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Staking in the world of cryptocurrencies: what it is, how it works, and how to get profits from it
Staking Explained
Cryptocurrency
19.09.2021
Updated 30.12.2021
10:43

Now staking is gaining popularity because it is a more ecological, less energy-intensive, and available to anyone way of getting digital money. But newbies still do not fully realize why staking attracts people and how it differs from classical mining. In this article, we will try to help our readers with solving this issue.

What staking is 

Staking is the storage of digital money in a wallet specifically designed for that, which allows to maintain the work of a blockchain and receive passive income for it. Many call this opportunity the best alternative to a demanding, complex, and ecologically unfriendly classical mining of cryptocurrencies.

If we put it most simply, during staking, we lock some number of the cryptocurrency in a digital account, which starts to bring passive income right away. It is similar to the scheme of classical banking deposits, which is transferred to the realities of the cryptocurrency world.

The mechanism of staking is a concept built on the use of the Proof of Stake algorithm. The name itself explains its essence very well. Operations in blockchains with the use of PoS are confirmed based on the verification of a number of coins frozen in specialized wallets.

Who developed Proof of Stake algorithm? 

The universally recognized creators of this algorithm are considered to be Sunny King and Scott Nadal. These two developers were the first to describe the mechanism of PoS work for their cryptocurrency PeerCoin, which gradually turned from a hybrid PoW-PoS algorithm to pure ‘Proof of Stake’ during its historical development.

In 2014, the revolution in the use of Proof of Stake happened. Using PoS as a basis, developer Daniel Larimer created a new variation of the algorithm named Delegated Proof of Stake — DPoS.

This time users not only fixed their balance in the wallet but also received some weight of voices (depending on the volume of frozen coins). And votes could be used to choose some number of nodes processing operations within the cryptocurrency network.

The choice could be changed any moment, and nodes themselves were in a constant struggle for trust, competing for the limited number of places in the live rating (for example, there were 100 possible nodes; and only 20 of them, which had received most voices from stakers, would confirm operations in fact).

A fewer number of verifying nodes on the basis of the DPoS algorithm significantly increases the number of operations per second but loses in terms of the decentralization parameter. Users trust the chosen group of nodes; however, trust is not the most reliable mechanism in the world.

How staking functions

Staking is a procedure, which is to store (hold) cryptocurrency savings in a wallet without activity for the long term. A user who has frozen or simply holds digital coins in the account receives some percentage of the income for doing that. Staking became popular due to the fact it offers a way more significant income compared to other directions of passive income on investing.

Blockchains using PoS verify and validate new blocks with the help of staking. At the same time, classical blockchains apply complex and expensive equipment of millions of miners worldwide for that purpose.

If traditional mining operates based on power competition among a lot of computer hardware, Proof of Stake validators do not struggle to mine the next block in any way. Validators are defined through the choice, which has relation to the number of coins in the wallet (in the system) or a special reserve (stake).

The following rule is usually fair for stakers – ‘the more money is in the wallet, the higher probability that you particularly will become a validator is’. As a result, the main and indisputable advantage of this method of earning on cryptocurrencies shows up: while mining requires you to buy expensive equipment, learning how to adjust and maintain the workability, all you need for staking is to simply invest money in the purchase of cryptocurrency and keep it in your wallet.

Proof of Stake is truly the best solution for maximal scalability. For this reason, Ethereum is now working on the transition to this type of algorithm, which was mined through video cards most of its history.

But many prefer Delegated Proof of Stake (DPoS) as an option with the transfer of responsibility for processing operations to the limited number of nodes after all. These nodes-validators independently manage the network and process transactions, leaving the rest an interest income on staking and a voting system for a limited list of nodes.

Reasons why staking is not available to any cryptocurrency

Staking of cryptocurrency is a function that is available only on those coins that work based on the Proof-of-Stake algorithm (PoS) or its modernized variations. Using it only, you can:

The workability of the blockchain network based on the Proof-of-Stake algorithm is ensured by the procedure of transaction validation by users, on wallets of whom cryptocurrency is stored. The more tokens in the account, the more chances to become a validator and receive a reward for that you have. The insurance from malicious actions is provided by the fact a fraudster will lose all funds if he tries to make any changes to the blockchain.

The PoS-based consensus allows to abandon complex and energy-intensive mining and pass this right of block mining and getting the reward to those who simply hold the coin.

Unfortunately, not all coins were initially created with and then followed the PoS concept.

In this regard, you need to focus that staking is not available to any cryptocurrency and is possible only:

  1. With coins that expressly state the support of Proof-of-Stake or its subtypes:   Delegated Proof-of-Stake, hybrid PoS / PoW.
  2. At cryptocurrency exchanges, platforms, and projects that launched their own staking of cryptocurrency.

