What Is Staking In Cryptocurrency And How Does It Work?
If you’re a crypto investor, you might have heard about the concept of ‘staking’. If you’ve ever wondered what staking means, find out here and learn how you can get involved.
What is staking and why does staking exist?
To understand staking, it’s important to first understand the concept of blockchain technology.
Blockchain technology is the technology that enables cryptocurrency to exist. Essentially, a blockchain is a distributed database of transactions that are immutable (cannot be changed)and shared among ‘nodes’ (thousands of computers) spread across a computer network (in this case, the world). Each node acts as a validator to update and verify that each transaction made on the blockchain is legitimate. The process of how the blockchain works to validate a transaction is best summarised by the image below from Investopedia.
Every time a transaction is confirmed to be legitimate by a network of computer nodes, it is clustered together into a new block(s) on the blockchain. In essence, the goal of blockchain technology is to record and distribute digital information, but most importantly, not to allow it to be changed or edited. Because of this, blockchain technology (also known as immutable ledgers) is basically records of permanent transactions (blocks) that cannot be altered, deleted, or destroyed.
Proof-of-Work (PoW) Validation
Now that we know blockchain technology relies on blocks of validated transactions, how are transactions validated in the first place?
Traditionally, transactions on the blockchain were validated using algorithms known as Proof-of-Work (PoW) algorithms. You might have heard this concept referred to as ‘mining’, which describes the process of how transaction records are added to the blockchain. ‘Miners’ use high-performance computers with large amounts of computing power to solve very complicated mathematical calculations. For every transaction input entered into the blockchain, a cryptographic hash puzzle (essentially a digital signature of a chunk of data) that is difficult to decode is created and this is what miners work to solve. Hashes are generated to secure data transferred on a public network, and by solving these hashes, transactions are validated digitally and added to the blockchain ledger. In return, those miners responsible for solving the complex calculations are rewarded with a payout of whatever cryptocurrency it is they are mining.
You can think of miners as essentially being auditors. They are verifying the legitimacy of blockchain transactions, specifically, to prevent the double-spending problem. Double-spending is a case where a cryptocurrency owner illicitly transacts the same cryptocurrency twice. Let’s use an analogy of counterfeit cash to understand this concept. Suppose you had one legitimate $100 bill and one counterfeit $100 bill. If you were to try and purchase a product with both the real bill and fake bill, and someone was inspecting both bills in detail, they would find that both bills have the same serial number and could conclude that one has to be a fake. So we can think of blockchain miners as people who check transactions to make sure that users have not tried to spend the same cryptocurrency twice in an illegitimate manner.
Blockchain mining is a well-known concept — In fact, the first-ever cryptocurrency, Bitcoin, works using this exact algorithm. However, because miners require expensive and complex hardware to solve the calculations, it is a highly energy-consuming process. It is for this reason that Bitcoin has negative connotations tied to it from an environmental perspective since the energy required to mine bitcoins is polluting the environment.
So this is where staking comes into play.
Proof-of-Stake (PoS) Validation
Proof-of-Stake (PoS) is another form of validation used to confirm transactions on the blockchain. Unlike Proof-of-Work validation, PoS doesn't need nearly as much computing power. For this reason, PoS is a much more green and energy-efficient method to add to the immutable ledger.
The PoS technology is actually quite simple to understand and is where the term ‘staking’ is introduced. The process of validating transactions using PoS involves participants first making a pledge to a specific cryptocurrency protocol. For example, Etherium (ETH), which uses the PoS validation method — requires participants to pledge (i.e. stake) an amount of ETH into the protocol. From all of the participants pledging ETH, the protocol chooses validators to confirm blocks of transactions. So the more coins you pledge, the higher the chance you will be chosen as a validator. These verified transactions become new blocks on the blockchain, adding to the immutable ledger. Therefore, whoever successfully participates in creating a new block receives staking rewards in a form of cryptocurrency. In the majority of cases, the staking rewards are rewarded in the same type of cryptocurrency that participants are staking or pledging in the first place (in this example ETH). However, there are some blockchains that pay our rewards to their staking validators using different types of cryptocurrency.
Depending on the blockchain/protocol, there may be a set time period you have to stake your cryptocurrency for — such as a week, a month, 90 days etc. before you can be paid out your rewards. This is to incentive users to keep their assets locked up so that the validation process can occur. However, some exchanges do not have a lock-up period, and your original staking amount can be withdrawn (plus any rewards you earned) at any time of your liking.
And that’s probably all you need to know about the staking technology to get started.
Types of crypto staking platforms
There are several ways in which you can get started staking, but since this is an introductory lesson to staking, we will focus on the simplest way.
Exchanges are by far the simplest way to stake cryptocurrency for beginners. These typically allow you to set the amount of a specific crypto that you would like to stake, and the exchange handles the validating node(s) on your behalf, essentially acting as the middle-man between the staking party and the validating one. Most exchanges will have some form of fee involved (usually taken out of your staking rewards) for providing these services.
User-friendly exchanges that offer staking
There are countless exchanges out there where you can stake your crypto, however these are the two that I have found to be user-friendly.
It’s important to note that the amount of rewards you will be paid out for staking heavily depends on the crypto you are staking in the first place. Usually, you are paid out a percentage return, similar to how you earn interest on your bank account savings. Typically, the higher a return that crypto offers you in rewards for staking — the higher the risk. However, for stablecoins which are pegged to the US dollar and less prone to price fluctuations (click this link here to check out my article about stablecoins if you want to learn more), you can still earn a hefty return staking these (sometimes greater than >10% annual return), which by far beats the tiny <0.1% return a lot of financial banks are offering these days!
Click here to sign up to Binance and receive a 100 USDT cashback voucher when you deposit $50 or more (USD) into your account.
*Once you have signed up, staking can be accessed via this link.
Click here to sign up to Coinbase and receive $10 (US) when you deposit $100 or more (USD) into your account.
Swyftx — Australian option
Click here to sign up to Swyftx to start earning rewards on your crypto
I’ve written a separate article that provides detailed information about the Swyftx Earn program, check it out here if it interests you: Is This The Best (Risk-Free) Way To Earn High Interest On Your AUD Savings?
I hope you enjoyed reading this article and didn’t find it too boring, hit me up in the comments if you have any questions, thoughts or concerns!
Have a splendid day,
Be sure to check out the following trustworthy platforms + receive rewards for signing up!
Kucoin — One of the largest cryptocurrency exchanges. Lend out your cryptocurrency for high-interest returns.
For Australian investors
Swyftx — cryptocurrency exchange + earn rewards for holding crypto.
Stake — an online stock broker for Australians wanting to invest in the ASX or U.S stocks. Get a free stock in Nike, Dropbox or GoPro when you sign up and fund your US trading wallet, or get $10 if you fund your AUS trading account.
Investing always involves a level of risk. You aren’t guaranteed to make money, and it is possible to lose the money you start with. I am not a financial advisor, so none of what I say should be taken as financial advice. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.