Crypto Staking: A Beginner’s Guide

Introduction

Staking refers to the process of locking up cryptocurrency assets to support the operations of a blockchain network and earn rewards in return. It is a consensus mechanism employed by proof-of-stake (PoS) blockchains, which rely on validators who hold and stake their tokens to secure the network. By staking their tokens, individuals contribute to the security and integrity of a digital network and receive a share of the rewards generated by that network.

Consensus Mechanisms and the Evolution of Staking

Staking originated in the early days of the blockchain industry as a way to incentivize users to participate in network maintenance. Unlike traditional proof-of-work (PoW) systems that require mining (essentially running high-powered computers to secure the network), PoS networks rely on validators who hold and stake their tokens to secure the network. At it’s core, this works by creating an economic incentive for validators to operate honestly since if they don’t — and other network participants detect it — their stake is “slashed” and they lose the value from what was staked. As a result, PoS networks function through an economically driven consensus mechanism as compared to a “work” driven consensus mechanism — namely how much computational effort, essentially time and energy, go into security the network.

Economic Value and Mechanics

Staking provides economic benefits to both network validators and token holders. Validators receive rewards for participating in network maintenance, while token holders can earn rewards on their tokens for essentially putting them at risk.

There are analogies to crypto staking in traditional markets. One analogous concept is leasing property. When you lease a property, you earn rental income based on the duration of the lease and the value of the property. This property is still yours, however, it is at the time borrowed by another economic actor and it could be said to be “at risk”. In crypto staking, you can think of staking it as “leasing” your coins to a blockchain network and earning rewards based on the amount and time you lock them up. The ultimate mechanics of this are slightly more nuanced in practice.

How to Profit from Staking

Profiting from staking is relatively straightforward. Each proof-of-stake network may have slightly different mechanisms but for this blog we will focus on the leading PoS blockchain, Ethereum. To generate yield on your ETH, you need to 32 ETH and lock it up for a fixed duration. This initially prohibited a large number of users from being able to access this until liquid staking solutions like Lido Finance, RocketPool, and Coinbase Staked ETH emerged. These protocols / services enable users to lock up smaller denominations of ETH that are then combined by way of the underlying software so that any user can benefit from staking. The services typically generate a fee (say 10% of fees earned) in exchange for the convenience of being able to use them. In addition, liquid staking solutions like these allow users to not only stake their underlying assets and earn yield, but also use these asset derivatives as collateral elsewhere. This is especially powerful since otherwise the user’s assets would be fully locked up in these staking contracts.

Conclusion

Staking has emerged as a popular activity in the world of decentralized finance (DeFi), allowing users to participate in blockchain networks and earn rewards actively. By understanding the concept of staking, its history, and how it differs from traditional PoW systems, individuals can leverage their crypto assets to contribute to network security and benefit from the rewards offered by staking. Remember, staking involves risks, and it’s crucial to research and choose reliable protocols and platforms before engaging in staking activities.