15ugrThis is a alternative consensus mechanism used by some cryptocurrencies to validate transactions and add new blocks to the blockchain. With proof of stake, stakeholders can earn rewards by holding and “staking” their coins rather than consuming large amounts of energy mining like with bitcoin.
How Does Cryptocurrency Staking Work?
To understand staking, it helps to first explain how blockchain validation works with proof of work coins like bitcoin. With proof of work, miners use powerful specialized computers and graphics cards to solve complex math problems in order to add new blocks to the blockchain and receive block rewards in crypto as compensation for their effort. This process requires massive amounts of electricity.
Proof of stake acts as an alternative to mining that is more eco-friendly and incentivizes coin holders to actively participate in transaction validation and security. Instead of competing to mine new blocks, with proof of stake a process called “fork choice rule” is used to randomly select a staker to validate transactions and earn rewards. The key idea is that stakeholders should have an amount of the coin that is proportional to their ability to be selected to add a block to the blockchain.
Some key aspects of how staking works:
- Stakers deposit or “stake” a minimum amount of the coin in a non-custodial wallet to become eligible to validate transactions and earn staking rewards.
- The chance of a staker being selected is proportional to their percentage of the total staked amount. So those staking larger amounts have a higher chance of validating a block and earning rewards.
- If selected, the staker validates a block of transactions, which involves checking transactions are valid and in the correct order. They earn a block reward for their efforts.
- The staked coins cannot be used for anything else while staked, adding an element of commitment. Stakers risk slashing or penalties if they behave maliciously like signing two different blockchains.
- Validated blocks are added to the blockchain in the same way as with proof of work, maintaining decentralization and security without high energy usage.
This process disincentivizes hoarding coins and encourages active participation to earn yields, helping distribute coins more widely in the ecosystem over time. Now that we understand the basic mechanics, let’s look at some popular proof of stake coins.
Major Proof of Stake Cryptocurrencies
While bitcoin and ethereum currently use proof of work, several top cryptocurrencies have adopted proof of stake as their primary consensus mechanism. Here are some of the major proof of stake coins available to stake today:
Cardano (ADA)
Cardano was one of the earliest successfully deployed proof of stake blockchains. It utilizes a system called Ouroboros to select stakers in an optimized, random and secure way. To stake ADA, users delegate their holdings to a staking pool, with rewards split proportionally among delegators. Minimum staking amount is 500 ADA. Average annual staking rewards currently around 5%.
Tezos (XTZ)
Tezos was one of the earliest platform blockchains to implement on-chain governance and self-amendment capabilities. Staking rewards average around 5% annually. Minimum stake amount is 8 XTZ. Tezos uses a liquid proof of stake protocol called Liquid Proof of Stake that provides instant staking and increased security. Stakers can delegate coins to validators.
Polkadot (DOT)
Polkadot is an interoperability blockchain project that allows connected blockchains to transfer data and transactions between each other. Minimum stake amount is just 1 DOT to start earning around 10% APY rewards. DOT uses a Nominated Proof of Stake consensus where stakers can delegate their stake to validators.
Algorand (ALGO)
Algorand is a layer 1 blockchain focused on scalability and finality with a pure proof of stake algorithm called Pure Proof of Stake. Average annual ALGO rewards are around 6%. Minimum stake is just 1 ALGO. It uses a decentralized random selection process to choose block proposers.
Cosmos (ATOM)
Cosmos is an ecosystem of connected blockchains utilizing the Cosmos SDK and their own consensus, Tendermint. Staking ATOMs earns around 7-10% APR. The minimum is 5 ATOMs. It utilizes a Byzantine Fault Tolerant consensus protocol to maximize decentralization. Stakers bond assets and delegate voting power.
Now that we’ve covered the basics of how staking works and highlighted some top proof of stake networks, let’s discuss in more detail the key benefits of staking cryptocurrency.
The Benefits of Cryptocurrency Staking
There are several attractive benefits that come with staking cryptocurrency instead of simply holding coins in a wallet:
Earn Passive Income
By far the biggest incentive is the ability to earn cryptocurrency rewards without needing specialized mining equipment. Staking allows passive income generation on idle crypto holdings. Annual percentage yields (APY) can range from 5-20% depending on the coin and market conditions.
