What is Staking and How Does it Work? (2022)
The world of digital assets first came into existence through the creation of Bitcoin in early 2013. Since then, critics of the concept have criticized the fact that crypto mining is a very energy-intensive process, and this has prompted numerous environmental concerns regarding the longevity and utility of the Proof of Work (POW) concept. Numerous solutions have been put forward to counter this, but there are none as prominent as the concept of crypto staking.
What is Cryptocurrency Staking?
Crypto staking has been an increasingly popular topic in recent months as Ethereum announced its consensus algorithm switch from the proof-of-work to the proof-of-stake (PoS) blockchain network. This change is being brought about through the implementation of Ethereum version 2.0.
In simple words, crypto staking is an activity where the holder of a crypto asset locks their coins in order to participate in the process of validating new transactions. The coins are locked for a certain period, and this is called the lockup period.
Put very simply, crypto staking is a way of mining cryptocurrencies, because the stakes help maintain the security of blockchain networks while also helping to verify transactions.
Rewards of Crypto Staking
Users that choose to stake their crypto holdings receive rewards in proportion to their staked tokens or coins.
This can only be done on blockchains that utilize the PoS consensus algorithm. The security of these blockchains is comparable to those that use the PoW algorithm. However, where they stand out is in terms of their reduced energy consumption.
Who Created the Proof-of-Stake (PoS) Consensus Mechanism?
One of the first appearances of the Proof-of-Stake mechanism may be attributed to Sunny King and Scott Nadal. Their 2012 project called Peercoin used the PoS mechanism to ensure network security.
How Does Staking Work?
If we look at it from a user’s standpoint, staking is nothing more than locking their crypto assets in a wallet in order to receive rewards. It can be thought of as a way to earn interest on your investment, in exchange for verifying transactions.
The funds are locked as a way of ensuring the honesty of the stakers when they decide to verify the process transactions. If a validator is dishonest, then they are punished, and the exact nature of this punishment depends on the version of the algorithm that is used.
How is Staking Rewards Paid Out?
The rewards from successfully and accurately validating a transaction for many cryptocurrencies are usually paid out in the form of more coins of whatever asset is staked. However, this will depend on the asset in question, as several others choose to pay out the crypto rewards in the form of another coin.
The use of a PoS consensus mechanism completely eliminates the need for the expensive and energy-consuming hardware needed for proof-of-work and reduces the processing power being expended significantly.
What are Staking Pools?
A staking pool is a group of stakers that chose to merge their resources in order to increase their chances of being chosen as block validators. Staking pools tend to earn rewards that are higher than individual stakers, and these rewards are distributed proportionally to the contributions of the crypto investors to the pool.
Most cryptocurrencies that use the proof-of-stake consensus algorithm and offer staking have numerous active staking pools. However, the maintenance of a staking pool requires significant expertise and effort, and therefore, most prominent pools charge their users commission, which is a part of the staking reward that the users earn.
Can a Beginner Stake Crypto in a Pool?
Yes, most staking pools are extremely beginner-friendly.
They have a very low minimum amount of investment required to be a member of the staking pool. They also have no withdrawal fees, making it very easy for you to join a pool and start earning rewards on your investment.
Most pools also provide flexibility to their users in terms of how and when they can withdraw their staked assets to a crypto wallet.
Is Staking Coins the Same on Every Blockchain?
There are different shades and flavors of the proof-of-stake consensus algorithm, meaning that each blockchain has the option to change the mechanism of staking cryptocurrencies according to their need.
The Delegated Proof-of-Stake (PoS) Mechanism
The most notable alternative version of proof-of-stake is the delegated proof-of-stake (DPoS) mechanism created by Daniel Larimer in 2014. While it was first used as a part of the BitShares blockchain, it quickly became popular and got adopted by more assets and cryptocurrencies, including Steem and EOS.
DPoS allows its users to commit their coin or token balances as votes, and the users have voting rights based on the number of their coins and tokens. These votes are used to elect a number of delegates that manage the blockchain on behalf of their voters for a certain amount of time.
In this case, the staking rewards are distributed to the elected delegates, who then distribute part of the rewards to their electors proportionally to their individual contributions towards the process to validate transactions.
Which Cryptocurrencies can be Staked?
Initially, only some cryptocurrencies could be staked, because not a lot of coins used the PoS mechanism. However, nowadays, there are numerous cryptocurrencies that offer their users the choice to stake their tokens and earn interest in return for keeping the network secure and processing transactions.
The projects that support staking include Ethereum 2.0, Tezos, Icon, Algorand, Cosmos, etc.
KuCoin exchange allows its users to stake the coins held without having to lock them. This is done through a mechanism called Soft Staking.
What is Soft Staking?
Soft Staking is a process that allows users to receive the rewards of staking without ever locking their funds. This concept was first introduced by the KuCoin exchange in July 2019, and quickly caught the attention of over 300,000 users.
How soft crypto staking works is that it rewards crypto investors on a daily basis, meaning that there is no need to lock their crypto for months. The interest that is paid out to the stakers is calculated in the form of an "effective daily interest", and this is used to pay out the rewards.
Soft Staking Compatibility with Different Trading Strategies
Soft staking crypto has many advantages, the biggest among them is that it is compatible with a variety of trading strategies.
For example, say your investment strategy involves taking advantage of trends in crypto prices. In this case, you will often hold your crypto assets for a few days at the very least. If the exchange that you use offers soft staking, then you can earn rewards for every day that you are holding your cryptocurrencies.
This allows for quicker and more efficient compounding, as well as additional flexibility with portfolio management. Through soft staking, you can enjoy your staking rewards in addition to your trading profits.
What is Cold Staking?
Cold staking is another method that is commonly used to stake cryptocurrency assets. It works in pretty much the same way as normal staking, except the process of staking is carried out offline. In simple terms, you will stake your coins in an offline wallet, such as a hardware wallet. The rest of the process works in the same way, with you verifying transactions and getting rewards in exchange.
Cold Staking vs Online Staking
The basics surrounding both online and cold staking are the same, as mentioned earlier. The potential rewards that you can stand to earn are only credited to your wallet if you lock in your funds for the entirety of the period.
One of the major differences is that if you choose to stake through an offline staking platform, you do not have the option of joining a pool. Since these pools are predominantly available to online users, there are no pools available for staking offline.
Why Should You Consider Cold Staking?
The primary advantage of staking your crypto through an offline wallet is that your funds are much more secure. While offline wallets such as hardware wallets are not very convenient to use, they do offer a higher level of safety. Since your wallet is never connected to the Internet, it cannot be hacked.
Disadvantages of Cold Staking
However, this is not free from its faults. For starters, offline staking is only available through limited crypto exchanges. Therefore, if you wish to use your hardware wallet to stake your coins, you will have to find an exchange that supports staking through an offline wallet. In addition to this, there are other factors that need to be considered in terms of the suitability and compatibility of these wallets with different staking platforms.
Another disadvantage of offline staking is that you will not have the option of joining a pool, as mentioned earlier. This can be a problem, especially if you choose to stake a cryptocurrency that has a high minimum staking requirement. For example, Ethereum requires a minimum of 32 ETH for you to be eligible as a staker. Therefore, this can be an issue if you are not willing to invest such a high amount in staking.
Proof-of-stake is a major improvement to the energy-intensive proof-of-work algorithm. Through the PoS network, crypto users can help keep the environment less polluted, all while having quicker and easier access to their staking rewards.
The reduced barrier of entry to staking is especially useful to the newcomers in the world of cryptocurrencies and those who have small crypto holdings.
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