Have you heard about crypto investors staking their cryptocurrency to earn higher returns on their investments in recent years? If so, you might be curious about what staking actually entails, how it works, and whether it’s safe and profitable. Additionally, you may have concerns about digital security risks associated with staking, such as how to keep your investments secure and how to ensure your validation process is secure from untrustworthy nodes that could lead to significant losses.
If you have these questions, this article is for you. I will cover the basics of crypto staking and address these concerns. I will also explain how you can start staking crypto. To begin, let me provide a basic explanation of what staking is.
Crypto staking is a popular way for cryptocurrency holders to earn passive income by participating in the process of securing a Proof of Stake (PoS) network. This involves locking up a certain amount of cryptocurrency in a smart contract, which acts as collateral to validate transactions on the network. In return, stakers receive rewards in the form of newly minted coins.
If you’re interested in staking cryptocurrency but don’t want to take on the responsibility of being a validator, delegating your coins to a validator is the easiest and simplest option. Validators are responsible for maintaining the network by verifying transactions and adding new blocks to the blockchain. By delegating your coins to a validator, you are essentially lending your staking power to them, and in return, you will receive a portion of the rewards that the validator earns.
On the other hand, if you’re up for the challenge, you can choose to become a validator yourself. This requires a certain level of technical expertise and a significant investment in hardware and infrastructure. As a validator, you will be responsible for running a node and participating in the consensus process, which involves verifying transactions and adding new blocks to the blockchain. Validators are incentivized to act honestly and maintain the integrity of the network, as any malicious activity could result in penalties or even the loss of their staked coins.
On a decentralized network such as crypto, there exists no centralized authority or enterprise that governs the network’s operations. Instead, independent operators take on the responsibility of managing servers, known as “validator nodes.”
In a Proof-of-Stake (PoS) network, practically anyone can assume the role of a validator node. The requirement of a specialized computer equipped to execute numerous random computations per second, a feature of mining, is obviated. A regular personal computer will suffice to facilitate transactions.
Even in the absence of a powerful computer, it is feasible to run a PoS node on a cloud computing platform such as AWS or Microsoft Azure.1
By running a node, a valuable service is provided to the network’s users, and the network remunerates the operator by allowing the creation of new coins as a staking reward for each processed transaction set. These new coins acquired by the operator are termed as “staking reward.”
However, there is a significant requirement to consider: To operate a node, one must possess a certain minimum quantity of the network’s cryptocurrency. This crypto must then be transferred into a designated smart contract and locked until the operator ceases to validate.
The rationale behind the necessity to provide a stake is to deter validators from engaging in fraudulent activities.
I will delve into the “risks of staking” aspect later, but if an operator modifies the software to enable the processing of fraudulent transactions, the entire stake can be forfeited. Additionally, if the operator’s server experiences an extended period of downtime, resulting in an inability to process transactions, a portion of the stake can also be lost.
Therefore, staking serves as a form of collateral that validators are obligated to provide, ensuring that they remain honest and dependable. Although staking the minimum amount is necessary to become a validator, one may choose to stake a higher amount.
By offering a greater sum of cryptocurrency for staking, you increase your likelihood of being chosen as a transaction processor, which leads to a higher rate of staking rewards. This means that the rewards one receives for staking is a percentage of the total sum staked. In essence, the more cryptocurrency you commit to staking, the more crypto you will earn in rewards. Let us now direct our attention to the topic of delegating.
Many cryptocurrency investors are eager to earn staking rewards, which can be quite lucrative. However, setting up and configuring a validator node can be a daunting task for some, or they may not have sufficient crypto to meet the minimum requirements to be a validator.
This is where delegating comes into play. If you are unable or unwilling to operate your own validator node, you can delegate your crypto to someone else’s node. The node will charge a small fee to cover its expenses, but the majority of the rewards generated by your stake will be credited to your account.
In addition to operating a node yourself, delegating is another viable method for staking your crypto and earning staking rewards.
