Make your crypto work for you with Staking
Last week we covered how anyone could get started receiving at least a portion of their salary in crypto. Basically, that is just one other way to get active income. This week we will cover how to generate passive income with crypto by staking.
Passive income is income not generated by working or service provision, but by your assets working for you. One way to receive passive income in crypto would be to simply buy and hold, hoping that the price goes up enough to make some profit.
However, that’s not the most efficient way when you want to have a steady supply of income. Please note that, while you might receive the same amount of tokens when staking each month, the real-world value in Fiat can fluctuate.
But first and foremost, what is Staking?
What is Staking?
When bitcoin was created, it achieved one remarkable thing. The decentralized technology made it possible for 2 parties to interact with each other without having to trust each other. This was achieved by a consensus algorithm known as Proof-of-Work.
To put it simply, Proof-of-Work relies on computers solving a puzzle to verify transactions. Unfortunately, a lot of computational power goes into the process explaining why there is often outrage about the terrific effect of Bitcoin on the environment. (This is a topic for itself, so we won’t get into the details, but there are several sides to the argument). Additionally, Proof of Work isn’t as scalable which is one of the reasons developers started looking into different consensus mechanisms.
Proof of Stake is one of the most promising when it comes to scalability, high transaction speed and using energy more efficiently. In Proof of Stake networks, everyone that has a stake in the network gets to validate transactions on the network. This works because we assume that someone who holds a share in the network won’t be interested in manipulating it. Usually, the more coins a participant holds, the higher the chance that he gets to validate transactions. To reward nodes for confirming transactions, they receive staking rewards. Staking itself is similar to buy and hold, with the only difference being that you actively participate in transaction validation, which occasionally requires running a node or holding a minimum balance.
How does the process look like?
Once a node in the network holds the minimum balance it will deposit its coins into the network as a stake.
The size of the stake is proportional to the chance of being chosen as the validator for the next block. This means the more coins a node owns, the higher the chance of making money through staking. Once a node creates a block, it receives the staking reward. If the validator tried to manipulate or attack the network its stake would be confiscated to discourage malicious players.
Some Blockchain networks don’t rely on every stakeholder to participate in the validation process but use an algorithm known as delegated Proof of Stake (dPoS). In these networks, participants holding coins can delegate their “power” to nodes they trust. The blockchain is handled by these delegates rather than by every single stakeholder. These delegates play a crucial role not only in consensus building but also in decision making.
Staking rewards are also called “inflation rate” or community rewards by a handful of projects depending on which aspect they want to highlight.
Reading that the more stake you have, the better your chances, you might have thought: “What’s the point for a little trader like me then?”.
If that’s you, it might be worth having a look into Staking Pools. Remember how in the early days of Bitcoin, anyone could mine with just their normal PC? With wider adoption, this got harder and led to the emergence of mining pools that accumulate the energy provided by many. Similarly, Staking pools have evolved that bundle the staking power of all their members to increase their chances of validating new blocks and receiving the reward. In return for providing your stake, you’ll receive a proportion of the rewards earned. Since Staking pools incur costs to keep their infrastructure going, they will usually charge some kind of membership fee.
If you see staking just as a process to make more money, you might be mistaken. Many blockchain protocols combine staking with governance. Putting it simply, governance is a structure that every participant of the network agrees to follow. In a sense, this is similar to political systems across the world in which we all get a vote — at least in democratic countries. On PoS blockchains, staking is more than just validating transactions.
In several blockchain networks, nodes can actually vote on decisions ranging from which PR agency to chose to technical upgrades. In pure PoS blockchains, every node gets a vote while in dPoS these votes are delegated to the masternodes.
Without getting too deep into the blockchain governance details, the main driver behind blockchain governance is the idea that participants in the blockchain have an interest in keeping it afloat and won’t make decisions that in the short-term are beneficial but would hurt the network in the long run.
When staking on a blockchain that lets participants vote on decisions, be mindful of the responsibility that it brings with it and not just the short-term gains.
To round it up, here just a few examples of cryptocurrencies that can be staked and the requirements.
ETH 2.0: Since making the switch from PoW to PoS last year with the Caspar upgrade you can stake on Ethereum. Anyone with a minimum of 32 ETH running an ETH main net client can get started. As the current price of ETH hovers around $1800 the start capital required would amount to $57,600 not including setting up a node. In this case, looking into a service provider or a staking pool to get involved could be a more sensible choice.
Tezos: After a lot of turmoil following their ICO, Tezos has launched their long-awaited platform with their own version of PoS, the so-called liquid PoS. Staking in Tezos is referred to as “baking” and validating nodes are consequently called bakers. To bake on Tezos one needs 8000 Tezos ($32,000 at current market price) and run a full node. Alternatively, interested traders can use a service offering small holders to pool their investments similarly to a staking pool and share the baking rewards.
Algorand: Algorand is yet another Proof of Stake network that allows network participants to earn crypto from staking rewards. However, this does require running a full node on the blockchain as well. Nevertheless, several service providers support ALGO delegation, meaning you delegate your stake to a third-party that pools it and pays you the rewards made from staking. Rewards can range from 5% — 10% APR.
Please note, these are just 3 examples of staking blockchains. There are many more out there as a simple Google search will reveal.
All in all, when investing in a cryptocurrency running on PoS, it’s worthwhile to consider putting part of your holdings aside to stake. Depending on the blockchain chosen, staking can involve a lot more than mere transaction validation including decision making power in regards to technical upgrades. As always, it pays off to do your own research. Once you know what staking involves and what the benefits are for you, happy staking.
Not financial advice😉