Crypto 101: Staking Pools
If you’re new to crypto you’ve probably seen staking options everywhere. What does it mean, how does it work and what are the risks?
As a new entrepreneur, you need a stake in the game, but you can’t risk it all — Alexa Van Tobel
Bottom Line Up Front (aka TL;DR)
- Staking crypto generally refers to locking tokens for a reward
- Staking rewards are not huge and there are risks involved
- Staking can be an effective strategy to earn income
- Best practice is to start simple and stay safe
What does it mean to stake crypto assets?
In the broadest sense, when you stake crypto, you are creating a smart-contract that generates rewards for the use of your tokens. There are three common ways you can stake tokens for a reward:
- Consensus (validator) staking
- Providing liquidity
Each has its unique features and requirements. They also have a wide range of risks and rewards. Some require a high level of knowledge to do safely. Others can be quite simple.
For this article, we will focus solely on consensus (validator) staking.
The major blockchains typically use two mechanisms for validating transaction authenticity: proof of work (PoW) and proof of stake (PoS).
Bitcoin and Ethereum (currently) use a proof of work model. This means a network operator, commonly referred to as a “miner”, will compete with other miners to correctly solve a highly complex mathematical equation.
Thus, the miner must work to prove their solution to the equation is correct. This gives the miner the right to add a new block to the blockchain. The reward the miner receives for creating a block is a newly minted Bitcoin or Ether.
With proof of stake, a validator has to prove they are trustworthy by staking (locking) tokens to operate a validator node. As transactions are sent to the network, validators verify whether or not a transaction is authentic and in what order it occurred.
If a certain threshold of validators (usually two-thirds) agree, then the system has achieved consensus on the state of the network. How validators are selected to add blocks varies by consensus mechanism. This article provides a good overview.
Delegated proof of stake
In order to ensure validators are operating honestly, blockchain networks usually require a large stake of tokens to participate. If a validator tries to cheat, the penalty is the loss of some or all of the tokens the validator has staked.
The trouble is, this limits validator nodes to entities with lots of money. One way around this is to allow the validator to pool tokens from a lot of people and then delegate the rewards to each contributor. This helps increase the number of validators that are able to participate in the network.
This is also where you, as a token holder, can receive rewards from consensus staking. Almost all of the major PoS networks like NEAR, Terra, Avalanche, Fantom and (soon) Ethereum provide users a way to stake tokens with validators.
Validator staking for rewards
While they vary on the details, the basics are generally the same. First, you must buy the native chain token (e.g., LUNA for Terra, MATIC for Polygon, FTM for Fantom, etc.).
Once you have purchased the token, you will likely have to send it to a chain native wallet (e.g., Terra Station, Polygon Wallet, Fantom Wallet, etc.). Here is an example from Fantom:
Creating a wallet is pretty straightforward. Much like creating a MetaMask or Trust Wallet account, you will either download or bookmark the chain native wallet, generate a seed phrase and a password and then you should be ready to go.
And as always, be sure to store your seed phrase and password in a safe place. Never share your password or seed phrase with anyone you don’t trust (and even then, think twice!).
On the left-hand side of the image above, you can see there is a link for staking. To begin staking, simply click that link. This will take you to a screen that looks like this:
From there, you will select “Add Delegation.” This will take you to this screen:
Select the pulldown menu that says, “Select a Validator”, which will bring up a list that looks like this:
From this list you will need to select a validator. There is no hard-set rule on what you should look for in a validator. There can be a few variables depending on the network you’re staking on.
Some general things you want to look for are:
- The level of self-delegation (how much “skin” the validator has in the game)
- The uptime of the server (higher % uptime = better / safer)
- The reputation of the validator (check Discord / Telegram / Reddit / Website)
- The fees the validator charges (lower doesn’t always = better)
Fantom is nice because the Fantom Foundation runs their own validators. While they may not pay the absolute highest rewards, staking with them certainly reduces the homework you’ll have to do.
Once you select a validator, you will enter the amount of tokens you want to stake and (in this case) click continue. This will take you to this screen:
If your wallet requires a password or other security measure, you will likely have to input that here. Once done, select “Delegate” and you should be on your way.
