What is Staking? Benefits and Risks Every Crypto Investor Should Know

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For the crypto market, staking is one of the optimal methods to invest funds in tokens of Proof of Stake blockchains. So what is staking? Let’s explore staking as well as its benefits and risks together with Tonraffles through this article!

What is Staking?

Staking is the process of locking up a certain amount of tokens in a blockchain to receive rewards. These rewards depend on your initial investment, including the number of tokens and the duration you have staked.

However, unlike a similar action called farming, where tokens are also locked to earn rewards in a crypto project/protocol, the tokens locked in staking are also used to participate in transaction verification activities of the blockchain through the Proof-of-Stake mechanism.

Similar to depositing money into a savings account at a bank to earn interest upon maturity, staking requires you to commit a certain amount of tokens to participate in this process. However, the key difference is that when staking, you are not merely an investor but also play a role as a supporter of the blockchain project. This helps improve the security, transaction speed, and scalability of the project because you are actively involved in the Proof of Stake mechanism of the blockchain.

Another benefit of staking is its small-scale impact on the environment and energy consumption, which is clearly different from the Proof of Work mechanism.

• You may be interested in: Understanding Consensus Mechanisms: The Foundation of Blockchain
• Quick Guide: Learn How Blockchain Technology Works in 5 Minutes

What is Proof of Stake?

To understand staking mechanisms, it’s essential to grasp the concept of Proof of Stake (PoS).

In overview, Proof of Stake (PoS) is a consensus mechanism in blockchain, offering a more efficient alternative to Proof of Work (PoW). Unlike PoW, which involves mining with significant hardware and energy requirements, PoS allows users to participate in transaction validation by staking assets.

In Proof of Stake (PoS) mechanism, users who own a significant amount of native tokens of the blockchain they are participating in have a high chance of becoming validators and receiving rewards for verifying transactions on the blockchain. This helps minimize environmental impact and creates an efficient and secure consensus mechanism in transaction confirmation.

PoS helps reduce the risk of network security breaches, as the profit from attacking becomes less appealing. The selection of the next block validator typically occurs randomly, but priority is given to those who own large amounts of assets.

The main staking models include

• Staking as validator: Users stake a specific amount of tokens directly into the blockchain as validators to receive rewards for verifying transactions. This model directly affects the operation and security of the blockchain.

  Example: Ethereum allows users to stake directly into the network.

• Delegated staking: Users delegate their tokens to the wallets of project development teams or node operators to receive regular profits without directly participating in transaction verification or other activities in the network. Although not directly involved, this form is still referred to as staking.

  Example: Casper Network uses this model to support small investors.

• CEX staking: With the increasing popularity of staking, more and more exchanges provide staking services. This allows users to stake their tokens on centralized crypto exchanges (CEX) like Binance, ByBit, OKX, and many others.

To use CEX for staking, simply use the platform as a wallet to hold your tokens. This is the simplest method, but it also comes with some limitations. One of these is the trust factor in the CEX to securely hold your assets. If the CEX gets hacked or goes bankrupt, you could lose your assets.

Whether using a CEX for staking is a good idea depends on your circumstances and personal preferences. If you’re comfortable with the risk, using a CEX can be a convenient way to store the value of your assets.

Liquid staking

Liquid staking involves users staking a particular asset to receive representative tokens at a 1:1 ratio.

For example, when staking ETH on Lido, users receive stETH equivalent tokens, and Lido delegates the ETH to multiple validators.

The benefits of liquid staking include increased liquidity for staked assets, providing yield opportunities from DeFi, and offering flexibility for users to sell representative tokens to mitigate losses during market volatility.

Moreover, liquid staking reduces the risk when validators encounter issues by delegating tokens to multiple validators and using insurance funds to compensate users when necessary.

Re-Staking

Re-Staking is a solution to address the issue of centralization in the Mev-Boost application network. EigenLayer is one of the pioneering projects implementing Re-Staking, aiming to penalize nodes with malicious behavior and ensure benefits from Mev.

The system operates by users staking ETH, which validators use to operate the network and perform security tasks such as oracle, data availability, and deploying sidechains or rollups.

Re-Staking helps mitigate the network’s dependence on Mev-Boost, balance MEV profits and security, reuse Ethereum’s capital, and may drive demand for additional ETH to stake. However, there are still risks regarding efficiency, concentration of power, and the security of this new model.

Earning money from staking

Passive income: The PoS mechanism allows you to earn money passively. Simply deposit your tokens on a staking-supporting platform and hold them there. Without needing to perform any transactions or movements, you can still achieve passive income from staking your tokens monthly.

