One aspect of crypto that appeals to many investors is a sense of community that is lacking in most TradFi brands. When was the last time someone got excited about Goldman funds or Walmart stock for their brand stories? Exactly.
In crypto, many investors have brand loyalty to different coins and blockchains. In 2014, Ethereum, an extremely popular blockchain, introduced the concept of staking regarding its plans to switch from PoW to PoS via the Ethereum 2.0 upgrade. Since then, crypto analysts have been tracking how staking influences the crypto economy. Before fully understanding the topic, you must have a working knowledge of the basics.
In some ways, you can imagine a blockchain network as a neighborhood. In this neighborhood, each house (a node in the blockchain) is responsible for monitoring suspicious activities to maintain safety and order.
The challenge is it can be difficult to maintain security and agreement as the neighborhood grows. The existing neighborhood watch captains may become overwhelmed. How can residents ensure the integrity of new neighbors?
Staking in crypto is similar to residents committing to participating actively in the neighborhood watch program. By staking their cryptocurrencies, residents say, “I have a stake in this neighborhood and an investment in its safety and well-being.”
The more residents participate and the larger the stake they commit, the more vigilant and secure the neighborhood becomes. This collective vigilance deters bad actors and maintains the neighborhood’s integrity, just as staking in a blockchain network enhances its security and resilience against attacks or fraudulent activities.
Let’s look at how this works for crypto in more detail.
What Problem Does Staking Solve?
One of the primary challenges of cryptocurrencies is validating transactions and ensuring the security and integrity of the blockchain, the underlying technology behind these digital currencies.
Traditionally, this was done through “mining” using Proof of Work (PoW) systems like the original Bitcoin protocol. However, mining has two significant issues: it requires immense computational power and energy, leading to concerns about environmental impact and efficiency.
Proof of Stake (PoS) systems use staking for these problems. Instead of relying on energy-intensive mining operations, staking allows users to participate in transaction validation and network maintenance by “locking up” a certain amount of their cryptocurrency holdings. This process is far less resource-intensive compared to mining.
Key Problems That Staking Solves
The fundamental problems staking helps solve include the following:
Energy Efficiency: Unlike mining, which requires powerful computers running continuously and consuming large amounts of electricity, staking is energy-efficient and more environmentally friendly.
Lower Barrier to Entry: Mining often requires significant investment in specialized hardware, whereas you can conduct your staking with a standard computer and a smaller amount of cryptocurrency.
Network Security: In PoS systems, the more cryptocurrency a person stakes, the higher one’s chances of being chosen to validate transactions, which encourages holding and investing in the network, thus enhancing its security and stability.
Decentralization: Staking allows more participants to be involved in maintaining the blockchain, as it doesn’t require the same level of technical expertise or capital as mining. This involvement can lead to a more decentralized and robust network.
In summary, staking offers a more energy-efficient and accessible way for users to contribute to and benefit from maintaining a cryptocurrency network, addressing the environmental and economic challenges of traditional mining.
How Does Crypto Staking Work?
At the basic level, staking means holding funds in a cryptocurrency wallet to support the operations of a blockchain network. Users lock or hold their funds in a crypto wallet to participate in maintaining the operations of a proof-of-stake (PoS) based blockchain system. Like earning interest in a traditional bank, stakers receive rewards, typically in the form of additional coins or tokens.
Different Ways of Staking
Staking can be done in various ways, including:
Direct Staking: Here, individuals directly participate in the staking process by locking their coins in a supported wallet or a blockchain network.
Staking Crypto Pools: For those who don’t have enough coins to meet the minimum staking requirements, staking pools are an alternative. These pools aggregate resources from multiple stakeholders.
Exchange Staking: Some cryptocurrency exchanges offer staking services, allowing users to stake directly through the platform.
Delegated Staking: Users delegate their coins to a validator who stakes the coins on their behalf.
Liquid Staking: This software solution allows users to stake directly on a proof-of-stake (PoS) network. It’s also known as soft staking.
