Staking 101: Everything you should know
Rewards, Risks, behind the scene, and more.
This is a continuation of last week’s “Proof of Stake” issue. To make the most out of this article, I strongly recommend you clicking here and giving it a read for further context.
I explained the main differences between Proof of Work (PoW) and Proof of Stake (PoS), how this latter functions, and why it is generally considered a better mechanism due to more efficient energy usage, operational scalability, lower entry barrier, among others.
In terms of results, the easiest way to think about “Staking” as a user is to imagine it as a fixed deposit in the bank, where you lock in a certain amount of funds for a period of time, and in return, you receive a predetermined commission.
In crypto, it works in a similar way. You can choose to lock in your coins for a fixed timeline, and in exchange, you are rewarded with an interest rate paid out in the same coins. Now, the magic combo that makes this so attractive is:
The
interest rate is much higherthan what we would normally have access to with any traditional financial institution, with double digits APY being very common.The
lock-in period is much shortercompared to again, any traditional financial system. It is normal to be only a few weeks or months.
For example: below is a screenshot where you can see the cryptocurrencies, the APY%, and the lock-in days required. There are options for as short as 15 days lock-in, and there are cases for as high as almost 40% APY.
Even DOT, a top 10 cryptocurrency by market cap, offers 11%+ APY for 30 days staking. Try getting half of this from a bank.
Too good to be true?
Good observation.
It is always important to know where we are putting our money, and what the risks are, so that we can make educated and informed decisions.
Now, let me refresh a few key things about Staking:
“Staking” is fundamental to the security and functioning of PoS Blockchains. The action itself refers to locking a certain amount of coins from a particular blockchain to gain access and gain the right to create blocks and validate transactions.
These coins that are staked are part of the collateral to incentivize positive behavior from the miners, therefore contributing to the security of the network.
In exchange, these validators will receive rewards paid out in the same cryptocurrency.
The amount of Stake, hardware/software requirements, the Timeline, and the Rewards will vary from blockchain to blockchain.
For example, Ethereum 2.0 requires a minimum of 32 ETH, with an undefined lock-in timeline due to network upgrades, and a current APR of 5.7%.
“Delegated Proof of Stake”
If you are a common user like me, you might find all these too expensive, too technical, and too long of a lock-in period. And you are right.
Enters, “Delegated Proof of Stake”.
Basically, you provide some coins to a “Staking Pool” for an amount of time, and people running this pool will do the entire behind the scene work, collating liquidity from a bunch of other people that would also like to gain some rewards.
This way,you get the best of both worlds:you can delegate and forget about the technicalities and responsibilities that come with Staking, and still receive the rewards.
What do Staking Pool organizers get?
They leverage your liquidity, to gain shared rewards.
I already explained that in order to become a validator in the blockchain, miners need to “stake” a certain amount of coins. In the case of Ethereum 2.0, it’s a minimum of 32 ETH. At the time I’m writing, 1 ETH is around $3,5000, which means you need at least $112,000 just to get your foot in the door.
So long story short, not everyone has that amount of money. What they do then, is to create a pool where they can collect coins from people who don’t want to do the hard work, but are happy to contribute with their liquidity in exchange for shared rewards. It’s a win-win.
What cryptocurrencies can you stake?
If you read till here, you probably understood that Staking comes from “Proof of Stake” which is a particular way a blockchain network is run.
By definition then, you are able to stake those cryptocurrencies that are built on a Proof of Stake blockchain. Take a look at Binance Staking Pool here for a list of examples.
Where can you stake?
There are increasingly more platforms to stake cryptocurrencies, if you google it there are plenty of options.
They all have different pros and cons, and it really will depend on what you prioritize. I personally find that the most straightforward and convenient way to do this is directly in the different exchange platforms, such as Binance or Coinbaise. These are some of the biggest and most well-known exchange platforms, so chances are it’s more secure, and it might have enlisted more coins as well.
There are some downsides as well, such as centralization, and probably not the highest returns.
Again, it really depends on you, but there are some call outs I’d like to highlight below.
What are the main risks and/or common mistakes?
Don’t get tempted with high APY%: Crypto is very volatile, so understand what you are staking and be mindful of the high speculation risk. If you are staking at a 30% APY, but during this period the coin loses 50% of the value, then even though the number of coins you own will increase, the net balance of its value will obviously decrease.
Liquidity risk: you won’t have access to it during your lock-in period. Some platforms will allow you to unlock your stake, but that means you will also lose your reward.
Understand how your Reward is calculated: for example, I see a lot of people get confused with APY, which means “annual percentage yield”. So if you are staking $1,000 for 1 month at a 15% APY, this doesn’t mean that your reward is $150 (15% of $1,000) by the end of that month. $150 is APY which is annual, so divided by 12 months, your monthly reward is $12.5~.
Watch out where you are staking: Always remember, “not your keys not your coins”. If you are delegating your coins to someone else, make sure that someone else is trustworthy.
Network attack: just as a bank can be robbed, a staking platform can also suffer attacks. Like I said in the previous point, do your research and choose a platform that is well known and has a robust security system. Better safe than sorry.
Is Staking different from Defi or lending?
YES! The output is very similar, meaning you put in some money for a period of time, and in exchange, you get rewarded with a commission or reward.
However, the reason why I’m highlighting this is that there are some fundamental differences that are important to understand, mainly:
Where the interest rate comes from
What is your money being used for
What the risks are
This last point is very important, because typically for Defi it is a bit more complex and risky. There are various names being used for all these products across different platforms, and it can get quite confusing.
In the future, I’ll cover Defi and key concepts and products within the Defi world. For today’s purposes, as a rule of thumb, know that you are only really staking when the product is strictly named “Staking”, such as “Binance Staking”. All other options, such as “crypto earn”, “liquidity pool”, and even “Binance DEFI Staking” are all different offerings. Even though the output is similar, what happens behind the scene is different, ergo the risks and rules might differ.
I personally think Staking is a great opportunity. If you already hold some coins that are from a PoS blockchain, you might as well gain some good rewards from them.
At the same time, this is definitely a more balanced and conservative approach for making money in crypto that offers a much higher reward than traditional ways. So if you are looking to diversify your portfolio overall but want to minimize both the risk and volatility of the crypto world, you should look into Staking!