Like a lot of things in crypto, staking can be a complicated idea or a simple one depending on how many levels of understanding you want to unlock. For a lot of traders and investors, knowing that staking is a way of earning rewards for holding certain cryptocurrencies is the key takeaway. But even if you’re just looking to earn some staking rewards, it’s useful to understand at least a little bit about how and why it works the way it does.
If a cryptocurrency you own allows staking — current options include Tezos, Cosmos, and now Ethereum (via the new ETH2 upgrade) — you can “stake” some of your holdings and earn a percentage-rate reward over time. This usually happens via a “staking pool” which you can think of as being similar to an interest-bearing savings account.
The reason your crypto earns rewards while staked is because the blockchain puts it to work. Cryptocurrencies that allow staking use a “consensus mechanism” called Proof of Stake, which is the way they ensure that all transactions are verified and secured without a bank or payment processor in the middle. Your crypto, if you choose to stake it, becomes part of that process.
This is where it starts to get more technical. Bitcoin, for instance, doesn’t allow staking. To understand why, you need a little bit of background.
A newer consensus mechanism called Proof of Stake has emerged — with the idea of increasing speed and efficiency while lowering fees. A major way Proof of Stake reduces costs is by not requiring all those miners to churn through math problems, which is an energy-intensive process. Instead, transactions are validated by people who are literally invested in the blockchain via staking.
Staking serves a similar function to mining, in that it’s the process by which a network participant gets selected to add the latest batch of transactions to the blockchain and earn some crypto in exchange.
The exact implementations vary from project to project, but in essence, users put their tokens on the line for a chance to add a new block onto the blockchain in exchange for a reward. Their staked tokens act as a guarantee of the legitimacy of any new transaction they add to the blockchain.
The network chooses validators (as they’re usually known) based on the size of their stake and the length of time they’ve held it. So the most invested participants are rewarded. If transactions in a new block are discovered to be invalid, users can have a certain amount of their stake burned by the network, in what is known as a slashing event.
Many long-term crypto holders look at staking as a way of making their assets work for them by generating rewards, rather than collecting dust in their crypto wallets.
Staking has the added benefit of contributing to the security and efficiency of the blockchain projects you support. By staking some of your funds, you make the blockchain more resistant to attacks and strengthen its ability to process transactions. (Some projects also award “governance tokens” to staking participants, which give holders a say in future changes and upgrades to that protocol.)
Staking often requires a lockup or “vesting” period, where your crypto can’t be transferred for a certain period of time. This can be a drawback, as you won’t be able to trade staked tokens during this period even if prices shift. Before staking, it is important to research the specific staking requirements and rules for each project you are looking to get involved with.
Staking is generally open to anyone who wants to participate. That said, becoming a full validator can require a substantial minimum investment (ETH2, for example, requires a minimum of 32 ETH), technical knowledge, and a dedicated computer that can perform validations day or night without downtime. Participating on this level comes with security considerations and is a serious obligation, as downtime can cause a validator’s stake to become slashed.