What is staking and how to make money from it?

01.07.2022

Beginner

#Cryptocurrency Staking #DPoS #Proof Of Stake

Key points

Staking (from the English ‘stake’ — ‘share’) is a way to earn passive income from cryptocurrencies that run on the Proof-of-Stake (PoS) consensus algorithm and its variants.
The essence of staking is to lock a certain number of coins in a wallet to gain the right, directly or via intermediaries, to help keep the blockchain of that asset running and receive rewards for doing so. In PoS blockchains, staking plays a role similar to mining in the Bitcoin network.
Staking can be a more attractive alternative to simply holding coins in a wallet, functioning as the crypto-industry analogue of a bank deposit. Returns differ by blockchain and can reach tens of per cent per year and more.

What is the Proof-of-Stake (PoS) algorithm and how does it relate to staking?

Proof-of-Stake (‘proof of a holding stake’) is a consensus mechanism in which the right to generate new blocks, verify transactions and add them to the blockchain is allocated among computing nodes (nodes) according to an algorithm that takes account of how many coins of the blockchain they hold.

In the basic scenario, a node that owns 1% of all coins in circulation gets the right to process 1% of blocks and, for its work, receives 1% of total network rewards. Many cryptocurrencies also factor in the holding period of coins and other variables.

In short, staking is the receipt of rewards for producing new blocks and verifying data using one’s stake (native coins).

The Proof-of-Stake algorithm was first implemented in 2012 in the cryptocurrency PPCoin (now known as PeerCoin). It subsequently became the most widely used mechanism for achieving consensus in blockchain projects.

One of the most popular and frequently used PoS variants is Delegated Proof-of-Stake (DPoS). The algorithm was created in 2013 by Daniel Larimer for the BitShares blockchain platform and is now used in many networks.

The chief advantage of DPoS is that a coin holder does not need to run their own node to take part in staking; they can delegate to validators who run high-performance nodes and keep them operating reliably.

On the principle of delegation, many similar mechanisms have been designed. A few of them are:

Leased Proof-of-Stake (LPoS) — leased proof of stake. Used in the Waves network.
Nominated Proof-of-Stake (NPoS) — features nominators who post bonds for validators and vouch for their probity. Used in the Polkadot blockchain.
Proof-of-Staked-Authority (PoA) — a hybrid algorithm combining PoS and validator reputation (Proof-of-Authority). BNB Chain runs on PoSA.

How does staking work in Proof-of-Stake?

In cryptocurrencies that run on ‘classic’ PoS, every official wallet functions as a full node, i.e., it verifies and confirms transactions and produces new blocks.

Technical requirements differ from one blockchain to another: in some networks a home computer suffices to run and manage a node, in others you will need professional server hardware. This way, decentralisation and blockchain security are ensured without the vast energy consumption typical of cryptocurrencies that use Proof-of-Work.

Participation terms can vary. In general, you need to buy the native coin of the network you wish to stake in and either send it to a smart contract yourself (for example, via a wallet) or delegate it to a validator.

Depending on the rate of coin issuance, staking returns can reach tens or even hundreds of per cent. At the same time, staking is a way coins are issued, so excessively high reward rates can lead to inflation of the coin, which hurts profitability.

How does staking differ in Delegated Proof-of-Stake?

In DPoS blockchains, any wallet with a balance can vote for delegate-validators — computing nodes among which, according to a complex algorithm, the right to generate blocks and verify transactions rotates, along with the right to receive rewards and transaction fees.

The number of validators varies widely across blockchains: BNB Chain has only 21, while Solana has around 1,800.

For example, here is the sequence of steps for staking Cardano (ADA):

install the Daedalus desktop wallet or the Yoroi browser wallet;
wait for the wallet to synchronise with the Cardano blockchain;
create a new wallet address;
transfer at least 10 ADA to the wallet;
in the Delegation Center, pick a suitable validator and click Delegate to vote for it by sending your coins;
staking rewards will arrive in the wallet at the end of each five-day epoch.

The procedure is similar for other popular PoS networks. To earn from staking Solana (SOL), choose a validator from the list in the Phantom wallet and delegate your coins. Rewards are distributed at the end of each epoch, which lasts about two days, and the yield is 7% per annum.

