What is Staking in Crypto?

Josiah Nang-Bayi, MD
9 Min Read

Staking has become one of the most popular ways to earn yields on cryptocurrency holdings. But what exactly does staking involve? In this comprehensive guide, we’ll explain the core concepts, benefits, risks, and myths around crypto staking to help you understand this transformative new capability within blockchain networks.

Defining Crypto Staking

Staking at its most basic level involves locking up or depositing a certain amount of your cryptocurrency holdings to help operate a proof-of-stake (PoS) blockchain network. By staking your crypto, you become a validator responsible for processing transactions, maintaining the network, and creating new blocks.

In exchange for dedicating your crypto to validate the network and process transactions, staking rewards are earned in the form of newly minted tokens from inflation or a share of transaction fees. Staking enables everyday cryptocurrency holders to act as validators, just like miners do in Bitcoin’s proof-of-work model. 

Leading staking cryptocurrencies include Ethereum, Solana, Cardano, Polkadot, Algorand, Cosmos, and Tezos. Staking is critical for securing PoS networks in a decentralized manner compared to proof-of-work mining which tends towards centralization over time due to economies of scale.

Active vs Delegated Staking

There are two main avenues for staking your crypto:

Active staking involves setting up the required infrastructure like nodes/wallets and actively participating in block validation yourself. This requires higher technical proficiency but offers maximum rewards.

Delegated staking allows you to delegate your staked assets to professional validators who handle the operations in return for a cut of the staking rewards. This sacrifices a share of rewards but is far easier for novice users.

Delegated staking services include exchanges like Kraken and dedicated staking providers like Lido. Delegated staking enables participation with minimal barriers.

How Does Crypto Staking Work?

Here is an overview of the staking process works:

1. Obtain staking coins – First acquire tokens on a PoS network that allows staking like Ether, Atom or Cardano.

2. Choose a validator – On active staking setup your own validator nodes. For delegated staking, choose reliable professional validators and stash your tokens with them.

3. Stake tokens  – Officially declare staking intent and delegate tokens to a validator to become an active participant in the network with “skin in the game”.

4. Validate blocks/transactions – Actively participate in block validation and transaction processing according to protocol rules based on your staked holdings.

5. Get rewarded – Earn periodic staking rewards pro-rata to your staked holdings for helping maintain the network compared to other participants.

6. Manage stake – Actively manage your stake by adjusting validator, reinvesting rewards, and unstaking if desired. Monitor staking metrics.

Staking Incentives and Rewards

What incentivizes crypto holders to stake their assets to secure networks instead of just speculating? Several rewards make staking very appealing:

Token rewards – Earning newly minted tokens dilutes holdings less than PoW mining rewards while offsetting holdings lost to inflation.

Compounding yields – Reinvesting staking rewards compounds portfolio holdings over time. Long lockups amplify yields.

Governance rights – Staked tokens equate to voting shares for governance polls and proposals. Stakers influence development.

Network security – Stakers are financially incentivized to maintain the integrity and security of the network. More decentralization benefits all.

Passive income​​​​​ – After set up, staking provides crypto exposure with passive yield generation compared to active trading.

Staking rewards offer compelling incentives for long-term focused crypto holders to put their holdings to productive use.

Benefits of Crypto Staking

Beyond direct rewards, staking offers several key advantages:

Energy efficiency – Staking consumes a fraction of the energy of proof-of-work mining, supporting eco-friendliness.

Accessibility – Anyone with a minimum staking amount can earn rewards compared to expensive ASIC mining.

Better UX – PoS delays and fees are often lower than PoW chains, improving usability for payments.

Security – Spreading consensus duties across diverse participants enhances decentralization and security.

Participation incentives – Staking encourages long-term holding and network involvement versus short term speculation.

Scalability​​​​​ – Sharding and layer 2 solutions can enhance PoS throughput and speed to higher levels than PoW chains.

Staking boosts the capabilities of blockchain networks while rewarding participatory behavior from token holders.

Is defi different from crypto

Risks and Drawbacks of Staking

Staking has been proven to be very profitable and mostly a sustainable source of passive income for players in the blockchain space. However, staking has its downsides as stated below.

Illiquidity – Lockup periods ranging from months to years restricts accessing your staked capital. This reduces maneuverability.

Custodial risk – Delegated staking requires trusting validators and third-party custodians to act honestly and competently.

Missed opportunity cost – Tying up assets in staking can mean missing out on price appreciation opportunities via trading or selling.

Hardware/uptime requirements – Active staking requires consistently maintaining infrastructure online to avoid penalties.

Concentration risk – Larger professional validators concentrate power compared to distributed individuals staking.

Slashing penalties – Validators suffer token losses if protocol rules are violated accidentally or intentionally.

Staking requires extensive due diligence and accepting reduced liquidity to minimize these risks impacting earnings or principal holdings.

Staking Myths and Misconceptions 

Given staking is still fairly new, some common myths still persist around the practice. Let’s debunk a few:

Myth: Staking funds means handing over custody.

Reality: Users retain full custody when actively staking. Only delegated staking requires sharing custody with a third-party validator. You remain in control of assets.

Myth: Staking costs nothing.

Reality: While no upfront costs, staking requires hardware (mostly electronic gadgets -laptops, smart phones, other computers- but not extensive hardware as seen in PoW networks) maintenance, lockup opportunity costs, and slashing risks. These “costs” offset some rewards.

Myth: Staking earns guaranteed high returns.

Reality: Actual yields depend on many factors like staked assets, validator fees, and network inflation rates. Returns are variable, not fixed.

Myth: Staking is suitable as a primary income.

Reality: Given fluctuating rewards and liquidity restrictions, staking works better as a supplemental source of yields, not sole income.

Myth: Staking requires advanced tech skills. 

Reality: Delegated staking enables passive yield generation on PoS networks with zero tech requirements. Some learning is advisable though.

Staking can provide value for many crypto holders but also comes with limitations and risks that should be approached with eyes wide open.

the components of defi

Future of Crypto Staking

Staking is still in the early innings; considering that the applications of the underlying technology (blockchain) and the defi infrastructure are still believed to be in nascency; but poised for massive growth ahead:

– More networks launching with staking integrated will multiply opportunities.

– Ethereum’s transition to proof-of-stake will onboard millions of new stakers. This has already began and is poised to grow exponentialy

– Cross-chain bridges and DeFi/CeFi services will enable “staking as a service” models, conveniently available to all, even those with, minimal knowledge

– Governance participation will become increasingly valuable on public blockchains. And this can be extended to other facets of life.

– Regulation will provide standards for custodial staking services to boost consumer safety though currently regulations around the entire blockchain is still a bit challenging.

– Slashing protection via insurance will emerge to cover penalties on staked holdings.

Staking offers the power to generate yield on crypto assets while securing and governing blockchain networks. As adoption rises, expect staking to become just as commonplace as earning interest at a bank – but without any middlemen. The decentralized future of finance belongs to the stakers.

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Josiah Nang-Bayi, MD is a medical doctor by profession, an author, a financial literacy and digital assets enthusiast, an entrepreneur and a growing philanthropist.
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