Increased coins over time
Regular staking rewards compound your total holdings, allowing you to accumulate more of the underlying coin the longer you stake. This multiplier effect can significantly boost your long term returns through the power of compound interest.
Support the blockchain network
By staking your coins, you are actively participating in consensus and validating transactions which directly helps secure the network and make it more robust over time. Compared to miners, stakers have a bigger incentive to operate nodes honestly since slashing penalties can be severe.
Provides liquidity
Cryptocurrency staking encourages distributing coins across more addresses rather than hoarding. This boosts liquidity which is important for a blockchain network’s growth and maturation. It also lowers volatility by reducing the impact of major sell-offs.
More environmentally friendly
Compared to energy-intensive mining, proof of stake networks use 99% less electricity and have a much smaller carbon footprint. This makes them more cost-effective and sustainable alternatives as cryptocurrencies scale massively in the future.
Earn rewards passively
Once coins are staked, the rewards accumulate automatically without needing to actively trade or monitor markets. This allows holders to generate yield in their spare time or while holding long-term without extensive hands-on work.
As with any investment, staking cryptocurrencies does have some inherent risks that should be understood as well. Let’s cover those next.
Risks of Cryptocurrency Staking
While staking provides attractive benefits, it is important for users to understand the potential downsides:
Impermanent loss
For coins that do not use non-custodial staking and require liquidity provision like certain DeFi protocols, there is a risk of impermanent loss if the staked asset’s value changes significantly versus the asset it is providing liquidity against.
Slash penalties
Stakers risk getting slashed or losing part of their stake if they behave in ways that damage the network like signing two different blockchains. This deters dishonest behavior but is a risk factor for stakeholders.
Network failures
No blockchain is completely smooth running or immune to downtime, bugs or governance issues that could negatively impact staking rewards or access to funds in rare cases. decentralization helps mitigate this risk.
Smart contract risks
When earning yields through smart contracts like liquid staking protocols, there are risks of vulnerabilities or hacks that could result in loss of funds similar to DeFi risks. Non-custodial wallets mitigate this.
Inflation from new coin issuance
Staking rewards are typically paid out of the blockchain’s coin issuance which increases overall circulating supply over time. This inflationary effect could lower price appreciation potential versus a deflationary asset. However, it incentivizes use and distribution.
Regulatory uncertainty
Global regulations around cryptocurrencies are still developing and the tax treatment of staking rewards varies by jurisdiction. Ensure compliance with local laws which could negatively impact returns.
By choosing established proof of stake networks, using non-custodial wallets, and diversifying stakes across coins, investors can take measures to mitigate risks. But there are no guarantees of returns, so do proper research before committing funds for the long run.
Now that we understand the core concepts and benefits/risks of staking, let’s move on to actually setting up staking for some major cryptocurrencies.
How to Stake Cardano (ADA)
Cardano was one of the earliest successfully deployed proof of stake blockchains and has one of the highest staking rewards currently available. To get started:
Choose a Staking Wallet
The two most popular non-custodial Cardano wallets that support staking are Yoroi and Daedalus. Yoroi is a light wallet for desktop and mobile, while Daedalus is a full node wallet for desktop. Download the appropriate wallet based on your needs.
Fund your Wallet
Send the minimum of 500 ADA to your new wallet from an exchange. Ensure the wallet is fully synced to the blockchain before proceeding.
Choose a Stake Pool
Open the wallet and go to the “Delegation” section. Research stake pools and select one to delegate your funds to based on the pools’ stake percentage, fees, and reliability. Higher percentage pools have higher chances of rewards.
Start delegation
Click “Delegate” and transfer your stake to the selected pool. This process locks your ADA for staking and you’ll start receiving rewards within the next epoch cycle, around 5 days.
Monitor Rewards
Check your wallet after each epoch to view rewards accumulating. You can re-delegate to adjust pool selection anytime it’s not in an active stake period. Rewards average around 5% APY currently with Cardano.
And that covers the basic process to start earning staking yields from your Cardano holdings. The process is quite simple and lets you generate passive income from idle crypto assets.
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