Crypto Staking Explained For Beginners

February 3, 2024
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I will give an overview of cryptocurrency staking, the benefits to you and the blockchain and how it works in practice. Firstly we’ll cover the two different types of blockchains.

Proof Of Work (PoW) vs Proof Of Stake (PoS)

These are two main concepts to understand in cryptocurrency that earn rewards; one is a relatively unique way of earning rewards available to a minority of people, whereas the other is open to every holder of specific cryptocurrency projects.

Proof Of Work (PoW)

This is how Bitcoin miners earn their units of Bitcoin through the process of mining. This is a process where very high-grade computers are used to solve calculations set by the blockchain to validate transactions and network participants. Ethereum, another popular cryptocurrency, also used a similar process for validating transactions before upgrading to proof of stake.

This process, known as crypto mining, is costly for the ordinary person and is generally unobtainable without significant financial outlay. Once the sum is solved, the miner is paid in BTC. All the other miners trying to solve the calculation don’t earn anything for trying; this is often known as game theory.

Think of this like a child in a class at school earning merits for being the first to get a question correctly in class.

Can I Stake Bitcoin?

The short answer is no - this is a proof-of-work asset, so only miners can gain rewards, and this is a very specialist thing to do that needs financial backing that most of us do not have, for example, a warehouse, thousands of computers and a military-grade cooling system, not to mention the renewable energy to make it viable in terms of profit.

Proof Of Stake (PoS)

This is how most crypto projects work to validate transactions and maintain the security of their blockchain network using proof-of-stake consensus mechanism.

In this case, holders choose to delegate their holdings to the network for a set period of time. They are then ‘locked’ to a pool or validator. These validators then gain rewards for processing transactions. A percentage of the rewards are then distributed to individuals who have delegated their units to the validator.

Depending on the projects, they will offer validators different rewards for processing the transactions, and hence the APY available to those individuals staking can vary between projects.

So staking with a proof of stake blockchain is more of a team effort. Using the school analogy again, one child (the validator) would be selected to answer the question, but they can use information from all the other pupils In the class (the stakes); if they get the question right, the child earns merits (validator rewards) they then share some of that merit with the rest of the class for helping (staking rewards)

What is Crypto Staking, and how does it work?

Cryptocurrency staking is a way of earning rewards by helping to maintain the integrity of the blockchain you are staking on. Sol is one of the popular cryptocurrencies that can be staked for rewards, making solana a popular choice among investors.

In the majority of cases, you delegate your units to a single or set of validators who then do the work of verifying transactions on the blockchain. In return for delegating your tokens, you can earn a passive income through a distribution of the fees. Another option is to participate in a staking pool, where multiple token holders pool their resources together to increase their chances of being selected as a validator and earning rewards. Stakers can benefit from this method of earning passive income while also contributing to the security and decentralization of the blockchain network. The number of tokens you delegate or pool can affect your potential rewards, so it's important to consider the amount carefully.

This is called on-chain Staking.

Different projects are staked in different ways. However, the vast majority can be staked using your ledger or other hardware device utilising ledger live or the protocol's own wallet.

You can use the project-specific wallet and add Staking for projects like Near Protocol, Cardano and Avalanche. Some projects like Vechain give you rewards just for holding in your wallet. Other projects have slightly more complex routes to staking your tokens but nothing that can’t be overcome with little research, much of which we plan to cover on the academy here.

On-chain Staking vs Off-chain Staking

Staking on a crypto exchange or off-chain Staking is an anomalous term. This is because you aren’t staking at all. Instead, you are earning a yield from the exchange having control of your tokens. However, in a node-based staking system, you can stake your tokens and participate in the network's consensus mechanism, earning rewards for validating transactions and securing the network. The staking period can vary depending on the specific blockchain and its protocol.

There is also a risk involved when leaving your coins on a centralised exchange; remember your holdings will not be kept on a hardware wallet, as the saying in crypto goes, not your keys, not your crypto, so be aware of the risks. The other downsides are earning lower reward rates and an inability to control anything about your bag whilst locked into these offerings.

