What is crypto staking?

Cryptocurrencies had a banner year in 2021. Wild price swings, institutional adoption, spectacular gains, rapid tech innovation, celebrity backing, social media dominance and the emergence of low-stakes, high-gains memecoins have accorded crypto investing a cult-like status.

However, among all the razzmatazz, there is an aspect of crypto ownership that hasn’t gotten the attention it deserves: crypto staking. This is a way to earn yield from your holdings—but only with certain cryptocurrencies. Knowing which ones might influence your purchasing decisions.

Let’s take a close look at what crypto staking is, how it works and why investors should pay attention to it.

Canadians can buy and sell crypto on CoinSmart*
Go to Site

What is staking?

Crypto staking is the process of pledging or locking up crypto holdings in exchange for rewards or interest payments, typically in the form of additional coins. By lending coins to their respective blockchains and serving as a validator (more on that later), investors can put their assets to work rather than having them sit idle in their crypto wallets, the digital equivalent of stuffing cash under the mattress.

Staking your crypto assets allows you to generate significantly more passive income than you would from parking cash in a traditional savings account or guaranteed investment certificate (GIC).

“Investors can now transition their digital assets, which have previously been unproductive commodities, into yield-generating instruments,” says Brian Mosoff, chief executive officer of crypto-investment firm Ether Capital Corp.

Although staking doesn’t insulate investors from price volatility of the underlying asset, it’s growing in popularity as a response to historic low interest rates. Investors seeking alternative investments with higher returns may want to consider staking.

Crypto staking requires locking in your coins for a specified length of time—from a few weeks to a few months—and agreeing not to withdraw them for that period. You also can’t perform any transactions with your staked assets. If you choose to unstake your assets before the lock-in period ends, the interest generated will be deducted from your principal.

How to stake a cryptocurrency

To stake crypto, you first need to own a cryptocurrency that uses the proof-of-stake (PoS) consensus mechanism, such as ethereum or cosmos, rather than the older proof-of-work (PoW) mechanism, which is used for bitcoin and litecoin. (The ethereum blockchain is in the midst of a transition from its PoW model to a more energy-efficient PoS model. The multi-phase upgrade, known as Ethereum 2.0, is expected to expand in June 2022 and continue into 2023. Learn more about staking ethereum.)

You can buy proof-of-stake coins at a crypto trading platform such as CoinSmart, which facilitates purchases in Canadian dollars. (Learn about buying ether, cardano and polkadot, three major coins you can stake.) Once you hold them, you can choose the amount you want to stake on their PoS-based blockchain. By participating, you help maintain a blockchain system’s operations, such as validating transactions.

Some projects have no or low thresholds for staking—for example, you can start staking cosmos with a minimum of 0.05 ATOM and cardano with a minimum of 1 ADA (minimums vary by staking platform). Ethereum, however, requires a minimum of 32 ETH, worth about US$88,768 (as of Feb. 1, 2022), unless you join a staking pool (see below).

What does a validator do?

By depositing crypto assets into staking, a holder becomes a validator, whose role it is to approve valid transactions on the blockchain. (Learn about the responsibilities of an ethereum validator.)

At the very least, validators must have a high-end computer with large storage capacity and a high-speed internet connection. They’re also required to install validation software and keep the system running 24/7. In exchange for this service to the network, the staker receives additional tokens as a reward.

Once you’re set up, you don’t need to spend a lot of time tending to staking-related tasks. “Users simply need to hold the token and activate a validator software or use a staking service to help perform the activity,” says Mosoff.

What is a staking pool?

Becoming a full validator brings the biggest rewards but also requires a substantial minimum investment. For that reason, going solo may not be a viable option for those new to crypto staking. Fortunately, there’s a simpler and cheaper way to participate: staking pools.

A staking pool allows a group of coin holders to combine their resources, usually through a staking service, to increase their chances of being rewarded. This consolidation, or pooling, allows them to improve their odds of validating blocks and receiving rewards. Compared to solo staking, though, a staking pool offers smaller yields because each validation reward is split among the participants.

Staking pools are only available on blockchains that adopt the PoS model. They’re typically run by a pool operator, or a staking service, and participants must lock their coins in a specific blockchain address, or wallet, to join in. As a pool staker, you don’t need an expensive computer—the pool operator does the heavy lifting.

The risks of crypto staking

Before staking crypto assets, investors should understand the risks. The first is underlying price fluctuations, which may surprise those who don’t intend to hold their assets long-term. If the price of your staked asset drops substantially during the lock-in period, you may not be able to unstake it and sell it; as a result, you could suffer a loss that’s bigger than your gains from staking.

In addition, while your crypto assets are locked in, you can’t use them for any transactions, so there’s a potential opportunity cost. Further, depending on the blockchain on which you’re staking, there’s a real risk that you may not receive any rewards at all. There are several reasons why you might be denied rewards on the polkadot blockchain, for example.

“There’s also the possibility of technical weaknesses or vulnerabilities in the staking protocol design that may result in the loss of funds,” says Mosoff. While this risk is low, it does exist, and it’s important to acknowledge that this is a new technology that’s still being developed, he adds.

Moreover, while it’s normal for crypto prices to fluctuate wildly, “investing in certain protocols could result in a total loss of capital,” says Michael Zagari, an investment advisor at Mandeville Private Client Inc. He adds that “receiving 30% interest on a $0 asset is 0%.”

Canadians can buy and sell crypto on CoinSmart*
Go to Site

Crypto staking in 2022

Prior to 2021, there weren’t many cryptocurrencies using staking as a method of validation. “However, 2021 and 2022 are really the big years in which staking rolls out for big layer-one protocols, ethereum being the biggest and most exciting to bring this feature to light,” says Mosoff.

As staking rewards become more accessible, we’ll likely begin to see more access points and demand from investors, both retail and institutional. “It’s pretty clear by now that the asset class as a whole is here to stay,” says Mosoff.

The final word

Staking your coins on a PoS blockchain network is an attractive option to generate interest income if you’re planning to hold on to your assets for a while. Although these investments are not without risk, staking strategically, being patient and following the rules of the game can pay rich dividends.

Read more on crypto:

Best cryptocurrencies to invest in for 2022Trading tools that can raise your crypto gameHow to gain exposure to crypto without buying it

The post What is crypto staking? appeared first on MoneySense.