While staking might be a relatively new addition to the financial lexicon, it is important for people interested in cryptocurrency to understand what it is and its different types.
Staking has emerged as a great way of earning a passive income using cryptocurrency without having to trade or mine.
When you stake a cryptocurrency, you essentially lock up your coins to contribute to the blockchain network. Essentially, token holders are using their cryptocurrency as part of the validation process for a blockchain and are being rewarded by the network for helping secure it.
Whenever a block is added to the blockchain, new crypto coins are created and distributed to the block verifiers’ stake rewards according to the size of their holdings.
There are different types of staking, each with its benefits and drawbacks, so let’s check them out!
Different Types of Proof of Stake Consensus Algorithm
First, let’s look at different types of Proof-of-Stake consensus mechanisms designed to address the inefficiencies of the Proof-of-Work (PoW) protocols. Instead of using crypto mining, PoS blockchains rely on nodes selected based on their stake of platform tokens to verify and record transactions.
PoS is the most popular type of staking used by crypto projects to achieve distributed consensus. In a PoS system, users stake their coins to validate transactions and secure the network. The more coins a validator stakes, the more likely they are to be chosen to validate a transaction and create new blocks. In return for their efforts, the validators are rewarded with a portion of the transaction fees and newly minted coins.
The PoS algorithm has been adopted by many cryptocurrency networks, including Ethereum (ETH), Cardano (ADA), and Tezos (XTZ).
To incentivize responsible behavior, blockchains punish validators if they do not perform proper validations, reducing the value of their staked coins and rewards.
Delegated Proof of Stake (DPoS)
Used by some blockchain platforms, including EOS, Tron, and BitShares, in DPoS, token holders vote for the production of new blocks to a fixed number of delegates. For this, it uses a democratic voting mechanism in which votes are weighted by the amount of tokens locked up in a platform. Because it uses stake-weighted voting, delegation, and a very low threshold to participate in the DPoS voting process, it is considered more dramatic than traditional PoS protocols.
Leased Proof-of-Stake (LPoS)
LPoS is a consensus algorithm where a leasing mechanism allows users to “lease” their staking power to a node that intends to act as a network block producer. The more tokens a node has staked, the more chances it is being chosen to generate the next block and receive the rewards. Smaller token holders can pool their assets and increase their chances of receiving a share of the network’s transaction fees.
Hybrid Proof-of-Stake (HPoS)
Now, some projects like Dash and Decred use a hybrid PoW-and-PoS consensus mechanism and power on-chain operations. In most cases, these protocols rely on PoW miners to generate new blocks and then pass them on to PoS validators, which vote on whether to confirm the blocks and record them to the blockchain.
Different Types of Staking
Crypto staking allows you to earn interest on your cryptocurrency holdings. By holding your cryptocurrencies in a staking wallet, you can earn staking rewards, usually in the form of native tokens.
Hot staking involves using a hot wallet, which is always connected to the internet, to stake. Cold staking, meanwhile, consists in storing your crypto holdings offline in a hardware wallet. This way, you can protect your holdings with an additional layer of security. It is safer than staking in a hot wallet as tokens are not susceptible to online attacks while held in a cold or offline wallet.
Now, there are different ways you can perform staking. Let’s take a look!
Becoming a Validator to Stake
Under PoS, you can directly stake your coins by becoming a validator. This requires highly technical knowledge of crypto and the blockchain, a dedicated computer connected to the internet 24/7, and a large amount of crypto to be effective. To become a validator on Ethereum, users must stake 32 ETH.
Validators are assigned to produce blocks and are accountable for double-checking and confirming any blocks they do not make. This method exposes you to the risk of being slashed (losing a portion of your stake) if you violate the system’s rules.
Delegate your Stake
If you don’t want to run a node yourself, you can go for delegated staking, where you lock up crypto funds with a recognized validator and reap the rewards minus a small percentage of your yield as fees. You delegate the hard part while you earn block rewards.
For instance, in the case of ETH, anyone with 32 ETH who doesn’t want to run a node can delegate node operations to a third-party operator.
Delegating your stake to a validator is a much simpler and less risky way to participate in a PoS system. When you delegate your stake, you essentially entrust it to a third party, who will then use it to help validate transactions and secure the network. The rewards associated with delegating your stake are typically lower than those associated with running a validator node, but the risks and reward amounts are also lower.
Another option when you do not have time or resources to become a validator yourself is using pooled staking. Here, you delegate your tokens to another pool operator and let them make a bet in your name.
Pooled staking is a process where multiple individuals with smaller amounts of crypto pool their resources together to increase their chances of winning a reward. This option has low barriers to entry, and many staking pools offer liquid tokens.
With staking becoming immensely popular, many protocols, like Lido, Rocket Pool, and Stakewise, have emerged as a solution to the problem of locking your coins. In Liquid Staking, also known as “soft staking,” you lock up funds to earn rewards but still have access to your funds.
In this type of staking, a liquid staking provider takes token deposits, stakes those tokens, and gives the depositor a token equivalent to the amount deposited, redeemable for the staked tokens.
For instance, when staking ETH with Lido, users receive stETH tokens which are issued 1:1 to their initial stake. These stETH tokens are minted upon deposit and burned when redeemed. stETH can be used like regular ETH, and stETH balances are updated to reflect your ETH staking rewards minus any penalties.
There are many benefits to liquid staking, such as no lock-ups or minimum deposits, receiving staking rewards in real-time, and the ability to use staked tokens across the DeFi ecosystem to compound rewards.
Using CEXs to Stake
With the increasing popularity of staking, more exchanges are offering staking services. This means you can now stake your cryptocurrencies on several centralized crypto exchanges (CEX) such as Binance, Coinbase, and many others.
To use CEXs to stake, use the platform as your wallet to hold your coins. This is the most straightforward method, but it does have some drawbacks. For one, you are trusting the CEX to keep your coins safe. If the CEX were to be hacked or otherwise go out of business, you could lose your coins.
Whether or not using a CEX to stake is a good idea depends on your circumstances and preferences. If you are comfortable with the risks, then using a CEX can be a convenient way to stake your coins.
Staking is about allowing more individuals to participate in a decentralized, trustless process that will enable blockchains to work. It is committing one’s cryptocurrency assets to back a blockchain network and validate transactions.
The future of crypto staking looks bright. With the increasing popularity of cryptocurrencies, more and more people are looking for ways to earn crypto. Staking is one of the simplest and most effective ways to do this.
As we saw, each staking type has its benefits and drawbacks, so choosing the right kind of staking for your needs is important.
So what are you waiting for? Start staking your cryptocurrencies today and start earning rewards!