Introduction
Purchasing cryptocurrencies and keeping them as an investment is only the first layer of generating income. There are other ways to utilize the cryptocurrency reserves in such a manner that they further create another layer of passive income for the investor.
One such method to multiply the cryptocurrency income is to use the staking method.
What is Staking?
Staking is a method of cryptocurrency investing where the owners of a cryptocurrency asset can lock their assets into a protocol to earn profits. To understand staking, investors must understand that every cryptocurrency is traded on platforms like exchanges and DEX platforms. These platforms allow investors to purchase or sell a listed cryptocurrency for everyone.
Therefore, they need to provide their consumers with sufficient liquidity. It is important to mention that liquidity is the ability of a cryptocurrency to turn back into cash or other cryptocurrencies as soon as possible.
There is a requirement for cryptocurrency exchanges to ensure that every cryptocurrency in the market has enough liquidity so that the investors can purchase it without fear or high risk.
Working Mechanism of Staking
The cryptocurrency exchanges contain a considerable amount of liquidity in their reserves for selling to the users on the platform. However, as more investors purchase the assets from the network the supply is going to dwindle which can impact liquidity and inflate the prices artificially.
Under these circumstances, the exchanges need to maintain enough liquidity on their platforms to tackle these issues. Hence, they come up with the concept of staking.
Staking is a process where exchanges or other cryptocurrency trading platforms incentivize users to lock their crypto reserves in a liquidity pool.
These pools can make sure that the investors have enough liquidity on the said platform and in return, the stakers can earn rewards such as staking rewards. Many staking pools offer native liquidity tokens or yield tokens as rewards for their investors.
What is Proof of Stake?
There is another feature of blockchain that is tethered to staking that is known as Proof of Staking. Every blockchain requires an automated transaction verification system that is called the Consensus Mechanism.
One type of consensus mechanism is Proof of Stake or PoS. PoS also make use of staking cryptocurrencies for the delegators. The primary consensus mechanism is called PoW, which allows miners to compete with each other to verify every new transaction on a blockchain.
In contrast, the Proof of Stake system awards mining orders to the delegate who has the highest amount of staking reserves. The PoS system is considered an upgrade over the PoW system because it requires smaller computation power and also processes transactions much faster.
PoS system was developed by Daniel Larimer who also founded BitShares, Steemit, and EOS. The system uses a randomization process to make sure that the miner selection is fair and transparent. However, it also takes into account several other factors to award the mining orders to miners.
What is Delegated Proof of Stake?
The Delegated Proof of Stake or DPoS is another improvement on the simple PoS mechanism. It adds another layer of sophistication to the process of miner selection and lets the users vote. The users who wish to earn a vote must stake cryptocurrencies in the network.
Each staking investor is liable to earn one token. In this manner, the users do not depend on an automated algorithm to select the miner or the witnesses to verify their transactions.
On the contrary, they have the option to vote for their preferred miner and take part in the democratic process of selection. To assist the investors with voting, the blockchain network creates a record of all miners that is available for all voters.
Under the DPoS mechanism, the miners are called witnesses and they are appointed by votes. Meanwhile, the voters have also a responsibility to elect delegates. Both delegates and witnesses perform different functions within a DPoS blockchain.
How do Delegates and Witnesses Work?
DPoS Witnesses
The DPoS witness has the responsibility to add new blocks to the blockchain network. They depend on the votes from the stakers on a DPoS blockchain. To ensure that the process of witness selection is fair and transparent, the stakers on the network are allowed one vote per account. In this manner, the witness with the highest vote count can win.
The voters are free to elect as many new witnesses as they want. However, there is a necessity to maintain the decentralization of the network among 50% of the voters.
When the witnesses are elected, they can perform their function as transaction verifiers in exchange for rewards. Furthermore, witnesses are also obligated to carry out their job in the best possible manner to keep their rankings on the top.
The ranking of each witness is shared on the scoring system built on the blockchain network to serve as a voting reference for the stakeholders. At the same time, the DPoS also grants the chance for every witness to produce a block within the allotted time to grant equal opportunity.
