Last week, we discussed the difference between Proof of Work and Proof of Stake blockchain consensus models in preparation for today’s article, which takes a deeper dive into staking. We’ll examine this passive income model, including the good, the bad, and the ugly, so you can make an informed decision before putting your assets to work.

*Be sure to read Proof of Work vs. Proof of Stake before continuing.

Staking Consensus Model TL;DR

Proof of Stake (PoS) is a blockchain consensus model that was created to increase speed and efficiency of transactions while reducing gas fees. PoS creates a more equitable verification system where validators are chosen randomly instead of the Proof of Work (PoW) model, where computers work to solve puzzles quickly. To participate, you must stake a specified amount of native tokens from that blockchain. Participation in the validation process in PoS is rewarded with the chain’s native token.

Staking: The Good, the Bad, the Ugly

While staking has many benefits, it also has drawbacks and risks to consider.

The Good

Cryptocurrency staking is an attractive alternative for those who want to earn an income from their crypto assets since it does not necessarily require any technical knowledge or active trading. In many cases, staking provides a passive income with minimal effort. By staking your assets, you are contributing to the security of the blockchain, so there is some inherent “good” that comes from participating. As we noted in our previous article, selecting to participate in cryptocurrency exchange on blockchains that utilize Proof of Stake has a significantly reduced environmental impact compared to blockchains using other consensus models.

The Bad

The bad news is that cryptocurrency staking carries more risk than most other forms of passive income. In some cases, staking rewards can be much lower than expected, and there is always the risk of loss due to malicious actors or other factors. Significant waiting periods may exist before rewards are unlocked or distributed. There are often restrictions on how and when you can move your assets away from staking, essentially locking up your assets for a pre-determined period of time, the “vesting period.” This means that even if the market plummets, you cannot trade the assets you have in staking until the vesting period concludes.

The Ugly

The ugly truth is that cryptocurrency staking can be challenging to understand, and setting up a staking pool or node (both discussed below) can be complex and time-consuming. Additionally, there are often hidden fees and other costs associated with staking, and if done incorrectly, it can be costly. The system is set up so if a bad actor is participating in staking (i.e., attempting to validate inaccurate or fraudulent data), they lose some or all of their tokens. These penalties are often called “slashing.” If you are participating in a staking pool, that would include your assets.

How and where can you get involved?

There are a few ways to participate in staking.

Staking Pools

Staking Pools combine the assets of many contributors to fund a single pool operator that participates in the validation process. Most crypto exchanges, such as Coinbase, Binance, Crypto.com, Gemini, Huobi, and OKX, offer the option to participate in staking, where you can stake as much as you’d like directly from their platform. This is perhaps the most convenient option for the staking novice, but in return, the platform takes a percentage of your yields. You also have no choice as to what staking pool you participate in.

Alternatively, for a bit more “control,” you could participate in staking pools via a blockchain network’s official wallet apps, such as Avalanche Wallet (Avalanche) or Daedalus (Cardano), where you can stake assets held on those wallets and select a pool to contribute to. Again, these apps take a cut of your yields.

Some international banks are even getting in on staking offerings. For instance, the British digital banking app, Revolut, allows customers in the U.K. and Europe to stake crypto they hold on the platform.

Set up a Node

Image by Gordon Johnson from Pixabay

The most lucrative option is to become a validator by setting up a node. This requires significant technical knowledge, investment, and commitment. To become a validator, you must meet the minimum token threshold and maintain a reliable, dedicated computer that can perform validations 24/7 without downtime. It is a serious obligation because mechanical failure or downtime can result in slashing.

Is staking just for cryptocurrency?

Nope! Many NFT projects are now offering staking options. NFT staking is a process that allows holders of non-fungible tokens (NFTs) to earn rewards by staking their tokens in a particular project or platform. By staking their NFTs, they can access exclusive features or rewards such as discounts, the project’s native tokens, access to gated in-game assets, or the ability to participate in governance if the project is a DAO (learn more about DAOs in our article DAOs 101). The rewards for NFT staking vary significantly due to the wide variety of NFT projects in existence.

This NFT staking process is beneficial for both the project and its users. In addition to participants earning passive income and exclusive rewards, NFT staking increases the scarcity of the collection due to NFTs being “locked up” and unable to be traded during the vesting period. This can increase the prices of NFTs from the project that remain in circulation. But remember, just crypto staking, NFT stalking comes with many of the risks we previously noted.

Is staking dead in the U.S.?

This is the million-dollar question at the moment. With the recent SEC crackdown on Kraken’s staking services to U.S.-based customers, many believe it’s only a matter of time before such services are no longer allowed in the U.S. at all. As you might imagine, many crypto exchanges claim that they do not anticipate any ripple effects to impact their staking service offerings. Ultimately, this is another “wait and see” situation, as no one can predict how future regulation may impact staking services and participation.

This article provided a bird’s eye view of staking but keep in mind that the staking process’s ins and outs vary depending on what cryptocurrency or NFT project you are considering. Be sure to do your own research (DYOR) before taking the plunge. Things to consider include the terms and required vetting period requirements, minimum investment needed to participate, and when and how often rewards are paid out. Read the fine print. If something seems too good to be true, it probably is. And with that, be safe and happy staking!

Resources:

https://www.reuters.com/business/finance/what-is-staking-cryptocurrency-practice-regulators-crosshairs-2023-02-10/#:~:text=Staking%20is%20a%20process%20in,via%20third%2Dparty%20staking%20services.

https://www.coinbase.com/learn/crypto-basics/what-is-staking

https://www.forbes.com/advisor/investing/cryptocurrency/crypto-staking-basics/

https://www.coindesk.com/learn/crypto-staking-101-what-is-staking/

https://www.business2community.com/nft/best-nft-staking-projects

https://www.binance.com/en/blog/nft/nft-staking-a-quick-guide-on-what-to-know-before-staking-2357189661246193153

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The content is for informational purposes only. Nothing contained in this article constitutes a solicitation, recommendation, endorsement, or offer of a security, token, or application. This is not investment or legal advice. Please do your own research.