Explainer
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Crypto Staking: What Is Crypto Staking & How Does It Work?

Crypto staking can be an overwhelming subject even for experienced financial planners. Learn about what it is and how it works here.

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Key Takeaways:
  • There are two primary ways of staking crypto, dApp (decentralized app) staking and PoS (proof-of-stake) staking.
  • In the dApp ecosystem, staking is the passive income provided by a particular protocol to users that lock their assets into smart contracts.
  • PoS or Proof-of-Stake style staking is when tokens are staked to a validator on the network that is responsible for maintaining chain security.
  • The risks of staking crypto can broadly be split into three primary categories: security, smart contract, and market risks, with each having a potential impact on the returns generated by staking crypto.

Cryptocurrency can be an overwhelming subject even for experienced financial planners. As soon as you get a good handle on the latest developments, another innovation comes along. 

Luckily you’ve got us to help you stay ahead of the game and use the most cutting-edge methods to your advantage. So let’s find out about crypto staking, shall we? Keep reading if you want to find out what crypto staking is, what are the risks of staking crypto, what are some of the popular staking platforms and more. 

What is crypto staking?

At the simplest level, crypto staking is a kind of investment whereby you can earn passive income by putting your cryptocurrency to work. Essentially, it’s like owning a stake in a company and getting returns when that company makes a profit.

There are two primary ways of staking crypto:

  1. dApp

In the dApp ecosystem, staking is the passive income provided by a particular protocol to users that lock their assets into smart contracts. As the cryptocurrency generates returns, the terms of the smart contract are automatically fulfilled.

  1. PoS

PoS or Proof-of-Stake style staking is when tokens are staked to a validator on the network that is responsible for maintaining chain security. The more tokens that are staked to the validator, the more secure that blockchain is perceived to be and therefore the more valuable.

How does staking crypto work?

Or better yet, how do you make money from staking? The mechanics of this are complicated, but essentially your cryptocurrency enters a pool, kind of like a mutual fund or interest-bearing savings account, where it can be used to generate additional cryptocurrency.

A crypto staking project incentivizes users to lock up tokens in exchange for a yield. Tokenomics of most crypto projects set aside tokens to cater to this yield generation opportunity for users.

dApp staking

Crypto projects that launch their own token incentivize users to stake their tokens for the long term by offering a yield. This yield is baked into the tokenomics and are offered as ecosystem rewards.

PoS staking

Proof-of-Stake chains use validators as markers of authenticity of on-chain data. In order to ensure that the validator secures the chain, an economic incentive is used to encourage users to stake their tokens. The economic incentive received by the validator is split amongst its stakers. The higher the stake per validator, the greater the chance of producing the next block, thereby earning rewards.

What are the risks of staking crypto?

Is staking crypto safe? The risks of staking crypto can broadly be split into three primary categories: security, smart contract, and market risks.

Security risk

This relates to projects not following the appropriate risk measures to secure funds that users have entrusted with them. For PoS chains, security risk also includes the risk of slashing, meaning if a validator does not perform its duty of securing a blockchain, then all tokens staked are liable to be slashed. Hence it is critical to stake your PoS tokens to a trusted validator only.

Smart Contract risk

For dApp staking, users lock up their tokens in a yield-bearing position usually facilitated by a smart contract on a blockchain like Ethereum. If a project has not audited its smart contracts or inadvertently created a contract that can be exploited, then the users’ funds locked in the smart contract are at risk.

Market risk

As with all crypto, the markets are volatile, and the value of the tokens may differ based on external market conditions. Since the yield is generated in the native token, a drop in the token price can impact the user’s position.

When should someone consider staking?

You should consider staking only if:

  1. You believe in the project offering staking. Since staking yield is paid out in the project native token, receiving more tokens of a project you do not believe in is an exercise in futility.
  2. You are aware of the terms of staking. Each staking product differs in terms of lock-up periods, staking yields offered, and tokenomics of the project. A user must take these factors into account before locking up their tokens.

If you are comfortable with a volatile asset class. Cryptocurrency offers the possibility of big rewards but is more volatile than a lot of other markets. Don’t engage in staking crypto if you are highly risk-averse or if you have very limited financial resources.

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