You might be familiar with the idea that crypto possesses a distinct counterpart to traditional fixed-income assets. Instead of accumulating interest in dollars, you receive a share of a designated batch of crypto coins you commit and “stake.” This encapsulates the essence of crypto staking. However, what are the components, mechanisms, and pros and cons associated with it?

What is Crypto Staking?

Crypto staking involves locking crypto assets for a specified duration to contribute to the functioning of a blockchain. In exchange for staking your crypto, you receive additional crypto.

Numerous blockchains employ a Proof-of-Stake (PoS) consensus mechanism. In this setup, network participants seeking to uphold the blockchain by validating new transactions and adding blocks must stake predetermined amounts of crypto.

Staking ensures that only valid data and transactions are included in a blockchain. Participants endeavoring to validate new transactions commit sums of crypto to staking as a form of assurance.

If incorrectly validating flawed or fraudulent data, participants may face penalties, risking partial or complete loss of their stake—however, accurate validation of legitimate transactions and data results in earning additional crypto as a reward.

Prominent cryptos like Solana (SOL) and Ethereum (ETH) integrate staking as part of their consensus mechanisms.

Proof-of-Stake (PoS) Validation

The cultivation of a functional ecosystem on Proof-of-Stake (PoS) cryptos relies on staking within their networks. Typically, the larger the stake, the higher the likelihood for validators to add new blocks and receive rewards.

As validators accumulate substantial stake delegations from multiple holders, this serves as evidence to the network that the consensus votes from the validator are reliable. Consequently, the votes are weighted proportionally based on the amount of stake attracted by the validator.

Moreover, a stake doesn’t necessarily have to consist of tokens from a single individual. For instance, a holder can engage in a staking pool where pool operators undertake the validation of transactions on the blockchain, allowing participants to contribute less substantial amounts.

Each blockchain establishes its unique set of rules for validators. Staking pools enable collaborative efforts with others and permit the use of smaller amounts for staking. It’s important to note that these pools are typically constructed through third-party solutions.

How Does Staking Work?

Staking is exclusively facilitated through the Proof-of-Stake consensus mechanism, a specific approach employed by certain blockchains to identify trustworthy participants and validate the addition of new data blocks to the network.

This mechanism compels network participants, referred to as validators or “stakers,” to acquire and lock away a specific quantity of tokens. This discourages dishonest behavior within the network, as any malicious activity could lead to a decline in the value of the associated native token, resulting in financial losses for the perpetrator(s).

The stake, in essence, represents the validator’s “skin in the game,” ensuring their honest engagement for the benefit of the network. In return for their commitment, validators receive rewards in the form of native crypto. The larger their stake, the greater the likelihood of proposing a new block and earning rewards. Essentially, having more “skin in the game” correlates with a higher probability of being an honest participant.

Notably, a stake need not solely consist of an individual’s coins. Validators often operate staking pools, gathering funds from a group of token holders through delegation, thereby reducing barriers to entry for more users to participate in staking. Any holder can partake in staking by delegating their coins to stake pool operators, who handle the intricate process of validating transactions on the blockchain.

To maintain accountability, validators can face penalties for minor infractions such as prolonged periods of offline activity. In extreme cases, they may be suspended from the consensus process and experience fund removal, a practice known as “slashing.” While infrequent, instances of slashing have occurred in various blockchains, including Polkadot and Ethereum.

Each blockchain establishes its unique set of rules for validators. For instance, Ethereum’s blockchain mandates that each validator stake a minimum of 32 Ether.

What Cryptos Can You Stake?

As previously mentioned, the option to stake is exclusively available for cryptos associated with blockchains using the Proof-of-Stake consensus mechanism.

Major cryptos that support staking include:

• Ethereum (ETH)
• Cardano (ADA)
• Solana (SOL)
• Avalanche (AVAX)
• Polkadot (DOT)

Advantages and Disadvantages of Staking Cryptos

Staking presents a range of distinct benefits but is accompanied by its drawbacks. Here are key considerations:

Advantages of Staking Crypto

• Passive income: Staking offers a primary advantage by generating a consistent passive income stream. Users accrue rewards by holding and staking their coins, similar to earning interest on money in a savings account.

• Energy efficiency: Staking stands out for its superior energy efficiency compared to mining, which demands substantial computational power and energy consumption. In contrast, staking necessitates little more than a stable internet connection and some staked coins.

• Increased security: In Proof-of-Stake systems, the greater the number of coins staked, the more secure the network becomes. This heightened security is due to the significant cost associated with any attempt to attack the network, requiring most of all staked coins.

• Participation in governance: Some blockchains grant stakers the right to participate in network governance. This involvement may include voting on proposed changes to the network’s protocols or rules.

Disadvantages of Staking Crypto

• Risk of loss: In the event of network compromise or inadequate management of a staking pool, users face the potential risk of losing all the coins they have staked.

• Slashing: Certain staking systems implement a penalty mechanism known as “slashing,” where some staked coins, including the validator’s own and those delegated to it, may be forfeited if the validator node goes offline or fails to validate correctly.

• Inflation: While staking rewards can be enticing, they contribute to an increased supply of coins in circulation. This influx can lead to inflation, potentially devaluing the coins over time.

• Complexity: The intricacies of staking can be a deterrent for some users. Certain staking methods demand considerable technical knowledge, rendering them less accessible to individuals with limited technical expertise.

Ways of Staking Crypto

• Become a validator: This typically requires committing a specified staking amount of crypto, which may be substantial, along with specific computer hardware and software. Additionally, validators need to invest time and acquire knowledge to execute the validation tasks effectively.

• Join a staking pool: Some validators manage staking pools that aggregate smaller stakes from numerous users. This approach, known as ‘liquid staking,’ involves a liquidity token representing a user’s staked coin and its generated rewards. Validators handle the transaction validation tasks and distribute rewards proportionally to stakers after deducting fees.

• Lock-up tokens with exchanges: Several crypto exchanges provide lock-up options that consolidate tokens from multiple users. Users can choose the crypto and the amount they wish to lock up, determining their share of the rewards.

Bottom line

Crypto staking provides crypto owners an avenue to generate income that is distinct from traditional coin trading. Although the additional income may be an appealing benefit of coin ownership and may appear to be low-risk, it is crucial to bear in mind the potential drawbacks associated with owning and trading cryptos, which could outweigh the relatively modest rewards from staking.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.