The exchange offer this ‘staking’ or 'earning' to make funds from your holdings in various ways.

Let’s look at off-chain staking Polkadot on an exchange as an example, and we will assume that they staked the units you have added to the exchange earn programme.

On Binance, at the time of writing, they offer a flexible/no lock-up earning of 2.3% apr ranging up to 13.9% for a 90-day lock of up to 5000 units. , The highest reward they offer is on 120 days locked up at 16%, but this is only for 30 DOT, so a minimal amount, but it is a great headline rate to advertise. This all looks very simple (which it is) and rewarding; however, for a little more effort (see our Polkadot staking guide), you can earn 15.1% and compound your rewards daily. This shows where exchanges can make some money out of your holdings.

How much do you lose Staking on an Exchange?

Assume you lock up 1000 DOT on Binance at 13.9% (already lower than you can get directly on-chain). If you choose to re-subscribe every 90 days for one year, you will have made 146 DOT in rewards (assuming you add the rewards available to you every time you rejoin approximately every quarter)

However, if you had staked the same amount on the Polkadot network, you would have made 162 DOT in rewards. This is because you were assuming 15.1% APY and daily compounding.

So in this simple example, you are 16 DOT worse off over the year by taking the easy but, in my opinion, more risky and less profitable route of using an exchange. You haven't directly helped the project with the security of the network. If the market does revisit previous highs, that is a significant amount of funds you’ve given away to the exchanges for the sake of a bit of time and effort. Exchanges can also change their rewards differently to on-chain protocol conditions.

So you can see that you will generate more benefits from on-chain Staking on the project's network directly.

What is a lock-up when Staking?

Whenever you stake an asset, there is usually a degree of time your fund will be locked up. What do we mean by locked up? It is how long it takes to unbond or release your tokens from being delegated to the network and returned to your wallet. For example, Polkadot staking has a 28-day lock-up, Near protocol has a 3-day lock, and Cardano does not have a lock-up at all.

What is Compounding?

Compounding is when you can take the units you earn from Staking and add them to your staked pot. This makes your staking experience even more efficient as you earn rewards on the rewards you've already generated. This process, over some time, can be surprisingly effective.

Manual Compounding vs Auto Compounding Staking

This is precisely what it says on the tin. In some circumstances, you need to manually add your rewards back into your staking bag; each time this is done, there is a transaction fee… but this is usually a minimal amount on most networks.

Auto compounding is when the network's smart contract automatically adds funds to your staking bag. Although, in my experience, this is associated with no fees being used and is a much more efficient and less time-consuming way to stake, you will need to research each network you stake with to see how you can compound your rewards.

Yield Platforms.

These platforms offer yield/returns on various crypto projects in most cases, including BTC and other non-stakeable assets.

The long-term narrative of these platforms has always been that they lend out your funds, earn yield, and share that with the community of people on the platform.

This has been disproved in some cases during 2022 by Celsius and Blockfi.

The question to ask yourself is if you can't earn a yield yourself on these projects, then where are these platforms making these gains for you? If you can't explain the yield, there's a good chance you are the yield. This, to me, is a high-risk play. I know people who sadly have lost a lot of their crypto holdings to earn 2-3% on their BTC and other cryptocurrencies.

Summary of Crypto Staking Benefits

So, in summary, Staking can be a very effective way of generating units of projects you hold. They are passively generated and cost-free units that you can sell later.

The other benefit to Staking is that you can dollar cost average your purchase price without injecting any additional capital.

It is a VERY effective strategy in bear and transitional or choppy markets as you are less likely to sell the asset during this time, so why not let your holding passively grow?

It can still be part of your strategy during a bull market, but you need to manage it well if you plan to sell some or all of the assets. It would be best to be mindful of any lock-up periods involved so you don't miss your sell targets by being caught in that unbonding period.

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