If you’ve been in the crypto space long enough, you’ve probably heard of staking. Cryptocurrencies are a relatively new asset class, and as such, staking can be quite confusing for many investors. It can be tricky to know when and how often you should claim staking rewards and how it all works.
Staking briefly explained
Starting with the basics, staking is a crucial activity for proof-of-stake (PoS) blockchains, consisting of users locking or holding their funds in a crypto wallet to maintain the operations of a system.
While staking is similar to mining, the two are different. Stakers validate transactions, and the process is essential in helping the network reach consensus. The amount of transaction each user validates depends on how many coins he has “locked away.” Stakers are incentivized via rewards to find new blocks and add transactions on the blockchain.
How does staking work?
When it comes to putting a minimum amount for staking, this depends on the blockchain project. Once the requirements are met, the node stakes the token. The more coins a user stakes, the more transactions he can validate, making them more likely to forge the next block. Once the node creates a block, the user will be rewarded.
To maintain a truly decentralized blockchain in the spirit of DeFi, users who break the rules, such as attempting an attack on the network, will be penalized.
How profitable is staking?
Staking is widely considered one of the best ways to generate passive crypto income if done correctly. Fairly easy to set up as long as you have the tokens; you just need to make sure you hold the crypto in a wallet, with fees being minimum. Furthermore, unlike mining, staking is easier to execute, taking less equipment, energy, and active participation to get started.
With the average annual percentage yield (APY) being around 15%, staking can be profitable if you choose the right projects. What you’re looking for are the highest possible rewards with a growing cryptocurrency. Altcoins with no use case or fundamentals tend to have higher staking rewards, which lures investors in. Unfortunately, though, they also are a lot riskier and can end with a loss, so it’s always important to carefully consider.
The potential risks of staking crypto
Staking is relatively safe if done properly with the right staking provider. But in general, cryptocurrency market can be risky, so in the same way, there are some similar risks:
- The decline in market value — The cryptocurrency you are staking could decline in value, sometimes even drastically. Oftentimes, this the biggest risk an investor can face, particularly with smaller altcoins. An investor earning a 20% APY is still left with a net loss of 20% if the crypto asset declines by 50%, which is why we do not recommend to stake blindly.
- Liquidity — When trading a small or micro-cap crypto with very low liquidity, it is hard for investors to find a buyer of the asset. Similarly, staking these altcoins, investors may find it challenging to convert their rewards.
- Lockup period — Some blockchains do not let users access their funds for a certain period of time after they’ve staked them. Therefore, if the price of the crypto assets drops, you cannot un-stake.
- Rewards duration — Some cryptocurrencies take more time to distribute rewards, sometimes even weeks. Long-term investors will not be affected, but those who are looking for short-term gains may find it quite annoying.
When it comes to staking rewards, unfortunately, Uncle Sam wants a piece of those rewards as well. Similar to crypto mining, staking is taxed as income. Your staking rewards will be subject to income tax per cost basis.
We all want to enjoy the fruits of passive income. Today, more and more investors are looking to add some crypto to their portfolio. This is where staking can play a big part in compounding your crypto.
If you decide to invest in crypto and make more money with your cryptocurrency, staking is the way to go. As long as you do it right. RockX can help you boost your profits by helping you stake your tokens the right way.