Article by CryptoJelleNL
While the majority of people buy into crypto to speculate on price appreciation, the crypto market has many other ways to make money, such as staking – a mechanism that lets holders of a crypto asset generate an income without selling their precious coins.
In today's article, we dive into staking, what it is, its advantages and disadvantages, and whether or not it may be something for you.
What is staking?
Staking is a process where an investor can use their coins to validate transactions on proof-of-stake (PoS) blockchains; a popular alternative to the energy-intensive proof-of-work blockchains like Bitcoin. PoS blockchains generally boast higher transaction speeds at lower costs.
When you stake your Ethereum for example, it contributes to the processing of transactions – and in return, you get paid a share of transaction fees and block rewards. Staking your tokens contributes to the continuous vetting and processing of transactions, a process vital to the integrity of a blockchain.
In this regard, it is similar to mining, as it rewards investors for contributing to the functionality and security of a blockchain, but without having to invest in mining equipment.
How does staking work?
We know that staking involves putting your tokens to work, contributing to the processing of transactions on the chain – but how does this work?
This is where it gets a little technical, so bear with me: A proof-of-stake consensus mechanism uses so-called validators to check and process transactions, and maintain the integrity of the blockchain. The network tries to recruit validators by offering rewards for their contributions.
Generally speaking, the blockchain randomly assigns blocks (a batch of transactions) for validators to check, vet, and process – and pays out a share of blockchain rewards to the validator once the job is done. When a validator adds wrong data to the chain, the chain may penalize the validator by taking away some of their staked tokens, thus disincentivizing behavior that is harmful to the chain.
Advantages & Disadvantages
Staking gives investors a way to contribute to the health and operation of their favorite blockchain, instead of just passively holding the token. It also allows them to earn an income in addition to any price appreciation the asset might have.
Staking can also be incredibly easy, as most centralized exchanges these days offer staking services, taking care of the technical mambo-jumbo for you in exchange for a portion of the revenue generated by your tokens.
On the flip side, staking generally involves locking up your tokens for an extended period of time – which means you will not be able to quickly withdraw and sell whenever you deem necessary. Taking profits and/or losses will become more complicated if you choose to stake, which is why many people decide against it.
Moreover, blockchain networks punish validators for harmful behavior – so if you stake your tokens with a bad third party, you might lose a share of your investment because of their actions. It is therefore wise to do your due diligence before staking – essentially if you will use a third-party provider.
Is staking for me?
It depends on your motivation. If you just want to stake to earn a yield, the current economic situation makes it so that you'll probably be better off buying a US treasury bond. The current yield on staking ETH is 4.4%, while a 10-year treasury bond yields 4.3% (sourced from CNBC Markets) without having to own and lock up a volatile asset such as ETH.
Of course, some projects offer higher rewards than others – but when we look at the below chart (sourced from stakingrewards.com), there are only a few popular chains where the adjusted staking reward is higher than the risk-free rate.
As such, not many people decide to stake crypto *just* because of yield. Many stakers however already own crypto as a speculative bet, and in these cases it may make more sense to stake, as it allows you to add an additional compounding element to your long-term holdings.
Different Staking Solutions
While staking may be too technically complicated for many – most centralized exchanges, and other third parties, offer various ways for clients to stake their tokens, without having to worry about setting up the process.
Generally speaking, your favorite exchange will present you with staking options – often referred to as [Exchange Name] Earn, or [Exchange Name] Staking. The yields are often lower than when you go through the hassle of staking yourself, but these programs generally also offer greater flexibility. Depending on your risk profile, staking on a CEX may be the move for you.
If you want to earn a higher yield – it may be worth checking out DeFi staking as well. DeFi platforms like Curve, Maker, Compound or Yearn Finance (for example!) allow you to lend and borrow tokens – and it rewards investors that provide capital for these activities as well. There are more risks involved, but the rewards tend to be higher as well.
All in all, staking is an interesting vehicle in crypto that allows investors to earn an additional yield on their long-term investments. If you do not care much about short-term price fluctuations, staking a portion of your tokens may be an attractive way to earn some additional income, while also contributing to the health of your favorite blockchains.
Before staking your tokens, make sure to do proper research into the yields, risks, and rewards of each program, as they can vary strongly per service provider or blockchain.
Author's Disclaimer: This article is based on my limited knowledge and experience. It has been written for informational purposes only. It should not be construed as trading or investment advice in any shape or form.
Editor's note: CryptoJelleNL provides insights into the cryptocurrency industry. He has been actively participating in financial markets for over 5 years, primarily focusing on long-term investments in both the stock market and crypto. While he watches the returns of those investments roll in, he writes articles for multiple platforms. From now on, he will be contributing his insights for WOO as well.
Check out his twitter: twitter.com/cryptojellenl
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