Join Our 800,000+ Community

Get Ember

more posts

November 10, 2022

Crypto Staking 101: What Is Staking? 

Cryptocurrencies like Bitcoin aren't just financial tools to invest in; they're restructuring instruments that alter how society views incentive structures, governance, and property rights.

Most cryptocurrencies are created through mining, which relies on energy-intensive hardware to verify transactions and secure the network. However, newer cryptocurrencies opt for a more sustainable and environmentally friendly approach called staking. 

Staking represents a massive shift in how we create digital assets and distribute them, a process more akin to earning interest on a savings account than traditional mining.

So, what is staking, how does it work, and what are the benefits?

What Is Cryptocurrency Staking?

Whereas Proof-of-Work mining relies on computational power to verify transactions and produce new cryptocurrency units, staking relies on the users holding a cryptocurrency to verify transactions and create new units.

This shift from a hardware-intensive process to one requiring users to hold a cryptocurrency's units changes the entire incentive structure for participating in a network. Blockchain verification and security through stake alters how we view asset ownership and creates new economic opportunities for individuals and institutions. 

Simply put:

  • With Proof-of-Work (POW), the more you invest in hardware, the more rewards you'll likely earn.

  • With Proof-of-Stake (POS), the more you invest in the network (by holding cryptocurrency units), the more rewards you'll likely earn.

How Does Staking Work?

While staking depends on which crypto protocol you're using, the process is relatively straightforward — it typically works like this:

  • A user locks up units of cryptocurrency in a digital wallet.

  • The user becomes a prospective validator on the network, meaning they verify transactions and help produce new blocks on a blockchain network. 

For example, let's say Alice stakes 32 Ethereum (ETH), 100 Cardano (ADA), or 50 Tezos (XTZ). By staking her cryptocurrency, Alice effectively says, "I'm putting my money where my mouth is. I believe in this network enough to risk my capital."

  • After users stake their cryptocurrency, the protocol randomly assigns them the validator role. It would follow that the more cryptocurrency one stakes, the greater the likelihood they'll be selected as a validator. 

For example, let's say the protocol selects Alice. Alice then becomes responsible for verifying transactions and producing new blocks.

  • As a reward for participating in the network, the user would earn interest on their staked units. To ensure validators are behaving correctly and giving the network ample support, most protocols require some form of "unstaking," where users can't access their units for a set period (anywhere from weeks to a year).

  • Validators can withdraw cryptocurrency rewards after the staking period is over or reinvest them in the network to earn more rewards.

Let's Talk About Penalties

While staking offers a more sustainable and environmentally friendly way to produce digital assets, bad actors still have potential. 

To ensure validators behave correctly, most protocols penalize validators for going offline or for acting dishonestly. 

For example, if a validator proposes multiple blocks (equivocation) or submits contradictory attestations (votes), they may be subject to a punishment called "slashing." Slashing typically results in validators losing a percentage of their staked crypto.

This loss in crypto, called a "correction penalty" is meant to incentivize validators to behave correctly and support the network. However, if a validator is consistently offline or acts maliciously, they may be "slashed" more severely, losing anywhere from one to 100 percent of their stake.

These incentive and penalty structures are notably different from POW, which only rewards miners for verifying transactions and penalizes them through the cost of electricity. 

With staking, users are directly rewarded (or penalized) for their actions, creating a more direct connection between them and the network.

How Do You Start Staking?

Step 1: Invest in Crypto With Proof-of-Stake

POS coins offer consistent yields proportional to the amount you stake. There are many different ways to get started with staking, but one of the simplest is to invest in a cryptocurrency that uses POS. 

There are a variety of ways to accrue yield depending on the project. If you're interested in staking, the first step is finding a protocol that supports it. 

The list of proof-of-stake protocols is ever-growing, but some of the most popular include Ethereum 2.0 ( ETH), Cardano (ADA), and Tezos (XTZ).

Step 2: Transfer to a Blockchain Wallet

Once you've selected a protocol, you'll need to find a wallet that allows you to stake cryptocurrency. Hardware wallets and software wallets of all types typically support staking coins. 

Some hardware wallets include:

As for software wallets, the options are numerous:

A Note on Wallets: Above hardware and software, wallets are self-custodial, meaning you are the only one in control of your private keys and, as such, your crypto. Self-custody requires a bit more responsibility on your part but ultimately gives you more control over your digital assets. Another option is custodial wallets, where a third party holds your private keys for you. 

Some popular custodial wallets that offer staking include:

Cryptocurrency exchanges do most of the heavy lifting for you, taking your crypto and staking them behind the scenes, but this convenience comes at a cost. Crypto exchanges are centralized and, as such, are more vulnerable to hacks. They also tend to charge higher fees than non-custodial wallets, so weighing the pros and cons before selecting a custodial wallet is essential.

Consider Joining Staking Pools

Staking pools are a popular way to earn rewards without having to stake a large amount of cryptocurrency. 

Pools are groups of stakers that come together to pool their resources and increase their chances of being selected as validators. 

