Understanding staking in cryptocurrency: A guide to passive income
What is cryptocurrency staking?
Crypto staking is the practice of locking your digital tokens to a blockchain network in order to earn rewards—usually a percentage of the tokens staked. Staking cryptocurrency is also how token holders earn the right to participate in proof-of-stake blockchains.
Here’s a simple example: Suppose a blockchain network offers a 5% reward for a staking period of, say, a month. You decide to lock up and stake 100 tokens in the network. After a month, you’re able to access your staked tokens and you receive 5 additional tokens as your reward.
How many ways can crypto investors stake their tokens?
Cryptocurrency staking can take many forms, but it generally falls into two categories: active and passive.
- Active crypto staking means locking your tokens to a network for the purpose of actively participating in the network. Active participants may validate transactions and create new blocks to earn token rewards.
- Passive crypto staking involves simply locking your tokens to a blockchain network to help keep it secure and operating efficiently. Passively staking crypto is not time-consuming, but it generally yields lower token rewards than active participation.
Cryptocurrency staking is a relatively new innovation, but many specialized types of crypto staking already exist, including:
- Delegated staking. This form of staking enables crypto stakers to delegate their staking power to a validator node operated by someone else. The rewards earned are shared among validators and delegators. (Note: If these terms are confusing to you, watch the blockchain video below).
- Pool staking. A group of coin holders may combine their resources to compete more effectively for staking rewards. Any rewards earned are shared proportionally among the members of the pool.
- Exchange staking. Some cryptocurrency exchanges offer staking services, enabling users to stake their holdings directly on an exchange. The exchange handles the staking process on a blockchain network and distributes staking rewards to participants.
- Liquid staking. Users receive representative tokens in exchange for staking their crypto. The representative tokens can be traded or used, providing liquidity to the crypto staker.
Cryptocurrency staking can also be custodial or noncustodial. Custodial staking requires crypto holders to transfer their tokens to a staking platform, while noncustodial staking lets you keep your staked coins in your own digital wallet.
Cons of crypto staking
Crypto staking comes with risks. There are several drawbacks to cryptocurrency staking:
- Your assets have limited or no liquidity during the staking lockup period.
- Staking rewards (as well as staked tokens) can lose value when prices are volatile.
- Your cryptocurrency can be slashed (partially confiscated) for violating network protocols.
- When many users receive staking rewards, there is risk of cryptocurrency inflation.
- An attack on a blockchain network can impact your staked crypto.
- Cryptocurrency staking is not well regulated.
- Successful staking may require advanced technical knowledge.
Your increased involvement with a staking platform or blockchain network is what makes cryptocurrency staking risky—more risky than simply holding your tokens in a secure digital wallet.
Crypto staking is a way of earning passive income, and it can be seen as the crypto world's equivalent of earning interest or dividends while holding onto your underlying assets.
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