Staking in cryptocurrencies: a complete guide to passive income

Key Concepts

What is staking in blockchain? Staking is a mechanism that allows holders of crypto assets to lock their funds to ensure the security and functioning of blockchain networks. In return, participants receive rewards in the form of additional cryptocurrency coins. This process has become a popular way for investors to earn passive income, seeking to maximize the returns on their assets without selling.

Staking is only possible in blockchains that use the Proof of Stake consensus mechanism (PoS). Such networks include Ethereum, Solana, Cardano, Avalanche, Polkadot, Cosmos, and many other ecosystems.

How the Proof of Stake mechanism works

Proof of Stake is an alternative consensus mechanism developed in 2011 as a more energy-efficient replacement for Proof of Work (PoW) used in Bitcoin. The main difference is that PoS does not require computational mining.

In PoW blockchains, miners solve complex mathematical problems using computational power. In PoS systems, this role is performed by validators, who are selected based on the amount of staked cryptocurrency and other factors. This approach significantly reduces energy consumption and makes participation in the network more accessible.

Mechanism of Staking

The staking process is structured according to the following algorithm:

Stage 1: Validator Selection. The system selects validators based on the amount of staked coins, the duration of participation in staking, and sometimes a random element. This ensures a fair distribution of opportunities.

Stage 2: Verification and Validation. The selected validators check and confirm transactions, ensuring the reliability and transparency of the network. Each transaction must be verified before being added to the blockchain.

Stage 3: Block Formation. Verified transactions are grouped into blocks, which are then integrated into the distributed ledger of the blockchain. This creates an unbroken chain of records.

Stage 4: Reward Distribution. For correctly performing their functions, validators receive a portion of the transaction fees plus new coins created by the protocol. The amount of the reward depends on many variables.

Staking Categories for Different Investors

There are several approaches to staking that vary in terms of complexity and the knowledge required:

Self-management. You can run your own validating node. This option provides maximum control but requires deep technical skills and carries the risk of penalties for mistakes. Incorrect configuration can lead to loss of funds through the slashing mechanism.

Services through platforms. Many services offer ready-made solutions for staking, allowing newcomers to avoid technical complexities. This is the most convenient way for most users.

Delegating to validators. You can delegate your coins to a trusted validator or a specialized service while retaining ownership of the assets. Some blockchains integrate this function directly into wallets.

Participation in staking pools. Pooling funds with other participants increases the chances of earning rewards without running a personal node. Pools are especially useful for small investors who have not met the minimum requirements.

What are staking pools

A staking pool is a collective group of cryptocurrency holders who collectively lock funds to increase the probability of block validation. Participants receive rewards proportional to their contribution.

This mechanism is especially beneficial for small investors who cannot meet the minimum requirements on their own. However, before joining a pool, it is important to analyze its reputation, fee structure, and security mechanisms, as these parameters vary.

Liquid Staking: An Innovation in Income-Generating Assets

Liquid staking is an advanced form that eliminates one of the main drawbacks of traditional staking: the locking of assets. In classic staking, coins are frozen for the duration of participation, limiting their usage.

Liquid staking allows you to earn rewards while maintaining access to your assets. Typically, a user is issued a token that represents the locked asset. For example, when depositing Ethereum, you receive a token equivalent that can be sold, exchanged, or used in other protocols without losing staking income.

Some ecosystems implement native liquid staking, which does not require the issuance of additional tokens. Cardano with its ADA coin demonstrates this approach, providing investors with an optimal balance of flexibility and yield.

Advantages of Participating in Staking

Staking offers several significant advantages:

• Passive income. Earning regular rewards for assets that would otherwise remain unused creates an additional source of income.

• Strengthening the network. Participating in staking contributes to the security and stability of beloved blockchains. You directly support the ecosystem.

• Voting Rights. Many networks give stakers the opportunity to participate in governance and influence the project's development through voting on proposals.

• Eco-friendliness. Unlike energy-intensive PoW mining, staking requires minimal energy consumption, making it an eco-friendly alternative.

Risks and Dangers of Staking

Despite its attractiveness, staking is associated with serious risks:

Price Volatility. If the value of the locked cryptocurrency drops significantly, the rewards may not offset the losses. The temporary locking of assets limits the ability to exit quickly.

Fines for violations (slashing). Validators must adhere to strict rules. Violations, including prolonged node downtimes or attempts at double spending, will incur financial penalties and partial loss of staked funds.

Centralization. If a small number of validators control the majority of staked coins, it can lead to centralization and undermine the security of the network.

Technical Failures. Some protocols require the locking of assets for a certain period. Smart contract errors, software vulnerabilities, or technical failures can lead to freezing or loss of access to funds.

Intermediary Risks. The use of third-party services is associated with trust in their security. Hacking a platform or compromising a wallet can lead to theft of funds. DeFi protocols require full access to the wallet, which increases the risks.

Practical Guide to Starting Staking in 2024

Step 1: Choose a cryptocurrency. Determine the blockchain that supports PoS. Study the requirements for the minimum amount, locking conditions, and annual yield in detail.

Step 2: Wallet Preparation. Use a reliable Web3 wallet that supports staking features. Popular options offer user-friendly interfaces and secure storage.

Step 3: Start Staking. Follow the instructions of the chosen network: launch a validating node, delegate coins to a validator, or join a pool. It is recommended to start with reliable ecosystems such as Ethereum and Solana and conduct your own research before investing large sums.

Calculation of Staking Rewards

The amount of rewards depends on the following parameters:

• The volume of coins you have locked
• Duration of participation period
• Total amount of assets in staking across the network
• The level of inflation and the size of network fees

Some blockchains offer a fixed interest income, making predictions easier. Rewards are often expressed through an annual percentage rate (APR), allowing for the comparison of returns across different options.

Withdrawal of Assets from Staking

In most cases, you can withdraw cryptocurrency from staking at any time. However, the rules vary depending on the protocol. Early withdrawal may sometimes result in a partial loss of accrued income.

A significant breakthrough occurred with the Ethereum Shanghai update, allowing for the seamless withdrawal of locked ETH. Now Ethereum holders receive rewards automatically and can freely withdraw funds.

Why Not All Cryptocurrencies Support Staking

Staking is only available in blockchains that use Proof of Stake. Bitcoin and other PoW-based networks do not support this mechanism. Even within PoS ecosystems, not all tokens include staking functionality, as different projects apply different systems to incentivize participants.

Final Recommendations

Cryptocurrency staking is an effective way to generate income from inactive assets while simultaneously supporting the development of blockchain ecosystems. However, this process involves significant risks: market volatility, the possibility of slashing, technical vulnerabilities, and intermediary threats.

Before starting staking, carefully analyze the available methods, evaluate the reliability of the chosen platforms and blockchains, and conduct independent research. Pay special attention to the withdrawal conditions and protection mechanisms. Staking is optimal for long-term investors who are willing to actively support the development of cryptocurrency projects and gain economic benefits from it.