If the witness can complete the task their performance is added to their ranking profile and vice versa.
Delegates
The voters on a DPoS are also charged with selecting new delegates using the voting process. The delegates are charged with transaction validation and managing the network. They can also create proposals for changes.
The voters can then view these proposals and vote on them to get them approved or rejected. However, the delegates are unable to influence transaction control but they take part in the governance process.
They can issue proposals to change block sizes, reward rations for witnesses, minimum staking requirements, etc.
What is Cold Staking?
It is visible from the above information that there is more than one way that blockchains use staking. In some cases, exchanges can use staking to maintain their liquidity. In other cases, blockchains can incorporate staking into their consensus models.
There is another type of staking that every cryptocurrency investor should learn about and it is called Cold Staking. Cold staking takes reference from Cold wallet addresses.
Cold Staking means that the cryptocurrencies are locked in a smart contract but they are stored offline. In most cases, cold staking uses hardware wallets. Such a method is adopted to increase the security protocol for these staked cryptocurrencies.
Naturally, hardware wallets are more difficult to hack or steal from than hot digital wallets. The stakers are required to store their staked currencies in a designed hardware wallet. In case, the stakers decide to move their cryptocurrencies out of the staking address, it means that they can lose their staking rewards.
Pros and Cons of Staking
An intelligent investor does not accept any new idea or trading concept without weighing its positive and negative aspects beforehand. Therefore, the investor must explore the advantages and disadvantages of staking before adopting it. Here is a basic breakdown:
Advantages of Staking
The investors can deploy their static cryptocurrency reserve to earn additional income in the form of yields.
The stakers can also add a third layer of side income by staking the yield tokens in other staking protocols or they can also purchase more cryptocurrencies with their yield tokens and stake them to earn compound yields.
The stakers can get increased blockchain participation as some yield tokens may grant them governance rights such as voting etc.
Investors can become miners, validators, delegates, or witnesses using staking options available on a blockchain.
Limitations of Staking
There is a risk of fraud or scams if an investor ends up staking their tokens in questionable projects that can expose them to rug pulls or exit scams.
In case the staking protocol run out of liquidity, it can crash and result in the loss of all the staking reserves and rewards for its users.
There is also a danger of hacks and exploits, where threat actors can break into a staking pool and end up stealing staked funds and tokens.
There is also an issue with the incredible volatility of staked cryptocurrencies that can result in Impermanent Loss. IL means that the prices of the staked coins can drop to near zero while they are locked in and the investors cannot sell them.
A smaller factor of danger is that some staking protocols pay lesser rewards than others. Therefore, investors must compare APYs rations before staking.
Fundamental Rules of Staking
It is important to mention that each blockchain and crypto entity has local rules established for staking. However, the investors can take a look at the following principles to get the basic requirements of staking:
- The stakers must keep their staking wallets online at all times unless they are cold staking.
- The digital wallet the stakers are using should have support for staking and be integrated with the staking pool or DEX etc.
- The investors must maintain the minimum amount of staking reserves at all times to keep earning staking rewards.
- The investors are required to lock their reserves into the staking protocol for a specified amount of time.
- The stakers have to wait for a few days to allow their newly acquired cryptocurrencies to mature so that it is approved for staking rewards.
- The stakers should read the terms and conditions issued by every blockchain entity in detail to make sure that they are aware of all the rules and regulations specific to the network.
Differences Between Yield Farming and Staking
Yield farming is an extended version of staking that requires some skills and knowledge on the part of the investors. At their bases, yield farming and staking are different concepts however they share some similarities at their base.
Staking means that investors are agreeing to lock their cryptocurrency reserves in a protocol for a given time in exchange for rewards. Meanwhile, Yield Farming entails that the investors use the yield tokens that are issued by the protocol and use them to purchase more cryptocurrencies.
Then, they stake the newly acquired cryptocurrencies to increase their staked positions. In this manner, yield farming allows cryptocurrency investors to increase their yield income using the compounding effect.
When staking and yield farming are compared, staking is considered to be a less risky option. The investors must acquire enough experience with staking first before jumping into yield farming. Some yield tokens can transfer the ownership of the whole staked position to the new seller.
