Welcome back cheapskates to another crypto article (feels like we’re doing a lot of these right now right?) and this is one you’re going to want to read. If you’ve started investing in crypto or are thinking about it (and if you haven’t, head on over to our Crypto Investing guide to learn more) you may have come across the term ‘staking’. We’re pretty big advocates of staking when it comes to crypto as it’s a way of putting your money to use outside of just waiting for your investment to increase in value (though, we do invest for that too!). In this article we cover, what staking is, why we like it and why we think you may want to consider it.
As always, the following is not financial advice, read our disclaimer
What exactly is staking?
To understand what staking is, we first need to understand the two biggest methods used to secure and verify transactions on different crypto networks. Buckle up, because this bit is about to get a little nerdy but we will try to keep it light.
Proof of Work
The first method of securing crypto networks is called ‘proof of work’. This is the first and original method and is used by Bitcoin, Ethereum and many other coins. Essentially, proof of work it is the way the algorithm verifies transactions on the network. It ensures that transactions can’t be duplicated and can be easily verified by other computers on the network, allowing transactions to happen without the need of a centralised body (such as a bank). The easiest way to explain is through an example:
Let’s say Elon wants to send Jeff 1 bitcoin. In order to do this, the transaction will need to be recorded on the public ledger called the blockchain. The blockchain is basically just a public list showing all of the bitcoin transactions ever. In order to write this transaction to the blockchain, a new block will need to be added where the data for this transaction can be stored. In order to do this, the computers on the bitcoin network will ‘compete’ to solve complex mathematical problems in order to write this new block. This process is called mining and if they are the first one to solve the complex equation, they are rewarded bitcoins, the new block is created and Elon’s transaction can be written onto the blockchain. The solving of these complex mathematical problems is essentially the ‘proof of work’ and shows the other computers on the system that work was undertaken in order to ‘mine’ this new block.
However, there are a number of drawbacks to using this method of verification. One of the main drawbacks hitting headlines at the moment is that it takes an enormous amount of computational power and electricity to secure the entire network (apparently, bitcoin uses more electricity than Argentina!). This is because more and more people are using the network, meaning the mathematical problems are getting exponentially more complicated, meaning more computational power is needed to solve them.
To get around this, some clever people came up with another method of securing transactions on the network using much less power whilst still ensuring it could remain decentralised. Enter proof of stake…
Proof of Stake
In proof of work systems, the number of transactions you can verify is relative to how much computational power you have and the electricity you consume. However, in proof of stake systems, the amount of transactions you can verify is relative to how much of that particular coin you are prepared to ‘stake’ i.e. tie up in the system. In proof of work, miners are competing to solve the same problems and verify transactions at the same time. However, in proof of stake, validators are assigned transactions to verify and blocks to create based on how much they have ‘staked’.
Both systems use blockchain technology to store transactions, but because only one validator is charged with processing the next transaction, much less energy is used whilst still ensuring all computers on the network can verify each transaction on the blockchain. There is also an additional layer of security here, because if a validator tried to process a fraudulent transaction, they will likely lose the money they staked, meaning that there is additional motivation to ensure the integrity of the system.
OK, nerdy stuff over.
So why should you care?
Well the long and short of it is because you can use this information to make money with your money…..
If you wanted to make money as a miner for bitcoin, you would have to download the bitcoin software. But in order to run the software, you would need to purchase some SERIOUS computing kit costing thousands. Even then, you would be limited to what you could make, so these days most of the bitcoin transactions are handled by bitcoin farms that have huge capacity and power.
On the other hand, proof of stake can be taken advantage of pretty easily these days! Many crypto exchanges and wallets allow you to ‘stake’ your own coins into a pool of coins that are then used to validate transactions on that network. A portion of the fees from these transactions are then paid to you, similar to interest from a savings account! Unlike savings accounts though, the interest or APY is usually far higher than what you would earn from a UK savings account.
In essence, you can put your crypto coins to work for you to earn extra money. If you are holding crypto coins already in a regular wallet waiting for it to increase in value, it can be a nice way to earn extra on your currency. Let’s go through some examples:
- Currently on the platform trustwallet, you can stake BNB coin and earn 9.11% per year return.
- On the Binance platform, you can currently stake the coin CAKE for a whopping 36.42% per year return!
Some things to remember:
- Your returns are usually paid in the same currency as the coin you are staking
- Although the returns are shown in APY (per year) interest is usually paid daily and is usually only available to be locked in for a certain period (usually 3 months max)
So, are there any drawbacks?
Well, not per se, but there are some things to remember:
- Your crypto is still subject to the regular market swings. If for instance you are staking a coin and the value of that coin goes down on the wider market, your coin will too
- In some cases, you may have to lock your stake in for a set period. If you take your coins out before the end of that period, you lose any interest you have accrued. Staking with ‘flexible’ terms usually pays less.
- Although staking is broadly seen as a safe way to earn on your crypto, it is still subject to the relatively unregulated world of crypto so any loss of funds may not be protected.
- Validators that you pool your stake with on some apps can and do get cancelled. We haven’t as yet come across an instance where this has led to loss of money, but it’s something to be aware of. For this reason, we tend to only stake the well known coins with the big exchanges.
The long and short is that staking your crypto can be a great way to earn some additional commission or interest on the cryptocurrency you hold at rates far better than you could get from a bank. But as this is cryptocurrency, your returns are likely to be less consistent and the value of your money more volatile.
Thanks for reading! Head on over to our crypto section to see what else we’re talking about.
Let us know your thoughts by leaving a comment below!