What is Crypto Staking?
Crypto staking means that a cryptocurrency holder commits their coins to support a blockchain network and validate transactions. In return, the “staker” is compensated with a percentage of the network’s transaction fee, also known as staking rewards.
How Does Crypto Staking Work?
Think of crypto staking as having a savings account, where you deposit some cash as the principal amount. After a while the principal amount earns you an interest or dividend. In the context of crypto, the principal amount is the amount of cryptocurrency you lock up or “stake”, and the dividend/interest is the reward.
Why does locking your crypto earn you rewards?
This is because the network puts your cryptocurrency to work. Blockchains that operate on a proof-of-stake (PoS) consensus mechanism use this method as a way to add new transactions to the network. When the users commit their crypto to the pool, the network selects validators from the pool participants to verify blocks of transactions. Pledging more coins improves your chances of being chosen as a validator.
Whenever a new block of transactions is added to the blockchain, new coins are created and distributed to the validators as rewards for their participation. The higher the amount of crypto a validator has staked, the larger their portion of the rewards will be. It’s similar to earning dividends on your savings account based on the principal amount. Other factors that determine staking profitability are the lockup period and the coin’s volatility.
However, the concept of staking is only available on blockchains that run on a proof-of-stake (PoS) consensus mechanism. These include Ethereum, Polkadot, Cardano, Cosmos, Solana, Avalanche, Polygon, etc. Notable exceptions include blockchains like Bitcoin and Litecoin that run on a consensus mechanism called proof-of-work (PoW).
There are several approaches to crypto staking. These include:
- Staking-as-a-service or delegating your stake: This involves delegating your stake to a validator node. It allows you to retain control over your digital assets while giving a trusted third party the responsibility of operating the validator node. You still earn a percentage of the rewards that are proportional to your stake.
- Running a validator node: Setting up and maintaining a validator node gives you more independence and influence in the process. However, it requires some technical knowledge and regular maintenance
- Custodial staking: This is when a custodian, like a centralized exchange, handles the staking process on your behalf.
Staking is a way for ensuring integrity when verifying transactions on the network and discourages dishonesty by imposing penalties, in the form of slashing rewards, on bad actors.