30 Apr 2019
While we have not seen many gains in the past year there is a new way to make a little bit of money and that is by staking your coins or tokens in order to earn passive income.
While you may argue that earning gains and watching the prices go up is not the true purpose of cryptocurrencies and we should be more focused on usability and widespread adoption, it’s not surprising that cryptocurrencies are often seen as an investment rather than a useful technology. In fact, promises of huge gains are what fueled the 2017 crypto bull run.
With that in mind, it is no surprise that people are looking for new ways to earn money with cryptocurrencies. The newest trend in crypto space is staking your coins and earning a passive income.
"If you don’t find a way to make money while you sleep, you will work until you die" - Warren Buffet
Staking refers to a process within a consensus algorithm called Proof-of-Stake (PoS). Generally speaking, all blockchains have one thing in common: transactions need to be validated and properly ordered to avoid double spending. There are three main consensus algorithms used for validating transactions and putting them in order: Proof-of-Work (PoW), Proof-of-Authority (PoA) and Proof-of-Stake (PoS).
We won’t go into too much detail but there are key differences between them.
Proof-of-Work uses mathematical calculations (hashing) to add blocks to the blockchain which essentially confirms transactions. Whoever solves that calculation first gets a reward for adding a block to the blockchain. To solve this puzzle you need to have powerful computers (mining rigs) that consume a lot of electricity.
Proof-of-Stake, on the other hand, does not use a lot of electricity as the transactions are validated through a system of coin staking. The best way to understand PoS is through an example. If you hold 1% of issued coins you have a 1% chance of adding the next block to the blockchain and earning a block reward and transaction fees associated with that block. In the long run, 1% of all blocks in the blockchain will be produced by you. That essentially means that the more coins you hold the more you earn.
The third type, Proof-of-Authority, relies on a trustful identity to produce transaction blocks. That can either be one entity (centralized system), a closed group of known and pre-approved entities (private blockchains) or a system where coin holders vote for block producers (these kind of systems are sort of a mix between PoA and PoS).
Many believe that Proof-of-Stake is a better system as it is more (environmentally) sustainable. In fact, there are plans for the second largest cryptocurrency, Ethereum, to gradually move from a PoW to a PoS consensus algorithm.
"I am seriously looking forward to when the cryptocurrency community basically passes away with proof-of-work." - Vitalik Buterin
You can think of crypto staking as a passive income similar to dividends or interest on your savings account. The amount you earn depends on the coin price, the amount of coins you stake and for how long you lock them up. Generally speaking, the more you stake (and for the longest period) the better the returns.
When considering staking your coins you should first check if the coin or token uses PoS and is worth staking. There are also many ways to stake your coins. But because the entry barrier for becoming a block producer is relatively high, investors are usually using "non-node staking".
There are also many third-party custodians (staking pools) that will hold your coins and stake them in order to maximize gains. Two of those are Anchorage and Staked which are relatively new startups that raised venture capital.
Note that the process of pool staking is different with every Proof-of-Stake coin. Some require you to send your coins to a staking pool, while others allow you to keep the coins in your wallet and basically just vote for a validator node (a.k.a. block producer).
Staking coins is definitely a viable option for those that want to earn a passive crypto income but it does come with trade-offs and risks. When staking your coins always do your research and see if it's worthwhile.
Staking your coins requires you to lock your coins for a certain amount of time. This means that for that period you can't sell those coins (less liquidity). But if you are a long-term hodler it is certainly worth staking them.
There might also be security risks associated with staking your coins. Staking requires a block producer to be online 24/7. This could pose a security risk if the system also requires the block producer's wallet to be always connected to the internet (and thus vulnerable to attacks and hacks). But note that this applies to you only if you want to be a block producer (a full node).
Instead, you can decide to play a more passive role and delegate your stake to someone else who wants to be a block producer.
Some PoS cryptocurrencies (like Dash) require you to send your coins to the block producer (staking pool), which bears a risk of having your coins stolen or hacked.
But there is another type of cryptocurrencies where your coins do not have to leave your address/wallet. Moreover, your coins can even be put in cold storage and you could still participate in the staking process. In these systems, you would use your coins (stake) to vote for a block producer and then receive a part of the staking reward.
However you look at it, staking is definitely gaining momentum and is worth considering when making an investment. If you decide to stake your coins, always do your research first and make sure your crypto assets are as secure as possible.
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