With cryptocurrencies, one way to make a profit is to sell your investment when the market price rises.
There are other ways to make money in cryptocurrencies, such as staking. With staking, you can put your digital assets to work and earn passive income without having to sell them. You may have heard about staking for the much-anticipated Ethereum merger (more on that below).
In some ways, staking is similar to putting cash into a high-yield savings account. The bank lends your deposit and you earn interest on the account balance.
In theory, staking is not very different from the bank deposit model, but the analogy ends there. Here’s what you need to know about crypto staking.
What is a pledge?
Staking is when you lock up your cryptoasset for a period of time to help support the operation of the blockchain. In return for staking your cryptocurrency, you can get more cryptocurrency.
Many blockchains use a proof-of-stake consensus mechanism. Under this system, network participants who want to support the blockchain by validating new transactions and adding new blocks must “stake” a certain amount of cryptocurrency.
Staking helps ensure that only legitimate data and transactions are added to the blockchain. Participants trying to gain a chance to verify new transactions offered to lock the cryptocurrency amount as a form of insurance.
If they incorrectly verify flawed or fraudulent data, they could lose some or all of their stake as a penalty. However, if they verify correct, legitimate transactions and data, they are rewarded with more cryptocurrency.
Popular cryptocurrencies Solana (SOL) and Ethereum (ETH) use staking as part of their consensus mechanism.
However, until recently, ETH ran an energy-intensive proof-of-work consensus mechanism in parallel with Staking. The merger means that Ethereum will only use the proof-of-stake consensus mechanism from now on.
Proof of Equity Verification
Staking is how proof-of-stake cryptocurrencies foster a well-functioning ecosystem on its network. Generally, the larger the stake, the better the chance of validators adding a new block and receiving a reward.
“In PoS, validators use their assets as in-game skins, which are slashed or destroyed if they act maliciously,” said Gritt Trakulhoon, chief crypto analyst at investment platform Titan. For example, trying to create a block of fraudulent transactions that didn’t happen.
Since validators accumulate large stake delegations from multiple holders, which proves to the network that validators’ consensus votes are trustworthy, their votes are proportional to the amount of stake the validators attract.
Also, the stake does not have to consist of just one person’s tokens. For example, holders can participate in stake pools, and stake pool operators can do all the heavy lifting to validate transactions on the blockchain.
Each blockchain has its own set of validator rules. For example, Ethereum requires each validator to hold at least 32 ETH. At the time of writing, that’s about $55,000. Staking pools allow you to collaborate with others and use less than that amount of staking. One thing to note though is that these pools are often built through third-party solutions.
How does staking work?
If you own a cryptocurrency that uses a proof-of-stake blockchain, you are eligible to stake your tokens.
Staking locks your assets to participate and help maintain the security of the network’s blockchain. In exchange for locking your assets and participating in network validation, validators are rewarded with that cryptocurrency, known as staking rewards.
Many leading cryptocurrency exchanges, such as Binance.US, Coinbase, and Kraken, offer staking rewards. “More passive or novice users can put their cryptocurrencies directly on exchanges for more convenience in exchange for a portion of the equity gains on the exchange,” Trakulhoon said.
You can also set up cryptocurrency wallets that support staking.
“Each blockchain network typically has one or two official wallet apps that support staking. For example, Avalanche has the Avalanche wallet, and Cardano has the Daedalus and Yoroi wallets,” Trakulhoon noted.
If you have tokens in one of these wallets, you can delegate how much of your portfolio you want to stake. You pick a validator from different staking pools. They combine your tokens with other tokens to help you improve your chances of generating blocks and earning rewards.
How to Make Money Staking Crypto
When you choose a program, it tells you what it offers for staking rewards, and depending on the exchange, it can be anywhere from 4% to 7%.
Once you commit to staking cryptocurrencies, you will receive the promised returns according to the schedule. The program will pay you in return for staking cryptocurrencies, which you can then hold, stake or trade in cash and other cryptocurrencies as investments.
The program may also have limitations, such as you must commit your stake for three months before you can get your tokens back.
What are the benefits of staking cryptocurrencies?
- Earn passive income. Staking allows you to earn passive income if you do not plan to sell your crypto tokens in the near future. Without collateral, you won’t get this income from your cryptocurrency investments.
- It’s easy to get started. You can quickly start staking using an exchange or crypto wallet. “It’s as simple as setting up a crypto wallet, loading it up with cryptocurrencies, and clicking the ‘stake’ button on the validator or staking the pool in the wallet app,” Trakulhoon said.
- Support your favorite crypto projects. “Staking has the added benefit of contributing to the security and efficiency of the blockchain project you support. By staking some of your funds, you can make the blockchain more resistant to attacks and enhance its processing of transactions capabilities,” said Tanim Rasul, COO and co-founder of Canadian cryptocurrency exchange National Digital Asset Exchange.
What are the risks of staking cryptocurrencies?
When you stake your tokens, you may need to commit them for weeks or months, depending on the program. During this time, you will not be able to cash out or trade your tokens.
In response to this issue, Trakulhoon noted, “For some blockchains like Ethereum, there are decentralized finance (DeFi) applications such as Lido Finance and Rocket Pool, which offer ‘liquid staking’ products. These products provide staking Tokenized versions of assets, essentially making them “liquid”.
Still, since you’re selling on the secondary market, you’ll need to find a willing buyer or lender. Furthermore, there is no guarantee that you will be able to do so or get all your money back sooner.
Cryptocurrencies are also extremely volatile investments, with double-digit price swings common during market crashes. If you bet your cryptocurrency in a program that locks you in, you won’t be able to sell it in a downturn. The staking platform you choose can offer great annual returns, but you can still lose money if the price of your staking token drops.
Many proof-of-stake networks use “slashes” to punish validators for misbehaving, destroying some of their stake on the network. If you stake with dishonest validators, you may lose some of your investment.
“The slashing mechanism is designed to incentivize token holders to only delegate their tokens to validators they deem reputable or trustworthy, rather than delegating all of their tokens to a single or few validators,” Trakulhoon said.
Should you own cryptocurrency?
Staking is a good option for investors who are interested in generating income in long-term investments and are not concerned about short-term price fluctuations. If you may need to get your funds back in the short term before the end of the staking period, you should avoid locking them for staking.
Rasul recommends that you carefully review the terms of the pledge period to see how long it will last and how long it will take to get your funds back should you decide to withdraw.
He recommends only working with companies with good reputations and high safety standards.
If interest rates seem too high to be unbelievably high, you should proceed with caution, experts say.
Finally, like any cryptocurrency investment, staking carries a high risk of loss. Only bet what you can afford to lose.
Note: When investing, you may lose some, and sometimes all, of your funds.Past performance is not a prediction of future performance and this article is not intended as a recommendation for any particular asset class, investment strategies or products.
Can I make money by staking cryptocurrencies?
You can make money by staking cryptocurrencies, many enthusiasts like staking because they make money from their cryptocurrencies without selling them. But there are also some risks. Staking crypto can sometimes “lock” your coins for months at a time, which leaves you vulnerable in crypto slides because you don’t have access to them. It’s a dangerous arena and you can only get involved if you know what you’re doing.
Is the pledge worth it?