Examples of cryptocurrencies with the possibility of staking

A huge number of altcoins either allows to earn on staking or is preparing to implement such opportunities. Developers are interested in this kind of algorithm namely because it significantly expands a potential number of scenarios of coin application and increases its value for users.

The top of users’ expectations regarding staking looks like this:

How staking differs from mining

The main and key distinction of staking from mining is the consensus mechanism. The verification of transactions of coins working on Proof-of-Stake is executed without substantial energy and computational costs – by simple devices that have a wallet with the cryptocurrency stored in it. The principle is ‘the more cryptocurrency is in the wallet, the more you will be engaged in mining and the more income you will receive’.

The verification of transactions on Proof-of-Work is based on the use of powerful processor devices and significant electricity consumption. The principle is ‘earning on the basis of PoW mining will only rise for those who possess the most powerful and up-to-date devices, as well as regularly adjust them and keep an eye on their workability’.

Further, we will describe additional differences:

Advantages of staking 

Considering all of the above, advantages of staking can be united in such a simple list:

Risks of staking

Significant risks and drawbacks of staking may include:

  1. A higher number of problems in terms of cryptocurrency volatility – if investment into equipment can be returned by selling it a bit cheaper, the coin which dropped in price drastically reduces the weight of an investment portfolio and actual numbers of the annual income rate.
  2. It takes a while to receive a reward since it is added to your account not instantly.
  3. There are risks to bump into unscrupulous validators in projects where interaction with them is obligatory.
  4. If access to the wallet or account is lost, it will lead to the loss of all your investments.
  5. There are risks of rapid integration of more than 50% of the whole cryptocurrency within one fraudulent group of investors that will get a chance to impact the blockchain.

Types of staking 

Key types of staking can be united in such a list:

Independent technical staking 

Independent (technical) staking is a procedure that is carried out through freezing of the token in an online wallet and subsequent expectation of reward. The main problem is that to start staking, you usually should meet the minimum balance set by projects.

For instance, the upcoming staking of Ethereum coin will require no less than 32 ETH on balance. For DASH, the threshold is 1000 coins, and for Tezos – 10 000 XZT.

It is also important to know that:

Inflation-based staking 

Some cryptocurrency blockchain networks opt for staking with fixed income for holders based on inflation indicator. Such an option should encourage people not only to store coins and constantly accumulate them but also to withdraw part of the earnings.

A typical scheme is based on the fact that each week/month, a specific interest volume of coins is distributed among users who have frozen their funds in the wallet. Many are satisfied with this type of approach due to its predictability and simplicity.

Staking pools: how it works

A staking pool is an association of several users-holders that unite their cryptocurrency savings in order to increase chances to be chosen in the role of validator in the Proof of Stake network. The reward received for a block is then distributed between them proportionally to the interest share of the contribution of each participant of the pool. 

Pools are maximally efficient in popular networks, as well as in blockchains with a high entry threshold. But in most cases, organizers of such associations take an interest for their services, so one should be prepared for that.

Cold staking

Some cryptocurrencies implemented such a mechanism as cold staking working on the principle of the Proof of Stake consensus mechanism. In this case, users get a chance to earn from holding the coins in the wallet, which is not even connected to the network.

The only rule is not to withdraw coins from the storage. Once it is done, the reward will stop being accrued.

That is a perfect option for those willing to get the utmost safety of storing cryptocurrency in a conditional hardware wallet and, at the same time, get passive income from your investments.

Staking at the exchange 

Now, when many top exchanges launched staking as an official service, it became simpler than ever before to earn on it. What is required is to simply:

A reward for staking is usually available for withdrawal almost immediately and does not depend on when and under what conditions you cease this type of earning.

How to start 

For those who feel enthusiastic and want to find out how to start earning on staking, we recommend to:

Or you may register at one of the top cryptocurrency exchanges with staking support for the necessary asset and execute all of the above there.

General conclusions 

The Proof of Stake algorithm and earnings using staking is the next degree of development of cryptocurrency technologies and the economy of decentralized finances. They not only allow people without relevant technical knowledge to earn on blockchain but also significantly reduce the financial threshold to enter the market.

And considering the fact today a lot of cryptocurrency exchanges are implementing the staking feature straight from their website, it attracts more and more newbies to the field who did not even think about investments into the cryptocurrency world before.

FAQ

Staking is the storage of digital money in a wallet specially designed for that purpose, which allows to support the operability of blockchain and receive a passive income from it

The most popular cryptocurrencies for staking are Solana (SOL), Cardano (ADA), Algorand (ALGO)