What is Stake in Crypto? – Forbes Advisor Australia

With cryptocurrency, one way to make money is to sell your investment when the market price increases.

There are other ways to make money from crypto, like staking. With effort, you can put your digital assets to work and earn passive income without selling them. You’ve probably heard of staking in reference to the much-anticipated Ethereum merger (more on that below).

In some ways, the effort is similar to putting money into a high-yield savings account. The banks lend out your deposits and you earn interest on your account balance.

In theory, the stake is not that different from the bank deposit model, but the analogy only goes so far. Here’s what you need to know about crypto staking.

What is staking?

Staking is when you lock up crypto assets for a specific period of time to support the operation of a blockchain. In return for staking your crypto, you earn more cryptocurrency.

Many blockchains use a proof-of-stake mechanism. Under this system, network participants who wish to support the blockchain by validating new transactions and adding new blocks must “stake” set amounts of cryptocurrency.

Staking helps ensure that only legitimate data and transactions are added to a blockchain. Participants trying to earn a chance to validate new transactions offer to unlock sums of cryptocurrency in stakes as a form of insurance.

If they incorrectly validate incorrect or fraudulent data, they may lose part or all of their stake as a penalty. But if they validate correct, legitimate transactions and data, they earn more crypto as a reward.

Popular cryptocurrencies Solana (SOL) and Ethereum (ETH) use staking as part of their consensus mechanisms.

But until recently, ETH also ran the energy-intensive proof of work consensus mechanism in parallel with staking. The merger means that from now on, Ethereum will only use the proof-of-stake mechanism.

Proof of stake validation

Staking is how proof-of-stake cryptocurrencies cultivate a functioning ecosystem on their networks. Generally, the bigger the stake, the more chance the validators get to add new blocks and earn rewards.

“In PoS, validators stake their assets as a skin in the game, which is cut or destroyed if they behave maliciously,” says Gritt Trakulhoon, lead crypto analyst for Titan, an investment platform. For example, trying to create a fraudulent block of transactions that didn’t happen.

As validators collect larger amounts of stake delegation from multiple holders, this serves as proof to the network that the validator’s consensus votes are trustworthy, and their votes are therefore weighted proportionally to the amount of stake the validator has attracted.

Additionally, a bet does not have to consist of just one person’s tokens. For example, a holder can participate in a staking pool, and staking pool operators can do all the heavy lifting of validating the transactions on the blockchain.

Each blockchain has its own set of rules for validators. For example, Ethereum requires each validator to have at least 32 ETH. As of this writing, it’s around $55,000. A stake pool allows you to cooperate with others and spend less than the large amount to stake. But one thing to note is that these pools are usually built through third-party solutions.

How does staking work?

If you own a cryptocurrency that uses a proof of stake blockchain, you are eligible to stake your tokens.

Staking locks your assets to participate and help maintain the security of the network’s blockchain. In exchange for unlocking your assets and participating in the network validation, validators receive rewards in that cryptocurrency known as stake rewards.

Many leading crypto exchanges, such as Binance.US, Coinbase and Kraken, offer stake rewards. “A more passive or novice user can just stake their cryptos directly on the exchange for a little more convenience, with the exchange taking a portion of the stake,” says Trakulhoon.

You can also set up a cryptocurrency wallet that supports staking.

“Each blockchain network usually has one to two official wallets that support staking. For example, Avalanche has the Avalanche wallet, and Cardano has the Daedalus and Yoroi wallets,” Trakulhoon points out.

If you have tokens in one of these wallets, you can delegate how much of your portfolio you want to put up for staking. You choose from different stake pools to find a validator. They combine your tokens with others to help your chances of generating blocks and receiving rewards.

How to make money by staking crypto

When you choose a program, it will tell you what it offers for stake rewards, and depending on the exchange, it can vary from 4 to 7%.

Once you have committed to bet crypto, you will receive the promised return according to the schedule. The program will pay you the return in the cryptocurrency staked, which you can then hold as an investment, set up for stakes or exchange for cash and other cryptocurrencies.

The program may also have limitations, such as having to commit your stake for three months before you get your tokens back.

What are the benefits of betting crypto?

• Earn passive income. If you don’t plan to sell your cryptocurrency tokens in the immediate future, staking allows you to earn passive income. Without effort, you would not have generated this income from your cryptocurrency investment.
• Easy to get started. You can quickly get started betting with an exchange or crypto wallet. “It’s as easy as setting up a crypto wallet, loading it with crypto and clicking the ‘stake’ button on validators or staking pools in the wallet app,” says Trakulhoon.
• Support crypto projects you like. “Staking has the added benefit of contributing to the security and efficiency of the blockchain projects you support. By staking some of your funds, you make the blockchain more resistant to attacks and strengthen its ability to process transactions, says Tanim Rasul, CEO and co-founder of the National Digital Asset Exchange, a cryptocurrency trading platform in Canada.

What are the risks of betting crypto?

When staking tokens, you may have to use them for weeks or months, depending on the program. During this time you will not be able to withdraw or exchange your tokens.

In response to this issue, Trakulhoon notes that “for some blockchains like Ethereum, there are decentralized finance (DeFi) applications like Lido Finance and Rocket Pool that offer ‘liquid staking’ products. These products offer a tokenized version of the staked assets, which essentially making them “fluid.”

However, since you are selling on a secondary market, you need to find a willing buyer or lender. Also, there is no guarantee that you will be able to do so or get all the money back early.

Cryptocurrencies are also extremely volatile investments, with double-digit price swings common during market crashes. If you stake your cryptocurrency in a program that locks you in, you won’t be able to sell during a downturn. The staking platform you choose may offer lucrative annual returns, but if the price of your staking token falls, you may still incur losses.

Many proof of stake networks use “slashing” to punish validators who take inappropriate actions, destroying some of the stake they put up on the network. If you bet with a dishonest validator, you may lose part of your investment for this reason.

“The slashing mechanism aims to incentivize token holders to only delegate their tokens to validators they feel are reputable or trustworthy, and not to delegate all their tokens to a single or small number of validators,” says Trakulhoon.

Should you bet crypto?

Staking is a good option for investors interested in generating returns on their long-term investments who do not care about short-term fluctuations in price. If you might need the money back in the short term before the wagering period ends, you should avoid locking it for wagering.

Rasul recommends that you carefully review the terms of the wagering period to see how long it lasts and how long it will take to get your money back at the end when you decide to withdraw.

He recommends only working with companies with a positive reputation and high security standards.

If interest rates seem too high to be true, you should approach with caution, experts say.

Lastly, staking, like any cryptocurrency investment, carries a high risk of loss. Only stake money you can afford to lose.

Note: When investing, it is possible to lose some, and sometimes all, of your money. Past performance is not a prediction of future performance and this article is not intended as a recommendation of any particular asset class, investment strategy or product.