What is steaking and how do you make money on it?

1. What is Proof-of-Stake (PoS) and how does it relate to stacking?
2. How does stacking work in Proof-of-Stake?
3. What are the differences between Delegated Proof-of-Stake?
4. Who are the steaking providers?
5. How does ETH stacking work in Ethereum 2.0?
6. What are the risks of cryptocurrency steaking?
7. What other types of stacking are there?

Main

Stacking is a method of earning passive income from cryptocurrencies based on the Proof-of-Stake (PoS) consensus algorithm and its variants.

The essence of steaking consists in blocking a certain number of coins in a wallet in order to obtain the right to participate directly or through intermediaries in maintaining the blockchain performance of a given asset and to receive remuneration for this. Stacking performs a similar role in PoS blockchains as mining does in the bitcoin network.

Steaking appears to be a profitable alternative to simply holding cryptocurrencies in a wallet, being analogous to a bank deposit in the crypto industry. Stacking yields vary from blockchain to blockchain and can be as high as tens of percent p.a. or higher.

What is Proof-of-Stake (PoS) and how does it relate to stacking?

Proof-of-Stake is a consensus mechanism in which the right to generate new blocks, verify transactions, and include them in the blockchain according to a certain algorithm is played out between computing nodes (nodes) based on how much of a given blockchain’s coins they own.

In a basic scenario, a node that owns 1% of all coins in circulation receives the right to process 1% of the blocks, and for its work it receives 1% of all rewards of the network. However, many cryptocurrencies also take into account the tenure of coins and other factors.

One way or another, staking is about getting that very reward for producing new blocks and verifying data with your share (native coins).

The Proof-of-Stake algorithm was first implemented in 2012 in the cryptocurrency PPCoin (now known as PeerCoin). Subsequently, it became the most used consensus mechanism in blockchain projects.

One of the most popular and frequently used modifications of PoS is Delegated-proof-of-stake (DPoS). This algorithm was created in 2013 by Daniel Larimer for the BitShares blockchain platform and is now also used in many networks.

The main advantage of DPoS is that a coin owner does not need to deploy his node to participate in stacking – he can delegate them to validators, who manage high-performance nodes and ensure that they run smoothly.

Many similar mechanisms have been developed on the principle of delegation. Here are just a few of them:

• Leased Proof-of-Stake (LPoS) – leased proof-of-ownership. It is used in the Waves network.

• Nominated Proof-of-Stake (NPoS) – provides for nominators who bail out validators and are responsible for their integrity. It is used in the Polkadot blockchain.

• Proof-of-Staked-Authority (PoA) is a hybrid algorithm that combines PoS and reputation validators (Proof-of-Authority). The BNB Chain runs on PoSA.

How does stacking work in Proof-of-Stake?

In “classic” PoS cryptocurrencies, each official wallet performs the function of a full node, that is, it checks and confirms transactions and releases new blocks.

Technical requirements differ from one blockchain to another: in some networks, a home computer is sufficient to deploy and manage a node, while in others, professional server hardware is required. In this way, the blockchain is decentralized and secure without the huge energy costs inherent in Proof-of-Work consensus cryptocurrencies.

The terms of participation in stacking may vary. The general mechanism is to buy the native coin you want to participate in stacking and send it to a smart contract yourself (e.g., through a wallet) or give it to a validator.

Depending on the speed at which coins are issued, the yield on staking can be in the tens or hundreds of percent. At the same time, it is a way of issuing cryptocurrencies, so too high a reward rate can lead to coin inflation, which will negatively affect profits.

What are the differences between Delegated Proof-of-Stake?

In DPoS blockchains, each wallet with coins on its balance can vote for delegate-validators – computing nodes between which, through a complex algorithm, the right to generate blocks, verify transactions, and receive rewards and commissions for transfers is transferred.

The number of validators can vary significantly from blockchain to blockchain: BNB Chain has only 21 validators, while Solana has about 1,800.

