What Is Crypto Staking?
Staking is essentially the lifeblood of blockchains that utilize the “proof of stake” consensus algorithm. Staking refers to when an individual locks up (collateralizes) a certain amount of tokens in order to validate transactions and earn rewards.
Proof of stake is a more recent alternative to the traditional “proof-of-work” consensus mechanism used by Bitcoin and other cryptocurrencies. With proof of work, miners use powerful computers to solve complex mathematical puzzles in order to validate transactions and add new blocks to the blockchain.
Want to learn more about the differences between proof of work and proof of stake? Read this article.
Why is staking even necessary?
You, as a casual crypto-collector, won’t likely be validating transactions and adding blocks to the blockchain yourself. You will, however, likely want to earn some passive rewards from your tokens.
There are two terms you should familiarize yourself with; delegator and validator.
Think of a delegator as an investor, and a validator as the person doing the work.
As a delegator, you’re investing in a validator, and trusting that they’re not going to lose your money by doing a poor job.
And what job will the validator be doing? Validating the legitimacy of transactions on the blockchain, of course.
Staking is just a way for validators (and the delegators supporting them) to put up collateral that essentially says “we’re invested, and we’re not going to do anything to put the integrity of this blockchain at risk”.
If validators mess up processing transactions, they get their tokens (collateral) slashed.
It’s really quite basic when you think about it. The stake being put up is essentially just insurance that the people validating the transactions aren’t going to act maliciously as it would be against their interest to harm the network.
What are the benefits of staking?
Staking secures the network by providing a financial inventive for the validators to do a good job. When the validators do a good job and process accurate transactions, they get rewards, usually paid out in the native token of the blockchain.
Let’s use Cosmos as an example. The native token for Cosmos is called ATOM. When the validators accurately process transactions, they receive rewards paid out in the ATOM token. If you delegate your ATOM tokens to any of the 150+ validators who are processing transactions on the network, a large cut of the rewards will be passed along to you. At the time of this writing, you can get over 20% annually – though staking reward rates tend to fluctuate based on various factors.
How do you stake your crypto tokens?
I’m assuming that sounds good to you so far. After all, who doesn’t like passive income?
So, how do you do it?
Well, the process differs from blockchain to blockchain. To stay consistent with the example above, I’ll show you how to stake ATOM tokens. Staking ATOM can be done via a few clicks using the Keplr wallet.
Keplr is a wallet designed for the Cosmos ecosystem. Remember, this is just an example, and the staking process will differ slightly depending on which blockchain and which wallet you’re using.
The overall process will likely be similar though.
Once you have downloaded the Keplr extension and set up your wallet, staking your ATOM tokens to earn passively is a 3 step process..
- Open the wallet and at the bottom, you’ll see a button that says “stake”.
2. When you click the “stake” button, a list of validators will pop up, along with validator specific information such as their voting power, their commission and the annual reward rate you can expect by delegating (staking) your tokens with them.
3. Click “manage” and a new tab will pop up that will enable you to delegate your tokens to that particular validator.
That’s pretty much it! Once you delegate your tokens to a validator, you’ll start earning passive income almost instantly – which you can claim whenever you want.
Note that there’s usually a lockup period, which means that once you stake, you won’t be able to unstake your tokens for a certain amount of time. With Cosmos, the token unbonding process is 21 days. This amount of time differs from blockchain to blockchain.
Tip: Use diversification to mitigate risk. If you have 500 tokens that you want to stake, you may want to spread that around to different validators. For example, rather than delegating all 500 tokens to a single validator, consider delegating 100 tokens to 5 different validators.
Staking is essentially the lifeblood of blockchains that utilize a proof of stake consensus algorithm. It requires delegating your tokens to be put up as collateral. The locked up collateral serves as a deterrent for bad actors who may try to infiltrate the network. If validators mess up, the collateral gets “slashed”.
Likewise, if the validators do a good job validating transactions and securing the network, they will receive a distribution of rewards – which will get passed along to everyone who delegated their tokens to them.
A lot of people hold tokens that can be staked, but never get around to doing it due to the assumption that it’s a complex process. Well, as you saw in the Cosmos/ATOM example, it’s actually quite easy and anyone can do it.
It’s certainly worth going through the process as the rewards can be a great source of passive income.