I briefly mentioned that staking is performed on PoS networks, but I have yet to explain what that entails. Therefore, in the next section, I will delve into the meaning of PoS.
Proof of Stake (PoS) refers to a type of cryptocurrency network that enables staking. In a PoS network, validators are required to put up a certain amount of cryptocurrency as collateral to ensure that they adhere to the rules of the network. This amount of cryptocurrency that is staked is known as the validator’s “stake.”
The process of staking is essential for the functioning of a PoS network. Validators who stake a greater amount of cryptocurrency are more likely to be chosen to validate transactions, as they have a greater incentive to act in the best interests of the network.
By staking their cryptocurrency, validators contribute to the security and decentralization of the network. This is because they are incentivized to validate transactions accurately and honestly, as any malicious or fraudulent behavior would result in a loss of their staked funds.
Overall, PoS networks provide an alternative to Proof of Work (PoW) networks, which require validators to solve complex mathematical problems in order to validate transactions. PoS networks offer a more energy-efficient and scalable approach to transaction validation, making them a popular choice for many cryptocurrency projects.
PoS and PoW are vastly different. PoW networks such as Bitcoin and Dogecoin require validators to possess powerful mining computers, capable of generating hashes thousands of times per second. The more computers under one’s control, the greater the likelihood of being selected as a validator. This process is commonly referred to as “mining.” On the other hand, PoS networks do not permit mining and do not provide an edge to validators operating multiple computers. Instead, PoS determines validators based on their stake sizes.
Now, let us delve into the most critical question surrounding crypto staking: is it financially viable?
Staking cryptocurrency can be a highly lucrative investment strategy when compared to simply buying and holding it. The reason for this is that when you purchase and hold a coin, your profit is solely dependent on the eventual sale of the coin at a higher price. However, by staking the coin, you can also earn a steady income from the staking rewards.
With many staking coins offering annual rewards of at least 4 percent, and some even going up to 14 percent, staking is a smart way to generate passive income. This is especially true when you consider that most savings accounts typically pay only 1 percent or less in interest.
Of course, staking also comes with its own set of risks. These risks need to be carefully evaluated before committing to a staking investment. In the following section, We will provide an overview of some of the risks associated with staking cryptocurrency.
Investing in crypto staking can potentially yield high returns, but it is important to note that it also comes with certain risks. It is crucial to be aware of the potential pitfalls that come with staking. Here are some examples of what could go wrong when staking.
You Lose Your Entire Stake
The possibility of losing all of your stake is the most severe risk you face when investing in cryptocurrency. Entrusting your coins to an unscrupulous validator node could lead to a complete loss of your investment.
It must be acknowledged that this is a challenging feat to achieve. Indeed, in all of my research, I have yet to encounter an individual who has testified to losing their entire stake due to a fraudulent node. By and large, staking nodes do not engage in fraudulent activities since it is incredibly difficult to avoid detection.
Notwithstanding, it is plausible to lose your entire investment if you delegate it to a malevolent node. Consequently, this is one of the pitfalls of crypto investment that must be avoided.
Some of your Stake will Lose
As one engages in staking, there is a possibility of experiencing a reduction in one’s crypto assets, albeit not entirely. The potential cause for such an eventuality could be attributed to the use of a node with faulty equipment or poor internet service when delegating. A similar outcome is feasible if one happens to be a validator themselves, equipped with subpar service quality. To mitigate this hazard, the most straightforward approach is to delegate to a node that is renowned for its high uptime or establish one’s node, thereby ensuring the availability of quality internet.
Price of Crypto Falls
The value of one’s crypto depreciating is deemed as the most significant concern for most stakers. A potential unfavorable outcome is if the crypto’s value plunges more rapidly than the staking rewards are issued. In such a scenario, the seller might end up with a net loss when selling. As an illustration, if an individual stakes Polkadot (DOT) at a yearly return rate of 14.5 percent, and DOT experiences a price decline of 25 percent throughout the year, the end result could be a loss of 10.5 percent upon selling.