Generally speaking, the risks of validator staking are pretty low. Provided you have found a reputable validator with high uptime, you likely won’t run into any issues.
However, if the validator node goes down (loss of power, hardware failure, etc.) a portion of your delegated stake may be slashed (taken from you). Typically those losses will be very small (e.g., 0.1%).
A more serious slash risk you may face is from double-signing. The penalty for double signing is much higher (e.g., 5%). The way this most commonly happens is if a validator goes down, but then has an automated backup node come online at an inopportune time.
There is also a very small (but very serious) risk of delegating to a malicious validator. While highly unlikely, it is still a remote possibility. A malicious operator would likely receive a 100% slash, so it pays to do a little research before you commit a large number of tokens to a validator.
Best practice is to only select validators with a good reputation and spread your stakes across different validators.
Lastly, you must be aware that some validators have an unlock period that can range from a few hours to several weeks. For instance, NEAR has a 56-hour unlock period, while Terra Station will lock your stake for 21 days.
As crypto markets can move very fast, you run the risk of a token going up significantly in value, but then not being able to sell it because the token is locked.
If you’re holding for the long-haul, this shouldn’t be too big of an issue. But it might be worth it to keep some in your wallet in case you want to sell at an opportune time. This is especially true for tokens with very long lock periods.
Staking benefits and rewards
Just know, you probably won’t get rich from staking your tokens. Some networks will pay rewards in tokens other than the one you’re staking (e.g, stake Terra LUNA, receive UST). Others, like Fantom, pay directly in the native token (stake FTM, receive FTM).
Third party staking services have sprung up in recent years. Some will auto-compound your earnings to increase your annual yield. Many offer the ability to immediately unlock your tokens.
Others will allow you to generate a different token you can use or trade in place of your staked token. While these services are beyond the scope of this article, it is important to recognise that using them increases a number of risks. In other words, they should be used with caution.
Regardless of where you decide to stake, you will probably earn somewhere between 5–10% annual percentage rate for consensus staking tokens. If you’re planning on long hodling the token anyway, this can be a great way to earn a little passive income and increase your holdings.
But if you’re short-trading the token, or only bought it hoping for a quick price pump, staking may not be the best option. Moreover, some tokens like FTM have really well developed DeFi protocols on chain and some may offer significantly higher APRs for lending or providing liquidity.
Of course, those protocols will also come with substantially higher risks. If you’re new to crypto, it’s probably best to avoid those at first. If you do decide to start experimenting, best practice is to only use small amounts and do a lot of research first.
Once you understand how the protocols work and you fully understand the risks, it can be beneficial to explore some of those options. Just be really careful though. There is no shortage of people that have been burned, or lost a lot of money gambling on those high-risk protocols.
Consensus staking major chain tokens can be a great way to earn passive income. While there are more risks involved than simply holding a token in your wallet, you can also increase the size of your holdings relatively safely.
If you’re really bullish on a particular token and plan on hodling for a long time, consensus staking might be a good choice. If you’re planning on trading often or using the token for other income generating strategies, consensus staking may not be the right way to go.
Whatever you decide to do, please be sure you do so responsibly. Never commit more than you can afford to lose and be sure to do your research and due diligence first.
As for me, I tend to use a mix of strategies, just depending on my time horizon. I staked LUNA for a while, but really started to sweat it when the price doubled and I was locked for 21 days!
Others, like AQUA on Planet Finance and FXS on Frax Finance will probably stay locked for years while I earn rewards. I used to stake all my FTM, but found it a lot more fun to goof around with DeFi.
I’m still super bullish on FTM but now I put it to use with other protocols. Obviously I can’t tell you what’s best for you, but if you’ve been wondering about staking, I hope this article helped!
Of course, these are just my opinions. I’m not a financial advisor, this isn’t financial advice, and always DYOR. Following any of these ideas might cause you to lose all of your money. I am 100% serious about that. I like tinkering with this stuff, but I’m on record acting like a total baboon. Invest accordingly.
Until next time, be safe, be smart and be sure to tie the camel.