Therefore, the investor can end up losing their whole staking positions and ownership of the staked currencies if they are not aware of the relevant laws in that blockchain mechanism.
In most cases, the yield farmers took to lending pools and borrow more cryptocurrencies in exchange for their staked tokens and it can increase their risk exposure by many folds.
Top Staking Coins in 2022
Countless cryptocurrencies are available for staking options. However, the investors need to conduct research and find out the most reliable staking options at their disposal. Here are some important staking coins that investors can consider in 2022:
Ethereum is the second-largest cryptocurrency by market cap. The Ethereum 2.0 or ETH coin is one of the most popular cryptocurrencies in the world second only to Bitcoin. The minimum requirement for staking ETH is 32 coins.
Ethereum recently shifted from PoW to PoS mechanism and it has around $12 billion stake in ETH. The average yield rates for ETH are 2.5% APY.
Solana
Solana is another blockchain network that is in the run to become one of the most popular cryptocurrencies in the network. This blockchain has incorporated systems like Proof of history that are good for scalability and transaction speed.
SOL is the 7th largest cryptocurrency by market cap. The staking nodes on Solana are controlled by 640 validators on the Solana blockchain.
The average APY projection for Solana is 7-11%. Custodial accounts like Ledger, MathWallet, Atomic Wallet, and Exodus provide support for staking Solana.
Binance
BNB is the third largest crypto by market cap and it is native to the Binance exchange. The projected APY for Binance coin is 6-9%. However, there is no minimum requirement for staking BNB for validators. Meanwhile, unstaking time is 7 days.
Sushiswap
Suhsiswap is a decentralized exchange that is used for staking and yield farming. The investors can earn up to 7-10% APY on Sushi coins which is considered a high return. Exchange platforms like Binance, OKEx, and Houbi have listed the Sushi coin. It is also compatible with MetaMask and Atomic wallets.
Polygon
Polygon is one of the most popular layer-2 solutions on the Ethereum blockchain. Polygon is a scaling solution and it can process up to 65K transactions per second.
The stakers can start with only one MATIC token on Polygon. They can also connect their MetaMask wallet with the Polygon network to become stakers. The minimum APY rate for MATIC is 14%.
BitDAO
It is backed by Peter Theil and Pantera Capital. It is one of the largest decentralized autonomous organizations or DAOs in the world. The average return is 14.77%.
Cardano is another blockchain founded by a former Ethereum co-founder. The project can process several thousand transactions per second. The native token ADA APY is 5-9%. However, long staking positions can become less rewarding with ADA.
Avalanche
Avalanche is very similar to Polkadot and Cosmos. The Avalanche blockchain requires 2000 coins staking to qualify as a validator. The APY estimate for its native token AVAX is around 8-14%.
Once the AVAX tokens are staked, the investors must wait for at least two weeks to start earning yield rewards. Furthermore, the minimum limit for AVAX staking is currently set at 25 coins. The unique feature of Avalanche blockchain is that it can scale millions of validators at any given time.
Tezos
Tezos is recognized on account of its Liquid Proof of Stake consensus mechanism. This is a system where delegation becomes optional. The native token of Tezos is XTZ.
The delegators can become bakers with Tezos which means that they can earn exclusive rewards from the blockchain. The yield matures after 35-40 days of staking. The APY projection for XTZ is 6.75-10.60%.
Tether
Tether or USDT is the stablecoin issued by Circle. When investors are staking with stablecoins they can avoid the risk of impermanent losses because the stablecoins prices are not volatile like other cryptocurrencies.
Since USDT is one of the most popular stablecoins that is used as a store of value and medium of exchange among crypto traders it is relatively safer. However, investors must always proceed with caution when working with stablecoins. The APY estimation is around 3.5% for USDT.
Conclusion
Investors will notice that despite Bitcoin being one of the most currencies, it is not staked. It is because; PoW coins do not support staking. Staking can be a great way to increase passive income through cryptocurrencies without needing to check the market status again and again.
Staking works best for long-term trading positions and makes sure that investors can utilize their static cryptocurrency reserves productively.