Because the total staking reward per epoch is fixed, yield depends on the share of issued coins locked in validator wallets. For popular blockchain platforms this is 50–90% of total supply.

Who are staking providers?

Staking is a popular strategy for allocating capital to digital assets. But setting up a node or a stake in a given crypto project can take quite some time.

Hence the rise of platforms that offer staking as an all-in-one service. These applications let users send funds into various pools via the provider’s wallet.

Staking providers also help analyse current staking yields in a chosen network and display other essential data. They simplify the process as much as possible for users, charging a small fee from the rewards earned.

Staking is offered by specialised services (Midas Investments, Everstake, Stake.fish, etc.) and by centralised exchanges (Coinbase, KuCoin, eToro, etc.). You can also stake via multi-currency wallets such as Trust Wallet and Atomic Wallet.

A current ranking of staking services is available on Staking Rewards.

How does ETH staking work in Ethereum 2.0?

In December 2020, as part of a large-scale upgrade called Ethereum 2.0, which envisages migrating the blockchain to PoS, an official test network called the Beacon Chain was launched. It is intended to become the basis for the new blockchain. The merger with the current Ethereum mainnet will be a separate milestone called The Merge and will take place before the end of 2022.

Ethereum 2.0 provides for staking, and you can already take part. To do so, send ETH to a special smart contract. Those who hold at least 32 ETH can become validators of the new network.

Some staking providers let smaller investors participate in ETH staking even if they lack the coins needed to run a node.

For example, the decentralised application Lido Finance lets you lock any amount of ETH and receive not only staking rewards but also staked liquidity tokens (stETH). The protocol delegates pooled funds to large validators and distributes staking income of 4% per annum daily among stETH holders.

The risk of ETH staking is that coins sent to the contract cannot be withdrawn until The Merge is complete. Some staking providers waive this restriction. Check the detailed terms in advance.

What are the risks of staking cryptocurrencies?

Staking can be an attractive and relatively safe alternative to merely holding cryptocurrencies in a wallet, promising returns that can be material. But several risks can reduce expected returns and even lead to losses:

because staking rewards are paid in the same cryptocurrency, exchange-rate swings affect the value of your holdings and the real return on staking;
the high yields advertised by some PoS cryptocurrencies (tens or hundreds of per cent per year) are often the result of rapid coin issuance. This can lead to a sharp fall in the coin’s market price and rapid devaluation of the investment;
staking terms may include lock-up periods from several days to several months. During this time the owner cannot redeem or sell their coins;
staking via providers carries counterparty risk: a third-party service can be hacked or misappropriate assets pooled from stakers.

What other types of staking are there?

Beyond staking PoS cryptocurrencies, there is so-called DeFi staking. This involves locking different types of tokens (utility and governance tokens, NFTs) in a smart contract to receive rewards or access certain services.

DeFi staking is most often used by blockchain projects to attract liquidity and to bolster the internal value of their native tokens. Decentralised exchanges and DeFi services use this tool actively, issuing their governance tokens as rewards for supplying liquidity.

Some blockchain games also offer staking of in-game NFTs, paying out in-game tokens as rewards, issuing other non-fungible tokens, or granting access to the game.

Frequently asked questions

What is staking?

Put simply, staking is taking part in transaction validation and the production of new blockchain blocks using cryptocurrency. Participants receive rewards — new coins of the network.

How do you take part in staking?

The main participants in staking are validators, who run nodes and play the role of miners in Proof-of-Stake blockchains. Often, even a holder of a small amount of cryptocurrency can delegate it to validators and thus take part in staking and earn rewards.

Can you make money from staking cryptocurrencies?

Staking is a popular way to earn passive income. Returns depend on two key variables: the volume of rewards (the rate at which new coins are issued via staking) and the cryptocurrency’s price.

How does mining differ from staking?

Mining is used in networks that rely on the Proof-of-Work algorithm, such as Bitcoin. The key difference from staking is the need for special computing hardware. For staking, you only need the blockchain’s native coins (if participating via an intermediary — a validator).

What is the difference between staking and farming?

Staking supports the blockchain itself using its native coins. Farming is earning trading fees from a decentralised exchange’s liquidity pool — an application built on a blockchain.