Pools typically take a small percentage of the rewards earned (usually between one to three percent) in exchange for their services. But because staking pools allow users to pool their resources, they offer a more accessible way for smaller investors to get involved with staking.

Which Cryptocurrencies Can You Stake?

  • Ethereum. Ethereum recently transitioned from POW to POS, initiating the protocol upgrade. The switch to POS means that users can now stake ETH and earn rewards for doing so.

  • Solana. Solana is a high-performance blockchain that supports the staking of its SOL token. SOL has historically offered about a 6 percent yield.

  • Cardano. Cardano is a proof-of-stake blockchain that allows users to stake its ADA token and earn rewards. What makes Cardano different from other proof-of-stake blockchain technologies is its unique consensus algorithm, which is designed to be faster than other mechanisms.

What Are the Pros of Staking Crypto Assets?

As discussed, staking offers a novel way to earn rewards on your digital assets while simultaneously supporting the network. Some crypto investors consider staking as a "double reward" system, as you're not only earning rewards on your deposited funds but also earning any potential appreciation in the price of the staked asset.

With that said, let's take a more detailed look at some of the pros of staking:

Easy To Start

Staking is relatively easy to set up and start. In most cases, all you need is a wallet that supports staking (which, as discussed, many do) and some crypto to start earning rewards.

Passive Income

Staking can offer a great way to generate passive income. Some staking rewards can be pretty significant, and if you stake for a long enough period of time, the rewards can add up to a substantial sum.

Security

Staking helps to secure the network and, as such, is an integral part of the proof-of-stake consensus mechanism. By staking your crypto, you're helping to decentralize the network and make it more secure.

Equipment

The variety of staking methods offer significant optionality for users. You can run a validator node yourself, join staking pools, or stake your crypto in a software or hardware wallet.

More Environmentally Friendly

Staking moves from a computational energy expenditure model to one that relies on economic incentives. As a result, it's more environmentally friendly than proof-of-work consensus mechanisms, a boon to those interested in more sustainable crypto projects.

What Are the Cons of Staking Crypto?

While staking offers many advantages, it's not without its drawbacks. Here are some of the risks of staking to consider before you start:

Price Volatility

The price of crypto is notoriously volatile, and this volatility can significantly impact your staking rewards. 

For example, if the price of the staked asset falls sharply, your rewards will be worth less in fiat currency. Conversely, if the price of the staked asset rises sharply, your rewards will be worth more in fiat currency. 

If you're looking for a reliable return, staking might not be the best option. Instead, you might do best to think of staking as a long-term investment; the rewards might not be immediate, but if you're patient, they can add up over time.

Lack of Flexibility

Many staking rewards programs have a lockup period, which means you won't be able to access your deposited funds for a set period. This can be anywhere from a few days to many months, and it's essential to be aware of the lockup period before you deposit your crypto. 

During lockup periods, there's no way to access your deposited funds, so you'll need to be sure that you won't need them during that time.

Risk of Losing Crypto 

If you're running a validator node, there's always the risk that your crypto could be slashed if you violate the rules of the network. 

Rule violation isn't always intentional; sometimes, it can result from user error, software glitches, or simply bad luck. As such, it's essential to be aware of the risks before you start staking your crypto. 

Furthermore, staking solutions from exchanges and pools typically comes with risks, so do your due diligence before selecting a solution. 

Finally, any time a service offers to do any heavy lifting, risk is involved. 

Conclusion

Staking can offer a great way to earn rewards on your crypto holdings, but it's not without risks. Staking is equal parts a technological revolution and an economic experiment, and it's still early days for the industry. 

As such, there are bound to be bumps in the road as the ecosystem matures. Nevertheless, staking presents a unique opportunity for crypto users to earn rewards on their holdings, and it's an exciting development in the world of cryptocurrency.

It's a lot to take in. For many, the staking process is cumbersome and daunting, so opting for a set-it-and-forget-it investment might be more your speed. 

One of the best options on the market is Ember Fund, an app that offers a simple and convenient way to invest in a basket of the top-performing cryptocurrencies

With Ember, you can invest as much money as you'd like, and the app will automatically stake your crypto and reinvest your rewards. That way, you can earn staking rewards without worrying about the details.

Ready to learn more? Download the Ember Fund App here

Sources:

Ledger

Trezor

KeepKey - Hardware Wallet | ShapeShift

SafePal

Atomic Wallet

Coinomi

Trust Wallet

MetaMask

Exodus Wallet

Electrum Wallet

Coinbase

Kraken

Binance

Don't miss out on our latest posts

November 21, 2022

October 2022 Recap Newsletter 📈

Welcome to the October 2022 Recap Newsletter! We hope everyone is safe & sound. Despite November being one of the wilder months in a while (given all the news), last month was a strong one for crypto.

November 16, 2022

Now Introducing: Recurring Deposits!

The Ember team is proud to announce the launch of our latest investing feature: Recurring Deposits

November 15, 2022

The Importance of Non-Custodial Investing

With all the news around FTX, we felt it would be helpful to run through what non-custodial wallets are and why they’re important.

Download Ember Fund