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Three Ways of Staking Crypto for Generating Passive Income

PoS staking x DeFi Staking

What is staking?

According to the Oxford Dictionary, “stake” has two meanings:

  • To “support (a plant) with a stake or stakes”;
  • To “gamble (money or something else of value) on the outcome of a game or race.”

Staking in crypto has a little bit of the two definitions above. When you stake, you are

  • locking your assets into a blockchain or a DeFi protocol to support it;
  • investing in a project you believe will succeed in the long-term.

What is staking in crypto?

“Staking” is an often overused word in crypto.

A simple definition of staking would be: lock your coins, get more coins.

However, things are not always that simple in crypto. There are multiple ways to stake in DeFi, with pros and cons.

Let’s check them.

Proof of Staking (PoS) in a nutshell

Have you ever heard about Proof of Staking (PoS)?

It’s a consensus mechanism used by some blockchains, such as Avalanche, Polkadot, and Solana. Ethereum will also become a PoS chain after the Merge.

The “consensus mechanism” is how blockchain computers validate transactions and keep the network running.

Blockchains are permissionless, so anyone can use a computer to join the network as a validator and start validating transactions. In the PoS mechanism, the validator will also have to “stake” a considerable amount of the token to become a validator.

To summarize, the more tokens a validator stake in the blockchain, the more transactions it validates.

For every block of transactions validated, the validator will receive some tokens as a financial incentive, such as AVAX, DOT, or SOL.

1) Staking in a blockchain

The cool thing about PoS is that you don’t need to be a validator to get the benefits of staking.

PoS lets normal users delegate their funds to validators, which benefits both parties.

  • The validator will get a bigger staking bag and a small fee for the validator yield;
  • The delegator will get the yield on their assets.

Most crypto networks will offer you an easy way to delegate your tokens through your crypto wallet.

Benefits of Staking in a Blockchain

  • Low-risk. Your tokens will be staked “directly” into the blockchain.
  • Easy way to generate passive income. You’ll only need a wallet.

Disadvantages of Staking in a Blockchain

  • Locked liquidity. Your money will be locked up during the staking period.
  • Lockup period: most blockchains have a long window to unstake your coins — generally more than two weeks.
  • Slashing risk: the main risk is delegating your coins to a bad validator. In that case, you may lose some part of the yield. Always look for reputable validators!

2) Staking using DeFi

To make things clear: staking in a blockchain is not DeFi.

You are not using any DeFi app, but interacting directly with the blockchain.

As we just mentioned, the drawbacks of staking directly on a blockchain are 1) locking your liquidity and 2) the lockup period.

For this reason, some DeFi apps allow users to delegate the tokens while maintaining liquidity and avoiding the lockup period.

How do they do that?

Protocols such as Lido, RocketPool, and Acala will give you a “staked-token” back in your crypto wallet when you stake through their services.

You can use this token to get more yield on other DeFi protocols or exchange them for other assets.

In other words, you are still liquid.

The staked-token can be redeemed by the actual tokens at any moment, avoiding lockup periods.

Benefits of Staking Using DeFi

  • Liquidity: You’ll get “staked tokens”, which can be used to generate yield in other DeFi protocols.
  • No lockup period: you can always redeem your staked tokens by the actual tokens

Disadvantages of Staking in a Blockchain Using DeFi

  • Smart Contract risks: smart contracts can be hacked or suffer an attack from a bug, even after being audited. So using those protocols is generally riskier than staking directly on the blockchain.
  • Price risk: staked tokens can devaluate, impeding arbitrage and risk-free market-making.

3) Staking in a DeFi protocol

Staking in DeFi means “locking” your tokens in the smart contracts of a DeFi project.

In this case, you’re not delegating your tokens to a validator on a blockchain. You are “removing” your tokens from the market and locking them into a smart contract.

Most DeFi protocols use staking as a mechanism to incentivize the HODLing of the token.

  • HODLing is important because people are “not selling” the coin, thus generating less sell pressure and keeping token prices up. 📈
  • Some protocols use staking to ensure they have liquidity in case of a Shortfall Event. See AAVE.

As a reward for your staked tokens, protocols will give you more tokens.

Most of the protocols have some kind of “time-locking” mechanism. The longer you stake the token, the better the yield.

Generally speaking, DeFi protocols will offer HODLers governance rights over the DAO. This might be interesting if you want to vote on proposals and help decide the project’s future. This is the case for Sushi, Uniswap, AAVE, among others.

Some projects will also let you vote on which liquidity pools should have more reward tokens. This is the case for Curve.

Benefits of DeFi Staking

  • Easy way to get more tokens from a project you believe;
  • Liquidity: some protocols will give you a staked token back, which can be used in DeFi;

Disadvantages of Staking in a Blockchain Using DeFi

  • Smart Contract risk: DeFi is risky, and even huge projects can get hacked. Take care.
  • Not always sustainable: you better always look for projects with high credibility, otherwise your tokens can devalue in the long-term - and the staking will be useless.

Final Remarks

We saw that staking has multiple meanings in crypto.

You can stake 1) in a blockchain, 2) through DeFi, or 3) in a DeFi protocol.

Staking is one of the most powerful ways of generating income in your preferred asset and is generally a better option than just letting your tokens idle in a wallet.

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Bullish on DeFi? Follow OptyFi on Twitter to get access to more DeFi=related content. See you!

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Thiago Zygband

Thiago Zygband

Crypto Content Writer and Community Manager. Find me on Twitter: https://twitter.com/zygbaeth