What Is Staking in Crypto: How It Works, Examples, and How To Start

You don’t need to be an expert in investing or cryptocurrency to start staking, but there are some essential points to know before diving in. 

What Is Staking?

Staking is a system that allows you to earn rewards or interest by holding or investing in select cryptocurrencies. The process utilizes the Proof of Stake (POS) model, one of the few consensus mechanisms for the blockchain network. 

For cryptocurrencies that use the POS protocol, such as Solana, these Decentralized Finance (DeFi) networks rely on peer-to-peer transactions without the traditional regulations a bank would require. This is executed by using smart contracts.

What Are the Benefits of Staking Cryptocurrency?

There are a few main advantages to staking cryptocurrency — and they’ll certainly make you reconsider letting your cryptocurrency sit without collecting rewards.

Generate Staking Rewards

When you deposit a sum of money into a bank, varying interest rates are associated with different types of accounts. For example, a bank rewards you with interest in a savings account in exchange for depositing your money into an account.

The same is true with staking rewards. Digital assets can collect rewards, similar to collecting interest at a bank. You can shop the various rewards that are offered for staking options.

Cryptocurrency staking requires selecting a validator for staking, and once you commit, you get a reward in exchange. Each validator has its own associated APY. This is an incentive for staking rewards, as staked assets can generate passive income for stakers.

Staking crypto is especially beneficial for those who plan to park their cryptocurrency assets long-term. However, not all crypto assets offer staking, so you should research and learn the options for staking. 

Below are just a few of the crypto assets that offer staking:

• Solana (SOL)

• Cardano (ADA)

• Ethereum (ETH)

Promote Security

When you stake, you earn rewards while supporting blockchain projects and contributing to their security and efficiency. Staking services secure and validate transactions on their network, impacting its credibility.

Encourage Efficiency

Proof of Stake is more energy-efficient because it doesn’t need to perform the complex computations that Proof of Work requires. The Proof of Work model utilizes mining devices, while Proof of Stake is more environmentally friendly and greener. 

POS offers higher-speed transactions and is more cost-friendly, yet taxes computing power less. These attributes make POS more scaleable, so it’s growing in popularity for projects.

What Are the Risks of Staking Cryptocurrency?

As with any investment in any asset class, there are always risks. Although staking is a legitimate investment option with growing appeal, it’s not without some risks.

Lockup Periods

When you stake your cryptocurrency, popular cryptocurrencies typically have a period known as the lockup period. 

Protocols for the respective cryptocurrencies determine the duration of the lockup period, which can vary from a few hours to a couple of days. The lockup period is a trade-off for earning rewards.

For example, users cannot sell or trade their staked coins when staking Solana. During this staking period, SOL tokens remain in your crypto wallet but are limited until the maturity date. Lockup periods help secure the network further.

Market Volatility

One of the biggest risks to understand is the market volatility of staking crypto. Market volatility comes into play for many reasons, and a news story or regulatory change can cause an abrupt shift in any investment, especially cryptocurrency. 

When staking crypto, your investment can go up or down, sometimes dramatically. This can be true anytime, including the lockup period. During times of market volatility, staked capital can lose value.

Validator Risks

Selecting a validator has its risks, and you’ll want to do some research before selecting a validator to mitigate your risks. 

First, find out what their uptime is — this is the period of time they are up and running. Next, find out their track record for slashing. Slashing is like a penalty when validators fall short of network requirements or engage in other activities that compromise the network.

Some investors use the diversification strategy with staking and spread their staked crypto across more than one validator. Others go all in with one validator.

Unstaking Periods

Before staking, you should know about the limitations on access to your funds during unstacking periods. There will be periods when you cannot withdraw funds or unstake. Each protocol determines the unbonding period, during which you cannot withdraw funds.

Now that we’ve covered some of the main risks with staking, it’s important to note that choosing a reliable crypto broker is important because security standards, fee transparency, and staking project selection can vary.

How Does Staking Work?

Staking is based on decentralization and works via a Proof of Stake (PoS) consensus mechanism. Users who stake, otherwise known as token holders, lock their tokens for a set amount of time, which aids in supporting operations and processes.

