Staking your cryptocurrency is a lot like earning interest on your deposits in a bank account. Although there are a few differences between the two, the analogy works pretty well for gaining an understanding into this aspect of cryptocurrency. Cryptocurrency projects that offer staking allow you to earn as much as 20% per year on your holdings. While 20% is quite a high return, an average return is around 5%. Staking is a great addition to the cryptocurrency space for a number of reasons. Staking adds aspects of familiarity, engagement, and reward into the ecosystem, making the investment all the more worthwhile.
Two Types of Staking
Broadly speaking, there are two types of staking. Centralized staking, also known as lending, and decentralized staking, which is more of a participatory action. With either form of staking, you earn the return on investment in the same asset that you’ve staked. So if you’ve staked XTZ, then you earn your reward in XTZ. The two types of staking have various pros and cons, so let’s dive into the details.
Decentralized staking works by directly locking up tokens on a blockchain. Tokens can be staked, or locked inside the network, in exchange for the chance to produce a block, which in turn, you would receive a reward for. This is called Proof of Stake. This method of block production is fundamentally different from how the bitcoin network operates.
Just like with bitcoin, there is a reward for producing the next block. This is how the annual rate of return is calculated. The rate of return is an estimate though, as it can fluctuate by quite a lot depending on how much others lock up for staking purposes. Here is a brief list of projects that you can stake your tokens to.
Perhaps the project that is getting the most attention on the proof of stake front, is Ethereum. Ethereum is currently a proof of work blockchain. The blockchain is transitioning to proof of stake, meaning anyone can participate in block production, simply by locking up some ETH. Staking will be available after the launch of Ethereum 2.0.
Centralized Staking AKA Lending
The main difference between lending and staking, is that you give up direct access to your funds, often to earn a higher rate of return. Various lending services such as BlockFi, Nexo, or Crypto.com connect lenders with borrowers, and earn their margins in between. You deposit your funds into their custodial wallet, and earn an agreed-upon rate of return. Most times, these services make you lock up your cryptocurrency for a predetermined amount of time.
With lending, you are not restricted by the blockchain needing to be proof of stake. You can lend any asset that the lending services wants to offer to borrowers. This is a major perk of lending out your assets. For example, you may be very bullish on bitcoin, and want to earn interest on the base amount of bitcoin you own. You won’t be able to do this in a decentralized fashion, as bitcoin is not proof of stake. You may however, choose to revoke your access to the bitcoin to a lender, that will give you a guaranteed rate of return. Be careful though, if a rate seems too good to be true, it probably is. Make sure you check the legitimacy, and reputation of the lender, before depositing your assets on their services. For example, Crypto.com has insurance in case of loss of funds, or a hack. Therefore, they might be a sensible choice for a lending provider.
Lock Up Periods
With both types of staking, there is often a lockup period that you need to be aware of. If you expect to have easy access to your funds that you’re earning a rate of return on, think again. This is one of the tradeoffs. It doesn’t matter if the market is plunging and you want to get rid of the assets you are staking. Your assets are locked into either a third party service provider, or the blockchain itself. You must wait out the duration that you agreed to before regaining access to your funds.
Some blockchains use the term “vesting” to refer to the lockup period. Vesting is a term borrowed from the corporate and business world. In the context of cryptocurrency, it is typically used in conjunction with the word period, i.e. “vesting period”. The vesting period is a duration of time that one needs to wait in order to gain access to their funds.
Some services exist that take out the technical complexity with staking your coins on a proof of stake blockchain. They simply automate the technical process of initiating the staking mechanism. Since proof of stake is relatively new to the world, it is still a technically involved process that requires some technical expertise to initiate. Some projects make the process super simple, by adding specialized buttons directly into their core wallet. Other projects haven’t built user interfaces to simplify the process, creating the need for staking service providers.
Pool-X is a new platform built by KuCoin, the technical aspect of staking. They’ve made it very simple for you to deposit your tokens, and stake them to earn a return on investment. Furthermore, they’ve built the ability for people to trade “staked” tokens for “unstaked” tokens, allowing you to skip the lockup period typically required to withdraw your tokens. You can exchange your locked tokens for unlocked tokens, and move them as you see fit.
Staking is a lot like having a savings account with your bank. The banks allow you to earn a percent of your holdings on a typical savings account. This is because banks are actually lending your money behind the scenes. The interest rate that they give you is their way of compensating you for keeping your money in their bank. The concepts of staking are therefore not that foreign to everyday individuals. The world of cryptocurrency tends to create new terms for old concepts. Here at CryptoVantage, we like to make sure you understand that the world of crypto is just updating the world of finance. Simply put: staking is saving.