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What is Staking? How Crypto Staking Works & More | NDAX Blog

Nov 18, 2021
byNDAX Labs

What is Staking?

Staking is a core element of many of the world’s most popular cryptocurrencies. There’s a good chance you were introduced to staking because you heard about generous rewards that far exceed standard interest rates. But staking isn’t just about generating rewards.

It serves as the foundation of the proof of stake (PoS) consensus mechanism, which secures the blockchain and validates all transactions on the network.

Staking was developed to address some of the inefficiencies of the proof of work consensus mechanism. It’s considered much faster, more efficient, and easier to scale. As a result, it has become the protocol of choice for cryptocurrencies such as Cardano, Solana, and Ethereum 2.0.

How does staking work?

In the simplest terms, staking is similar to holding money in a savings account that yields interest. In terms of cryptocurrency, the network uses your staked assets to maintain the blockchain and validate new transactions. In return, you’re entitled to a portion of the network transaction fees. The larger your stake, the greater your rewards.

To explain it in a little more detail, a proof of stake network is made up of many independent validator nodes. Whenever a transaction takes place, it’s up to these validators to approve it and cross-reference each other to verify the information. A group of verified transactions is grouped into a block, which gets added to the official blockchain and established as a permanent record.

How does the network select which validators get to add new blocks to the blockchain? The odds of being chosen are proportional to the size of a validator’s stake and the length of time they’ve held it. So a more significant stake increases the chances of being selected and reaping the rewards.

How is staking different from mining?

We’ve already covered how staking is the foundation for the proof of stake consensus mechanism. But there’s another consensus mechanism, proof of work (PoW), that validates the blockchain for major cryptocurrencies like Bitcoin and Ethereum 1.0.

Participants on PoW blockchains don’t stake their crypto assets to validate new blocks of transactions. Instead, they compete to validate new blocks by using computing power to solve mathematical puzzles. This process is known as mining. It serves as the ‘work’ that proves the validator is invested in the system.

Mining vs. staking

·   How are blocks added to the blockchain?
In PoW systems, miners with greater computational power have the advantage when it comes to adding new blocks to the blockchain. In contrast, validators in PoS systems are more likely to be selected to validate new blocks if they hold greater shares of the cryptocurrency staked on the network.

·   What are the requirements to mine or stake?
Mining requires advanced computer hardware that can be expensive to buy and set up. Staking, on the other hand, can be done by anyone with access to a computer by joining collective staking pools.

·   How much energy does mining use compared to staking?
Mining is a highly energy-intensive process. Staking protocols require far less energy than mining and are considered much more environmentally sustainable.

What coins use staking?

Proof of stake is becoming an increasingly popular protocol for cryptocurrency projects. Here are some of the top staking coins ranked by market cap.

·   Ethereum (ETH) *Ethereum 2.0

·   Cardano (ADA)

·   Solana (SOL)

·   Polkadot (DOT)

·   Terra (LUNA)

·   Algorand (ALGO)

·   Cosmos (ATOM)

·   Polygon (MATIC)

·   Tron (TRX)

·   VeChain (VET)

How can I stake my coins?

Anyone can participate in staking. The easiest way to get started is to delegate the technical operations to a third party by joining a staking pool. Another option is to run your own validator node, but this requires more experience and technical expertise.

What is a staking pool?

These platforms pool together the crypto assets of a group of people. Increasing the pool's size generates higher rates of interest, which is then distributed back to the pool members. You don’t need any special computer hardware or technical knowledge to participate. All you need is some cryptocurrency.

To delegate your staking assets to one of these pools, you can either stake with a staking-as-a-service (SaaS) provider, stake via a crypto wallet, or stake directly through a cryptocurrency trading platform. There is no need to transfer ownership of your coins to the validator – you always remain in the custody of your crypto.

When choosing a staking platform, stick with reputable operators who have many positive reviews. Also, be sure to check the staking conditions before participating. What interest rates are promised? If they seem too high to be true, approach with caution. Is there a lock-up period? Be sure that you’re prepared to leave your coins in the staking pool for the specified period.

What is a validation node?

If you’re more tech-savvy and want to get directly involved with the maintenance and security of a blockchain, one of the best ways to do that is by running your own validation node. However, this isn’t the best option for beginners.

Running a validator node requires expertise and the appropriate technical infrastructure to keep your node secure and online at all times. For example, if you make a mistake and your node goes offline or validates fraudulent information, your staking rewards will be slashed. Setting up your own node can also require significant investment. In the case of Ethereum 2.0, you need a minimum of 32 ETH to become a validator.

Benefits of staking

The main benefit of staking is the rewards. You can earn a steady flow of passive income even if you only hold a small amount of crypto. In addition, the barrier to entry is low, and you don’t need any expensive, complicated equipment to get started.

Interest rates on staked coins can far exceed rates you’d typically see in a bank savings account. For example, it’s not uncommon to find annual rates between 5%-20% for most major staking coins.

By staking, you’re not just earning rewards for yourself. You’re also contributing to the security and trust of the entire network. Staking funds on your own as a validator node or contributing to a staking pool increases the efficiency of the blockchain and provides more verification points to process accurate transactions. It’s a great way to support the projects that you believe in.

Risks of staking

Staking returns may be attractive, but staking comes with its own set of risks that you should be aware of before participating in a staking pool.

·   Lock-up periods
Certain staking assets, such as Cosmos or Tron, have mandatory lock-up periods. During this period, you’re unable to access your staked assets, resulting in potential losses if the price drops significantly during the locked period.

·   Cyber attacks on exchanges
There is always a chance that hackers will attack the exchange or wallet you’re using to stake your assets. Or, scammers might target you individually and try to trick you into giving up your private keys. So make sure you brush up on crypto security best practices and only stake your assets on reputable platforms.

·   Price fluctuations
Cryptocurrency is notoriously volatile. Even if you’re getting high APY rates on your staked assets, you’ll be left with a loss overall if the price of your staked asset takes a nosedive.

·   Liquidity
Many smaller altcoins attract participants to their staking protocol with the promise of high-interest rates. However, if this altcoin has low liquidity on exchanges, you may find it challenging to sell your assets or exchange them for bitcoin or stablecoins.

·   Validator risks
If you want to run your own node and receive regular rewards for validating the network, it requires advanced technical expertise. In addition, if your node goes offline or you validate incorrect information, your stake could be ‘slashed,’ which means you would lose a share of your stake.

Future of staking

There’s no better indicator of proof-of-stake’s efficiency than Ethereum’s shift away from the proof-of-work consensus mechanism. Ethereum hopes to finalize the move to Ethereum 2.0 sometime later this year or in early 2022.

Since many crypto projects rely on the Ethereum blockchain to secure their networks, it requires the speed, scaling efficiency, and lower energy requirements of the PoS protocol. In addition, validator nodes will be far more accessible and could spur record adoption rates and lead to greater decentralization.

JP Morgan believes that staking could grow to become a $40 billion business by 2025. This is an impressive prediction, especially coming from a bank that has been sceptical of cryptocurrency until very recently.

Decentralized finance is a rapidly developing industry with a bright future ahead. Its vast ecosystem of platforms can handle anything from smart contracts to flash loans collateralized by cryptocurrency. One of the best ways to get involved with the future of cryptocurrency is by staking your crypto on a platform  with a project that you support and want to help grow.