Crypto 101: What is Staking?
A breakdown on the basics of staking and Proof-of-Stake blockchains
For most first timers, jumping into the world of cryptocurrency can feel like entering a strange new realm. In fact, it’s not unlike Dorothy getting yeeted by a magical tornado into Oz (dizzying, overwhelming and surrounded by some seriously eccentric locals).
Only with crypto, I’d argue that there’s a steeper learning curve… Blockchains and liquidity and volatility – oh my!
So whether you’re completely new to Web3 and DeFi (Decentralized Finance), or you just want some easy-to-understand resources to aid in your quest to create more crypto converts – good news!
To help out my fellow newbies, we’re kicking off a Back to Basics series where each article will feature a rundown on some fundamentals of cryptocurrency, the blockchain, trading, investing and more.
Think of it as your yellow brick road to crypto enlightenment (or something less pretentious-sounding). Up first, we’re diving into the wonderful world of Staking – and speaking of which…
What is staking, anyways?
Staking is a method that some crypto platforms use to verify transactions on the blockchain. To be a little more technical, it’s an integral part of a consensus mechanism called “proof-of-stake,” but more on that in a bit.
For now, let’s focus on what staking means for you. If you own a cryptocurrency that operates using a proof-of-stake model – for example, Cardano, Solana, Tezos, and most recently, Ethereum – you can lock away (stake) some of your holdings with a stake pool for the long term to receive a percentage-rate reward over time.
Stake pools are simply server nodes that are used to validate transactions on the blockchain. Basically, the more staking power a stake pool has (i.e. the more crypto staked with the pool), the greater the chance the pool will have to verify the next block on the chain, and the more rewards it will generate.
What does Proof-of-Stake mean?
As we mentioned before, proof-of-stake is the consensus mechanism for processing transactions and minting new blocks on the blockchain. But what does that mean?
Proof-of-stake systems use validators to process transactions and create new blocks – similar to the role of miners in proof-of-work blockchains like Bitcoin. But rather than racing to solve complex equations, the proof-of-stake system uses nodes (servers that work to maintain and build the blockchain) which earn the right to create new blocks based on the amount of holdings they have – AKA their staking power.
(For a full breakdown on the differences between Proof-of-Stake and Proof-of-work blockchains check out this article.)
From there, a validator will be randomly chosen from those who have staked a minimum amount of coins for each block. The validator will then create (mint) the block which other validators will authenticate. Once the new block is complete, the validator will earn rewards in the form of the blockchain’s native coin, e.g. ADA on the Cardano blockchain.
Pretty straightforward, right? Well, there is one caveat…
If the block contains a fraudulent transaction, the validator who minted the block (and any validator who authenticated it) can lose a portion – or all – of their stake.
There’s a joke here somewhere about playing high stakes games, but I won’t subject you to that… You’re welcome.
What are the advantages of staking?
Staking comes with a variety of benefits, but perhaps the biggest and most relevant perk to you as a delegator is that your assets are essentially earning you passive income. Think of it like this: rather than letting your crypto gather virtual dust in a wallet, staking enables you to make your assets work for you long-term and generate rewards.
Here’s a closer look at at the biggest advantages of staking in a nutshell:
- Monetary Rewards.The returns on your investment – AKA yields – have the potential to be quite lucrative depending on the pool you stake with.
- Passive Income. Staking crypto may be one of the only truly passive ways of earning income. The more crypto you delegate, the greater the rewards you can earn – plus you always have the option to unstake your assets later if you want to trade them.
- Staking is Win-Win. By staking crypto, not only are you generating rewards for yourself, you’re playing an active role in boosting the blockchain network’s efficiency and security.
- Sustainability. Proof-of-Stake models are far more environmentally friendly by design, as opposed to Proof-of-Work networks which require expensive and resource-heavy electronic rigs to mint new blocks.
Does staking have risks?
Like any investment, staking does come with its own set of risks. But perhaps the most significant drawback is that staking certain cryptocurrencies can involve a temporary lockup or “vesting” period. During this period, you won’t be able to transfer or trade your staked tokens – even if prices shift.
However, not all cryptocurrencies involve a lock-in period. For example, ADA delegators do not have a vesting period, nor does their ADA leave the delegator’s wallet, which means they can switch pools at any time.
That said, here are a few other risks to consider:
- Project-Dependent. The crypto you stake (and the potential rewards) are dependent upon the strength of the project running the stake pool and their ability to attract more investors.
- Volatility. All crypto projects, no matter how big or successful, are subject to volatility. In the event of high volatility, there’s a chance that your returns may be worth less than your initial investment.
- Stake Pool Management. A stake pool is only as good as its operator. If, for some reason, a stake pool operator drops the ball, or the pool gets hacked, you can face the risk of losing some or all of your staked cryptocurrency.
How do I start delegating to a stake pool?
If you own cryptocurrency that follows a PoS model, you’re free to stake all or some of your holdings with any public pool at any time.
However, it is extremely important to be aware of the differences between stake pool options to find out which one is ideal for you. For example, pools will vary by factors such as delegation fees, rewards, margins (the percentage of rewards that go to stake pool operators before rewards are distributed), and saturation. You can find online compendiums that provide stake pools stats and comparisons such as this one for Cardano, or this one for Ethereum, etc.
If you already have a non-custodial wallet, all you need to do to start delegating is go to the delegation tab in your wallet and fill in the name or ticker of your chosen stake pool. From there you’ll simply click on the delegation button, select and confirm your wallet, and that’s it! Then you simply sit back, relax, and watch each epoch as the rewards roll in.
Looking for a pool to stake your ADA with? Check out NEWM stake pools where you can join us in building the fair music ecosystem of the future, and of course, earn some seriously sweet rewards.
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