. Here are a few popular ones that allow staking:

• Ethereum (ETH): After its upgrade to Ethereum 2.0, Ethereum now uses staking, and it’s one of the most popular coins to stake.
• Cardano (ADA): Known for its energy efficiency, Cardano lets users stake ADA for rewards.
• Solana (SOL): With its high-speed transactions, Solana is another popular staking option.
• Polkadot (DOT): A blockchain network designed to support other blockchains, Polkadot allows DOT holders to stake their coins for rewards.

Should You Stake Crypto?

The best part about staking is that it’s relatively simple, and you can do it passively—no need to trade or constantly monitor the market. Plus, it’s often more environmentally friendly than mining since it uses less energy. For anyone planning to hold their crypto long-term, staking can be a great way to generate a little extra income while you wait for your assets to increase in value.

However, the value of your tokens could depreciate whilst they are locked up which is a big risk. Only lock up stable tokens that have strong demand, good utility and a history of surviving bear markets.

Final Thoughts

Crypto staking is a simple and effective means of generating passive income and taking a more direct part of the entire blockchain. However, bad actor risks, market volatility, slashing, and regulatory issues can dissuade some from even trying.

The best solution is for stakers to be very mindful of the rules of their chosen blockchain, to do as much research as possible, and to always be aware that crypto investing always carries a certain amount of risk.

FAQs