What is crypto staking?

Crypto staking is the process of locking up crypto assets in order to earn rewards in the form of more crypto. It is the primary mechanism employed by certain proof-of-stake (PoS) blockchains, such as Ethereum, to validate crypto transactions. It is similar to the mining process used by proof-of-work (PoS) blockchains, such as Bitcoin. Also, many think the PoS mechanism is a much more energy-efficient and sustainable validation process. However, just like most crypto-based investment strategies, staking comes with inherent risks such as market volatility, lock-up periods that limit liquidity, and potential losses from technical vulnerabilities or protocol changes.

In this article, we take a look at what proof-of-stake blockchains are, how crypto users actually earn money through crypto staking, the risks involved, and why it is considered a more sustainable option than mining.

What are proof-of-stake blockchains?

Proof-of-stake (PoS) blockchains are a type of blockchain network that employ a validation mechanism called proof-of-stake. Some examples include Ethereum (ETH), Cardano (ADA), Polkadot (DOT), Solana (SOL) and Tezos (XTZ). PoS blockchains aim to provide a more efficient, scalable and environmentally sustainable solution compared to other mechanisms such as proof-of-work (PoW), used by Bitcoin, for example. 

In PoS blockchains, participants (also known as validators) validate new blocks of transactions based on the amount of cryptocurrency they hold and are willing to “stake” as collateral. They are then rewarded for their work and staking with more cryptocurrency. The more a validator stakes, the higher the chance of being selected to validate the next block and thus earn rewards. However, they are only rewarded if their work is accurate. If they attempt malicious behavior or fail to validate correctly, they can be penalized by losing a portion of their staked assets.

How much can you earn through crypto staking?

The amount you can earn through crypto staking depends on several factors, such as the cryptocurrency you stake, the platform you use, and the total number of participants. For example, Ethereum, Cardano, and Polkadot often offer annual rewards of between 5% and 20%. But these rates are not set in stone, and fluctuate based on how many people are staking and the total rewards available. Generally speaking, the more people staking their coins, the lower the individual reward, as the fixed reward pool is spread among a larger group. Some platforms take a portion of these rewards as fees, while others pass the entire amount on to users. 

What risks are involved in crypto staking?

While crypto staking offers users the chance to earn more cryptocurrency, it also comes with inherent risks that potential validators need to be aware of. One of the main risks is regulatory uncertainty, as evidenced when the Securities and Exchange Commission (SEC) took action against the crypto exchange Kraken for unregistered staking services. The volatility of the crypto market also means that while staking can prove lucrative if the staked cryptocurrency suddenly drops in value, the validator may face significant financial losses as their assets lose liquidity in the staking process. 

Once staked, crypto assets are locked up in the staking process, making it riskier during periods of greater volatility. Security risks, such as hacking also remain a concern, even for well-established platforms. In an attempt to mitigate this risk, some validators choose to stake their tokens using hardware wallets (offline and unhackable), although it can make the crypto staking process more complicated. 

Why is crypto staking considered sustainable?

Crypto staking is often praised as being a more sustainable validation method to other crypto mining strategies that rely on the proof-of-work (PoW) mechanism. PoW, used by networks such as Bitcoin, requires substantial computational resources to solve complex mathematical problems. According to the U.S. Energy Information Administration, cryptocurrency mining probably represents from 0.6% to 2.3% of U.S. electricity consumption. 

Comparatively, data from the Cambridge Centre for Alternative Finance suggests that Ethereum represents 0.005% of the power demand of Bitcoin, largely due to its different consensus mechanism. Studies are ongoing to determine the overall impact of the crypto industry on the energy system, while many companies in the industry are actively looking for more sustainable ways to power their operations, such as relocating their facilities to gain closer access to renewable energy sources.

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