The Economics of Staking
The staking economy revolves around the principle of rewarding users for participating in network activities like transaction validation. Unlike proof-of-work (PoW) systems that require significant energy and computational power, PoS and staking rely on an economic stake to ensure network security. The more a person stakes, the higher their chances of being chosen as a validator and earning rewards.
Staking injects a new economic layer into the crypto ecosystem. It offers a financial incentive for holding coins, encouraging longer-term investment and network stability. The rewards earned through staking often provide a steady income stream akin to earning dividends.
The Importance of Staking for the Crypto Economy
Staking strengthens the underlying safety net for crypto in several ways:
Network Security: Stakers help maintain network integrity, reducing the likelihood of attacks, which enhances network security.
Decentralization: Staking promotes decentralization by allowing a broader user base to participate in network activities. As evolving regulatory actions continue to undermine decentralization in favor of security concerns, staking is one way to continue promoting decentralization and network stability.
Energy Efficiency: Staking is less energy-intensive than mining, making it a more sustainable option for maintaining cryptocurrency networks.
Overall, staking is a promising solution that offers a more accessible, energy-efficient, and sustainable way of maintaining cryptocurrency networks.
Fraudulent Scams and Staking
Unfortunately, the crypto economy still struggles with fraud. Fraudulent or questionable staking programs can negatively affect the crypto economy.
Staking is one of the crypto investing models hijacked by bad actors. Illegitimate staking can resemble a Ponzi scheme, where instead of generating returns via legitimate staking activities or any real investment, the “returns” mostly come from the funds contributed by new participants.
This model is not sustainable and disproportionately benefits those at the top of the structure, usually the scam founders and early adopters, at the expense of later entrants.
Notable characteristics of fraudulent staking schemes include:
Unrealistically High Returns: Offers guaranteed high returns with little or no risk and are not aligned with the typical returns in standard staking or crypto markets.
Overemphasis on Recruiting: This scheme strongly focuses on recruiting new participants to invest in the scheme, promising that more recruits lead to higher returns.
Lack of Transparency: Vague or misleading information about how returns are generated, with little to no verifiable information about the underlying staking process or the assets involved.
No Genuine Underlying Investment: Returns are not based on actual crypto staking activities or any real, productive investment but are simply a redistribution of the new participants’ contributions.
Unsustainable Model: The scheme relies on a constant inflow of new participants to provide returns to earlier investors, which is inherently unsustainable and collapses once the flow of new investors slows down.
It is crucial to conduct thorough research and due diligence before participating in any staking program. Genuine staking involves receiving rewards for participating in and contributing to a blockchain network’s security and operations, not for recruiting new investors.
Be cautious of any staking opportunity that appears too good to be true, lacks transparency, or focuses more on recruitment than actual staking activities. As with all investment decisions, never take action solely based on emotional motivation.
Getting Started with Staking
Now that you know the red flags to avoid, you also know what to look for with legitimate opportunities. To start with staking, you must follow a few key steps to ensure you are well-prepared and informed.
First, select a cryptocurrency that supports staking – popular options include Ethereum 2.0, Tezos, and Cardano. Next, acquire the chosen cryptocurrency through an exchange or other means. Once you have your crypto, choose a staking method that aligns with your goals and resources.
You’ll need a compatible wallet to hold and lock your coins for direct staking. If you prefer joining a staking pool, research to find a reputable pool with reasonable fees and a strong track record.
For those who seek simplicity, several crypto exchanges offer user-friendly staking services, though it is crucial to assess the security and reliability of the platform.
Finally, always stay updated on your chosen network’s staking rules and requirements, as these can affect your rewards and staking experience. Remember: successful staking starts with thorough research, due diligence, and careful consideration.
Moving Ahead with Crypto Staking
While staking is transforming the crypto economy by offering new ways to participate and earn within blockchain networks, stakeholders should understand the nuances and risks involved.
Staking contributes to the robustness and efficiency of crypto networks, but like any investment, it requires careful consideration and risk assessment.
Do you stake crypto? If you invest in cryptocurrency, ZenLedger can help you quickly calculate your crypto taxes and find opportunities to save money and trade smarter.
Disclaimer: This material has been prepared for informational purposes only and is not intended to provide tax, legal, or financial advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.