Staking on official wallets: Many blockchain projects develop their own wallets for users to conveniently hold, receive, and transfer tokens. Moreover, these wallets often integrate staking features. You just need to download the wallet, hold the tokens, and can receive rewards from participating in the staking process.

Example: Trust Wallet allows users to directly stake tokens such as ATOM, EVMOS on the platform of the wallet to earn profits.

Staking tokens on exchanges: Many exchanges nowadays have integrated staking platforms, enabling users to earn passive income by staking tokens directly on the exchange wallet. The advantage of this method is that you can quickly perform token transactions if the market experiences significant fluctuations, without needing to wait for the transfer time from your personal wallet to the exchange.

Example: Binance allows staking USDT to earn an APR profit of 11%.

Earning money from staking not only brings profits but also is simple and convenient, making it an attractive option for those looking to capitalize on the price potential of tokens.

The Benefits of Staking

Staking tokens offers several significant advantages for operators, emphasizing the following points:

• Elimination of Dependence on High-End Hardware: The PoS consensus mechanism frees mining from the constraints of high-end computer hardware. Each node is connected to a blockchain wallet, ensuring it handles a fixed proportion of network transactions, independent of the processing power of the computer hardware.

• Investors Can Participate in Transaction Verification: Investors holding a sufficient number of tokens can participate in verifying transactions on the network, increasing transparency and trust in the transaction process.

• Preservation of Staked Asset Value: The value of assets participating in PoS staking is not affected by depreciation over time like ASIC machines and other mining equipment. This value is only subject to market price fluctuations.

• Environmentally Friendly and Energy Efficient: PoS is a more environmentally friendly and energy-efficient consensus mechanism compared to PoW, used in networks like Bitcoin. This reduces environmental impact and energy costs.

• Reduction of 51% Attack Risk: PoS minimizes the threat of 51% attacks on the network, enhancing the system’s security and stability.

Among these benefits, staking is particularly notable for eliminating the need to invest in expensive hardware, providing stable and predictable returns for operators. In contrast, PoW rewards are random and dependent on high-end computer systems.

Risks of Staking

• Lock-Up Period: Some projects require tokens to be staked for an extended period. This means that if you lock your assets, you cannot unlock them until the lock-up period ends. Even if you encounter losses, you cannot take any action until the period concludes. This can significantly impact your overall investment strategy.

• Delayed Rewards: Some projects do not distribute rewards daily and may take time to process the staker’s rewards. This can affect the liquidity and immediate benefits you receive from staking.

• Validator Risks: Validators, who are responsible for transaction verification, can pose risks if they make mistakes. Errors by validators can affect the network’s security and reliability, potentially leading to losses for stakers.

• Hacking Risk: There is a possibility that your wallet could be hacked. The security of your staked tokens depends on the safety of the staking platform and your personal security practices.

• Crypto Market Volatility: Volatility is a constant risk that every crypto investor faces. Market prices can drop sharply in a short period, leading to significant losses. Staked assets are still subject to market price fluctuations, which can impact the value of your staked tokens.

These risks highlight the importance of carefully considering the specific conditions and security measures of staking projects before committing your assets. Understanding these factors can help mitigate potential downsides while leveraging the benefits of staking in the crypto market.

Things to Consider When Participating in Staking

• Inflation Rate of Staking: This rate is calculated based on the issuance of new tokens relative to the total circulating supply. The introduction of new tokens can significantly affect the value of the token according to the laws of supply and demand. Understanding the inflation rate helps in assessing the long-term value and purchasing power of your staked tokens.
• Lock-Up and Unlock Periods: The lock-up period is the duration during which your staked tokens are locked and cannot be traded. You choose this period at the start. The unlock period is when you can stop staking, but to retrieve your staked tokens, you may need to wait for a specified period. Knowing these durations helps in planning your liquidity and managing your assets effectively.
• Interest Rates: This is the rate of return you receive after the staking period ends. The goal is to research and participate in staking opportunities that offer the highest and safest possible returns. Comparing interest rates across different staking projects is crucial to maximize earnings.
• Minimum Token Requirement: To participate in staking, you need to meet the minimum number of tokens required by the project. This requirement varies depending on the specific project. Ensuring you have the required amount helps in participating without any unexpected barriers.

Considering these factors is essential for making informed decisions and optimizing the benefits of staking in the crypto market. Proper due diligence can enhance your staking strategy and minimize potential risks.

FAQ STAKING