If you're a crypto investor, staking is a concept you'll hear about often. Staking is the way many cryptocurrencies verify their transactions, and it allows participants to earn rewards on their holdings.
But what is crypto staking? Staking cryptocurrencies is a process that involves committing your crypto assets to support a blockchain network and confirm transactions.
It's available with cryptocurrencies that use the proof-of-stake model to process payments. This is a more energy-efficient alternative to the original proof-of-work model. Proof of work requires mining devices that use computing power to solve mathematical equations.
Staking can be a great way to use your crypto to generate passive income, especially because some cryptocurrencies offer high interest rates for staking. Before you get started, it's important to fully understand how crypto staking works.
How staking in crypto works
With cryptocurrencies that use the proof-of-stake model, staking is how new transactions are added to the blockchain.
First, participants pledge their coins to the cryptocurrency protocol. From those participants, the protocol chooses validators to confirm blocks of transactions. The more coins you pledge, the more likely you are to be chosen as a validator.
Every time a block is added to the blockchain, new cryptocurrency coins are minted and distributed as staking rewards to that block's validator. In most cases, the rewards are the same type of cryptocurrency that participants are staking. However, some blockchains use a different type of cryptocurrency for rewards.
If you want to stake crypto, you need to own a cryptocurrency that uses the proof-of-stake model. Then you can choose the amount you want to stake. You can do this through many popular cryptocurrency exchanges.
Your coins are still in your possession when you stake them. You're essentially putting those staked coins to work, and you're free to unstake them later if you want to trade them. The unstaking process may not be immediate; with some cryptocurrencies, you're required to stake coins for a minimum amount of time.
Staking isn't an option with all types of cryptocurrency. It's only available with cryptocurrencies that use the proof-of-stake model.
Many cryptos use the proof-of-work model to add blocks to their blockchains. The problem with proof of work is that it requires considerable computing power. That has led to significant energy usage from cryptocurrencies that use proof of work. Bitcoin (CRYPTO:BTC) in particular has been criticized over environmental concerns.
Proof of stake, on the other hand, doesn't require nearly as much energy. This also makes it a more scalable option that can handle greater numbers of transactions.
Crypto users support transaction validation within blockchain networks.
How to stake crypto
Staking cryptocurrency may seem a little confusing the first time around, but it's a simple process once you get the hang of it. Here's how to stake crypto step by step:
1. Buy a cryptocurrency that uses proof of stake.
As previously noted, not all cryptocurrencies offer staking. You need a cryptocurrency that validates transactions with proof of stake. Here are a few of the major cryptocurrencies you can stake and a little bit about each one:
- Ethereum (CRYPTO:ETH) was the first cryptocurrency with a programmable blockchain that developers can use to create apps. Ethereum started out using proof of work, but it's transitioning to a proof-of-stake model.
- Cardano (CRYPTO:ADA) is an eco-friendly cryptocurrency. It was founded on peer-reviewed research and developed through evidence-based methods.
- Polkadot (CRYPTO:DOT) is a protocol that allows different blockchains to connect and work with one another.
- Solana (CRYPTO:SOL) is a blockchain designed for scalability since it offers fast transactions with low fees.
Start by learning more about any proof-of-stake cryptos that catch your eye, including how they work, their staking rewards, and the staking process with each one. Next, you can look for the crypto you want and buy it on cryptocurrency apps and exchanges.
2. Transfer your crypto to a blockchain wallet.
After you buy your crypto, it will be available in the exchange where you purchased it. Some exchanges have their own staking programs with select cryptocurrencies. If that's the case, you can just stake crypto directly on the exchange.
Otherwise, you'll need to move your funds to a blockchain wallet, also known as a crypto wallet. Wallets are considered the best way to safely store cryptocurrency. The fastest option here is to download a free software wallet, but there are also hardware wallets available for purchase.
When you have your wallet, choose the option to deposit crypto and then select the type of cryptocurrency you're depositing. This will generate a wallet address. Go to your exchange account and choose the option to withdraw your crypto. Copy and paste that wallet address to transfer your crypto from your exchange account to your wallet.
3. Join a staking pool.
While staking can work differently depending on the cryptocurrency, most use staking pools. Crypto traders combine their funds in these staking pools to have a better chance of earning staking rewards.
Research the staking pools available for the cryptocurrency you have. There are a few things to look for here:
- Reliability: You don't earn rewards while your staking pool's servers are down. Pick one that has an uptime as close to 100% as possible.