As an example, here is the sequence of actions in Cardano stacking (ADA):

• Install Daedalus desktop wallet or Yoroi browser wallet on your computer;
• Wait for the wallet to be synchronized with the Cardano blockchain;
• create a new address for the wallet;
• transfer at least 10 ADA to the wallet;
• select a suitable validator in the Delegation Center and use the Delegate button to vote for it by sending your coins;
• the reward from steaking will come to the wallet at the end of each five-day epoch.

A similar procedure applies to other popular PoS networks. To receive Solana Coin Stacking (SOL), you must select a suitable validator from the list in your Phantom wallet and delegate your coins to that validator. Rewards are distributed at the end of each epoch, lasting about two days, and the yield is 7% per annum.

Since the total amount of the reward for staking in each epoch is constant, its yield depends on how much of the coins released are locked into the wallets of the validators. For popular blockchain platforms, this value is 50-90% of total turnover.

Who are the steaking providers?

Steaking is a popular strategy for investing in digital assets. However, setting up a node or steaking in an individual crypto project can be quite time-consuming.

Therefore, special all-in-one steaking platforms have become widespread in the cryptocurrency market. They are applications where users can simply send their funds to various pools through the provider’s wallet.

Steaking providers also allow users to analyze the current profitability of steaking in the selected network and show other relevant data. Steaking platforms make it as easy as possible for users by charging a small commission on the fees they receive.

Both specialized services (Midas Investments, Everstake, Stake.fish, etc.) and centralized crypto exchanges (Coinbase, KuCoin, eToro, etc.) offer stacking services. Cryptocurrency stacking is also possible through multi-currency cryptocurrency wallets such as Trust Wallet and Atomic Wallet.

How does ETH stacking work in Ethereum 2.0?

In December 2020, as part of a massive update called Ethereum 2.0, which involves transitioning the blockchain to the PoS algorithm, an official test network called the Beacon Chain appeared. It is supposed to be the basis for the new blockchain. The merger with the current Ethereum mainnet will be a separate major event called The Merge and will take place before the end of 2022.

Ethereum 2.0 includes stacking, and you can become a member right now. To do so, you need to send ETH coins to a special smart contract. And those who own at least 32 ETH can become validators of the new network.

A number of stacking providers also allow small investors who do not have the necessary number of coins to launch a node to participate in ETH stacking.

For example, the decentralized app Lido Finance allows you to block any amount of ETH and receive not only staking rewards, but also stETH liquidity tokens in return. The protocol delegates the funds collected to large validators and distributes 4% annual staking income to stETH owners on a daily basis.

The risk of participating in staking ETH is that coins sent to the contract cannot be taken back until The Merge stage is complete. Although some staking service providers exempt from this restriction. We recommend checking the detailed terms in advance.

What are the risks of cryptocurrency steaking?

Stacking appears to be a profitable and relatively safe alternative to simply storing cryptocurrencies in a wallet, promising returns that can be substantial. However, there are a number of risks that can significantly reduce expected returns and even lead to losses:

• As participants in steaking earn income in the coins of a given cryptocurrency, fluctuations in its exchange rate affect the value of invested funds and the actual yield of steaking;

• The high staking yields offered by some PoS cryptocurrencies (tens and hundreds of percent annually) are achieved due to the high rate of coin issuance. This often leads to a rapid drop in the market price of the coin and a rapid depreciation of the investment in this cryptocurrency;

• Stakeholder requirements may include locking coins for a period ranging from several days to several months. During this period, the owner cannot withdraw and sell their coins;

• Staking cryptocurrencies using staking providers carries all the risks associated with trusting a third party, which could be subject to a hacker attack or misappropriate assets collected from the stackers.

What other types of stacking are there?

In addition to PoS cryptocurrency stacking, there is so-called DeFi-stacking. It consists of blocking different types of tokens (utility and havernance tokens, NFTs) in a smart contract to get a reward or access to some services.

DeFi-stacking is most often used by blockchain projects to attract liquidity, as well as to increase the intrinsic value of their native tokens. This tool is actively used by decentralized crypto-exchanges and DeFi-services, giving away their management tokens as a reward for placing liquidity.

Some blockchain games also offer NFT game stacking, paying out game tokens as rewards, issuing other non-interchangeable tokens, or providing access to the game in this way.