However, it’s crucial to note that the possibility of a declining price is a risk that is not exclusive to staking but is applicable to any form of crypto investment. Nevertheless, staking is considerably safer compared to just holding the crypto assets in a wallet.
Staking your cryptocurrency on exchanges is becoming increasingly popular, as it provides an easy way to earn passive income. Some of the leading exchanges that allow users to stake their cryptocurrencies without withdrawing them include Binance, Coinbase, eToro, and Kraken.
However, it’s worth noting that staking your crypto on an exchange is generally considered riskier than using a wallet. This is because exchange accounts are more vulnerable to hacking attempts. Nonetheless, staking on an exchange can be a viable alternative if you are unwilling or unable to withdraw your cryptocurrency.
Let’s turn our attention to Ethereum, which is currently the world’s second-largest cryptocurrency network. The question is, can Ethereum be staked in the same way as other coins?
Well, the answer is yes. Ethereum can be staked using a process called Ethereum 2.0 staking, which involves holding a certain amount of Ether and participating in the network’s consensus mechanism. This allows you to earn rewards in the form of more Ether. It’s worth noting, however, that Ethereum 2.0 staking has its own set of risks and requirements, so it’s important to do your research before participating.
Currently, the Ethereum network operates on a proof-of-work (PoW) system where validators need to expend electricity to solve hash problems in order to add transactions to the ledger. This means that Ethereum has to be mined and cannot be staked.
However, a new network called Ethereum 2 was launched in December 2020, which operates on a proof-of-stake (PoS) system and is capable of running all the software that is currently on Ethereum.
Unlike Ethereum, Ethereum 2 uses a different cryptocurrency called ETH2, which wasn’t sold in an initial coin offering (ICO) and cannot be purchased on an exchange. The only way to obtain ETH2 is by burning an equivalent amount of ETH, which grants you the ability to stake your ETH2 and earn a yield, similar to other PoS networks.
At present, there are no apps running on ETH2, but the plan is to eventually connect the current Ethereum network with Ethereum 2. Once this happens, ETH mining will be eliminated, and Ethereum will become a PoS network. At this point, there will be no distinction between ETH1 and ETH2 coins, and they will be merged into a single PoS coin called Ethereum.
The merge of the two networks is currently planned to occur in Q3 of 2022, but there have been multiple delays, so it’s unclear when it will actually take place.
If you’re interested in staking ETH2, keep in mind that there’s currently no way to convert it back into ETH1 and sell it on an exchange. You’ll be locked into your stake until the two networks merge.
It’s also worth noting that delegating your coins to a node on Ethereum 2 can’t be done directly. Instead, it has to be done indirectly, which can be a bit more complex than on other networks. If you don’t have the minimum 32 coins required for staking, you’ll need to join a staking pool or use an exchange to stake.
Crypto networks have made significant progress since their inception. Initially, crypto investors could only profit by selling their coins, which meant they had to exit the market. Unless one was willing to run a mining node, there was no way to generate income from a cryptocurrency network.
However, staking has revolutionized the process, enabling investors to earn cryptocurrency from their holdings without relying on price appreciation alone. Staking now offers a steady income stream similar to interest earned in a savings account. Nevertheless, staking comes with inherent risks and may not be suitable for everyone. If you wish to venture into staking, this article has provided crucial information to help you get started.
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I'm Carina, a passionate crypto trader, analyst, and enthusiast. With years of experience in the thrilling world of cryptocurrency, I have dedicated my time to understanding the complexities and trends of this ever-evolving industry.
Through my expertise, I strive to empower individuals with the knowledge and tools they need to navigate the exciting realm of digital assets. Whether you're a seasoned investor or a curious beginner, I'm here to share valuable insights, practical tips, and comprehensive analyses to help you make informed decisions in the crypto space.