Blockchain and cryptocurrencies are transforming the way we manage our finances. The crypto world has multiple methods to generate passive income, ranging from staking crypto and yield farming to automated market-making and NFT staking.
Crypto staking is gradually gaining traction from investors, and according to Statista, Solana has the largest total staked value of 52.78 billion US dollars, followed by Ethereum 2.0, Cardano, and Avalanche. But what is crypto staking, exactly, and how can investors use this method to generate passive income? Let’s take a look.
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Crypto staking is one of the best opportunities to earn passive income from existing crypto holdings. To participate in staking, users lock, or stake, their tokens in a staking pool or a wallet. The blockchain networks that run on the Proof-of-Stake consensus mechanism will allow users to stake native tokens to support the network and typically offer rewards in exchange. Staking is a great way to earn income since most of the staking pools offer high return rates to investors for locking up their tokens.
To maintain the consensus of a blockchain, some networks use the Proof-of-Stake consensus mechanism. The participants in the Proof-of-Stake mechanism are called validators. They set up validator nodes, stake their crypto holdings, and verify transactions to ensure the security of the network. In exchange for running the validator node and verifying transactions, the network incentivizes validators with rewards.
Blockchain networks randomly choose blocks and assign them to validators for review. The validators check the legitimacy of the transactions and add them to the blocks. Every time a validator adds a block, they receive block rewards and transaction fees. If a validator fails in performing the tasks, their staked holdings will be penalized. Different networks that run on the PoS consensus mechanism may function differently in terms of staking periods, rewards, performing tasks, etc.
The functionality of Proof-of-Work and Proof-of-Stake mechanisms is different at various levels. PoW requires specialized mining hardware equipment, and participants (called “nodes”) use this equipment to solve complex mathematical puzzles. Alternatively, in the case of PoS, validators lock up their crypto holdings in a smart contract and a validator validates the transactions. PoW requires significant energy and resources, whereas PoW is considered more environmentally sustainable and energy-efficient.
According to Ethereum co-founder Vitalik Buterin, PoS uses 99% less energy when compared to the PoW mechanism. With more blockchain networks using the PoS method, the number of crypto users involved in staking is increasing significantly. By providing an attractively high rate of returns, staking pools and DeFi protocols are increasingly popular in the crypto community.
At present, the Ethereum blockchain is in transition from the Proof-of-Work consensus mechanism to the Proof-of-Stake consensus mechanism. During this transition period, there are two types of Ethereum validators — miners and stakers. Miners validate the transactions on the execution layer (Eth1.0), while stakers validate the transactions on the consensus layer (Eth2.0). Ethereum validators need to move their crypto holdings from the execution layer to the consensus layer to stake their coins.
To validate transactions as a validator node, participants need to stake a minimum of 32 ETH. However, they cannot withdraw staked coins until the Ethereum Mainnet completely merges with the Beacon Chain. Also, while the hardware equipment requirements are not as high as Bitcoin mining, validators still need to have a fast computer with considerable storage connected to the internet 24/7 to verify Ethereum transactions.
However, investors who are not validators can also stake ETH and participate in the Proof-of-Stake consensus mechanism. They can stake their preferred amount of ETH on staking pools and earn rewards. With the help of staking pools, ETH holders can stake coins without having to set up and maintain a validator node.
Polkadot blockchain uses a nominated Proof-of-Stake (NPoS) consensus mechanism. There are two ways to stake DOT coins: by running a validator node, or nominating a validator. Both validators and nominators lock their coins as collateral and earn staking rewards for their contributions. Validators need to set up a validator node and maintain the necessary hardware equipment. You can also nominate a validator for staking coins.
Nominators stake their coins by nominating a validator, and earn their share from the total staking rewards earned by the validator. It’s important to choose reliable validators because the amount of reward earned depends on the performance of the validator. Unlike other protocols, Polkadot staking rewards are distributed equally among stakers. Polkadot rewards all the validators equally for their work, instead of rewarding them based on the size of their stake.
Chainlink is a decentralized oracle network built on Ethereum that connects on-chain smart contracts with off-chain real-world data. According to Chainlink CEO Sergey Nazarov, Chainlink staking will be introduced in 2022. Validators in Chainlink act as blockchain oracles and perform a wide range of tasks when compared to the validators on other networks. They will receive LINK tokens as incentives for performing the tasks efficiently.
Once the new staking model is enabled, validators would need to stake their tokens, and the most successful node operators will receive a greater portion of the rewards. Besides, it strengthens network security. As per the Chainlink 2.0 whitepaper, the staking model rewards nodes based on two factors: reputation and deposit. Validators with the best reputation will be paid more rewards and are allowed to make larger deposits to maintain the security of the network.
With attractive rewarding schemes, staking has become popular in the crypto community. The primary reason is the additional income staking from what would otherwise be idle crypto holdings. Additionally, staking has strengthened its position in the crypto world with extremely high rewards offered by certain protocols. However, staking has its pros and cons which need to be considered before jumping into this space.
Passive income generation is the biggest benefit of crypto staking. From minimal rewards to outrageous percentages, investors with different risk appetites can participate in staking and earn rewards. Staking is also relatively easy for crypto holders and can be done within a few clicks, especially on major crypto exchanges. It also does not have a high barrier of entry because users do not need a huge amount to get started.
Similar to any other space in the crypto world, staking also has certain risks. There is always the possibility of hacking and cyber-attacks, which can be avoided by staking crypto on hardware wallets. Cryptocurrencies are also known for their volatility. When investors stake their holdings for a certain staking period, they cannot liquidate them before the due date. Staked tokens can be penalized if the validator nodes do not uphold 100% uptime in processing transactions. Hence, it is important to be aware of both the upsides and disadvantages before investors start staking their coins.
The Proof-of-Stake consensus mechanism is eco-friendly when compared to the Proof-of-Work consensus mechanism. Several blockchain networks are employing the PoS mechanism to run the network efficiently while leaving a little carbon footprint. By providing high rewards, staking is gaining momentum and increasing its market share in the crypto world.
A huge shift toward crypto staking took place when Ethereum announced its plans to welcome staking in 2020. With the rise in DeFi, decentralized staking is gaining more attraction from investors at present. DeFi staking continues to flourish in 2022 with incredibly high returns and rewards for stakers and yield farmers. However, it is crucial to do thorough research about the platforms and protocols to invest wisely and make the most out of crypto staking.
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