There are several ways to verify cryptocurrency transactions, but two methods dominate the networks: Proof of Stake (PoS) and Proof of Work (PoW). Both are consensus mechanisms, but they have differences that make each unique.

Proof of Work (PoW)

The Proof of Work protocol has been around longer than Proof of Stake. PoW has been in play since 2009. Many thought it to be the most secure network, and some still hold this belief. This is because PoW utilizes mining, and miners are spread out globally.

One of the most popular cryptocurrencies, Bitcoin, uses PoW. Its security is rooted in decentralization, and its design structure requires much computational power to validate transactions.

Proof of Stake (PoS)

Proof of Stake emerged around 2012, and this consensus mechanism does not require the same complex calculations as Proof of Work. This is partly why PoS has had tremendous growth and global adoption, touting connections to 19 out of the top 20 smart contract platforms as of September 2023.

Another reason Proof of Stake is attractive is its much lower costs. Its cost efficiency makes it scalable and attractive for projects. Additionally, PoS is said to be more environmentally friendly than PoW.

PoS does not rely on miners, as in PoW, but instead requires validators, which we’ll discuss next.

Validators

Validators play an important role in staking cryptocurrency. They validate transactions to ensure legitimacy and adherence to the rules of the blockchain protocol. 

Validators are nodes in a PoS blockchain network, and they earn rewards when they confirm and verify transactions. However, if a validator engages in fraudulent activities by validating a transaction they shouldn’t, they risk losing some of their staked coins.

The role of a validator is essential to the process of staking cryptocurrency. Since validators are key contributors to the decentralization of cryptocurrency, they are, by design, located worldwide.

Finding a reputable validator is important when staking, as this reduces risk for you and the blockchain. Validators can earn rewards when they validate new blocks.

How To Start Staking

You don’t need to be a seasoned investor to start staking cryptocurrency — you just need to know the basics. 

Here’s a walkthrough of how you can get started with staking:

• Research cryptocurrencies that allow staking and reward opportunities. You may already have crypto investments, or you might be starting with your first cryptocurrency investment. Select one or more offering staking and review each reward's APY.

• Create a crypto wallet and purchase one or more digital assets that offer staking. Before you do so, review the minimum amount needed to stake.

• Research reputable staking platforms or crypto exchanges, review their reputation and security measures, and create an account to get started. 

• Select the investment you wish to stake and consider whether diversifying by staking more than one crypto investment makes sense.

• As you should with any investment, check your rewards regularly. Remember not to be alarmed if the investment increases or decreases dramatically, as cryptocurrency can have market volatility.

What Is the Minimum Amount of Tokens Required for Crypto Staking?

Minimum staking amounts vary depending on each cryptocurrency’s standard. 

For some, the minimum requirements may be a deterrent to getting started. However, outside of traditional staking, which we’ve covered, there are also other forms of staking that offer some flexibility and options.

Staking Pools

If an investor doesn’t have the total resources required for a particular staking opportunity, they can tap into a staking pool that enables them to invest in a collective pool of combined resources without needing to meet the minimum staking investment on their own.

Take Ethereum, for example. Typically, you would need 32 ETH, but with a staking pool, users can pool their money, as the name implies, and still take advantage of staking opportunities.

Investors are rewarded in proportion to their investments in staking pools or pool staking. Staking pools can help make staking crypto more affordable and create a more accessible entry point for certain investments.

But what if you have the minimum amount but just want more flexibility with your staked cryptocurrency? This is where liquid staking comes in.

Liquid Staking

With traditional staking, users trade off having access to their staked tokens to achieve rewards. With liquid staking, you can have the best of both worlds. Users can trade their staked investment as collateral, engaging in other DeFi protocols and projects. This is done via synthetic tokens. For example, stETH is a liquidity token that enables users to tap into their capital held in Ethereum (ETH).

The Bottom Line

Staking with cryptocurrency has pros and cons, but it can be a great way to create passive income. It’s essential to understand the various staking platforms and the benefits and risks of staking.

To learn more about how to invest in cryptocurrency and keep up with the latest news about digital assets, check out the rest of our Cryptopedia.