- Reasonable fees: Most staking pools take a small cut of the staking rewards as a fee. Reasonable amounts depend on the cryptocurrency, but 2% to 5% is common.
- Size: Smaller pools are less likely to be chosen to validate blocks but offer larger rewards when they are chosen since they don't need to divide rewards as much. You don't want a pool that's too small and could potentially fail. On the other hand, some cryptos limit the amount of rewards a pool can earn, so the largest pools can become oversaturated. For most investors, mid-size pools are best.
Once you've found a pool, stake your crypto to it through your wallet. That's all you need to do, and you'll start earning rewards.
What is proof of stake?
Proof of stake in crypto is a consensus mechanism -- a way for a blockchain to validate transactions. The nodes in a blockchain must be in agreement on the present state of the blockchain and which transactions are valid.
There are different consensus mechanisms that cryptocurrencies use. Proof of stake is one of the most popular for its efficiency and because participants can earn rewards on the crypto they stake.
Staking rewards are an incentive that blockchains provide to participants. Each blockchain has a set amount of crypto rewards for validating a block of transactions. When you stake crypto and you're chosen to validate transactions, you receive those crypto rewards.
Benefits of staking crypto
Here are the benefits of cryptocurrency staking:
- It's an easy way to earn interest on your cryptocurrency holdings.
- You don't need any equipment for crypto staking like you would for crypto mining.
- You're helping to maintain the security and efficiency of the blockchain.
- It's more environmentally friendly than crypto mining.
The primary benefit of staking is that you earn more crypto, and interest rates can be very generous. In some cases, you can earn more than 10% or 20% per year. It's potentially a very profitable way to invest your money. And, the only thing you need is crypto that uses the proof-of-stake model.
Staking is also a way of supporting the blockchain of a cryptocurrency you're invested in. These cryptocurrencies rely on holders staking to verify transactions and keep everything running smoothly.
Risks of staking crypto
There are a few risks of staking crypto to understand:
- Crypto prices are volatile and can drop quickly. If your staked assets suffer a large price drop, that could outweigh any interest you earn on them.
- Staking can require that you lock up your coins for a minimum amount of time. During that period, you're unable to do anything with your staked assets such as selling them.
- When you want to unstake your crypto, there may be an unstaking period of seven days or longer.
The biggest risk you face with crypto staking is that the price goes down. Keep this in mind if you find cryptocurrencies offering extremely high staking reward rates.
For example, many smaller crypto projects offer high rates to entice investors, but their prices then end up crashing. If you're interested in adding crypto to your portfolio but you'd prefer less risk, you may want to opt for cryptocurrency stocks instead.
Although crypto that you stake is still yours, you need to unstake it before you can trade it again. It's important to find out if there's a minimum lockup period and how long the unstaking process takes so you don't get any unwelcome surprises.
Why not all cryptocurrencies have staking
Cryptocurrencies need to use the proof-of-stake consensus mechanism to have staking. There are many that don't, and these cryptos can't be staked.
Proof of stake isn't the first or only consensus mechanism that cryptocurrencies can use. Proof of work was the first, since it originated with Bitcoin. Other early cryptocurrencies followed in its footsteps until Peercoin (CRYPTO:PPC) introduced proof of stake in 2012.
There's debate over which consensus mechanism is the more secure option. Although the computational power required by proof of work uses substantial energy, it also makes proof-of-work blockchains difficult to attack. Some cryptocurrencies choose proof of work for this reason.
Another, less common consensus mechanism is proof of burn, where miners must burn (destroy) crypto to validate transactions. No option is perfect, and cryptocurrency developers choose the one they like most for their specific projects.
When you should or shouldn't stake crypto
If you have crypto you can stake and you aren't planning to trade it in the near future, then you should stake it. It doesn't require any work on your part, and you'll be earning more crypto.
What if you don't have any crypto you can stake yet? Considering the returns you can make, it's worth researching cryptos with staking. There are many that offer this, but make sure to evaluate whether each cryptocurrency is a good investment. It only makes sense to buy a crypto for staking if you also believe it's a good long-term investment.
The proof-of-stake model has been beneficial for both cryptocurrencies and crypto investors. Cryptocurrencies can use proof of stake to process large numbers of transactions at minimal costs. Crypto investors also get the opportunity to collect passive income from their holdings. Now that you know more about staking, you can start investigating cryptos that offer it.
Lyle Daly has positions in Bitcoin, Cardano, Ethereum, Polkadot, and Solana. The Motley Fool has positions in and recommends Bitcoin, Cardano, Ethereum, and Solana. The Motley Fool has a disclosure policy.