Staking is often positioned as an alternative to investing in risky coins. By offering users a solid way of governing and supporting the network, Ethereum and Cardano are making it possible for investors to diversify using a new mechanism. This method is indeed slightly safer than just buying coins, but it also comes with multiple risks that should be considered.
We will talk about proof-of-stake, different methods of staking, benefits of using this strategy, and portfolio management tricks used by advanced investors.
What does it mean to stake crypto?
When Bitcoin started its triumphant march through the world of finance, the vast majority of people knew only one way to validating new transactions — the proof-of-work mechanism which was the foundational component of the Bitcoin network.
When the proof-of-work mechanism is employed, users of the network may only use it for utility or provide services as validators by using powerful computational devices to confirm additions of new blocks. While it is a strong and secure architecture, the slow pace of validation coupled with a notable impact on the environment makes PoW a big concern for investors and many users.
Both big coins used this mechanism during the peak of the crypto hype. Bitcoin and Ethereum were proof-of-work network with Cardano branching into a new direction. In 2018, the Ethereum development team announced that they will start working on migrating to the new Proof-of-Stake mechanism. The merge occurred in September of 2022.
The proof-of-stake architecture allows users with a stake in the network become validators. It is an expensive endeavor for an individual investor, but it offers many perks. Staking is participating in the network directly by using your capital to support the network and validate transactions while also running a node from your personal computer or a specialized device.
Many users wonder how to stake Bitcoin. The answer is: “you can’t”. Staking is possible only on networks like Ethereum and Cardano. However, you can use your Bitcoin portfolio and stake it as is on some centralized crypto exchanges offering SaaS (staking-as-a-service) products and allowing users to invest their portfolios entirely.
What is staking in cryptocurrency?
The crypto industry is quite diverse, but it does not mean that all portfolios build with crypto assets are diversified and can withstand all sorts of issues related to investing in cryptocurrencies. Let’s summarize some risks that investors face when buying coins:
- Unpredictable volatility. Even if you use the best volatility indicators and focus on forecasting the future level of uncertainty in the market, you will inevitably experience periods of extreme volatility when nothing can be done. It is the nature of any speculative market.
- Mainstream popularity. It was possible for early Bitcoin adopters to enjoy incredible growth and massive bull runs, but the market is much calmer now with many institutional investors coming in to normalize prices across the board. Investing in hundreds of tokens is not a viable option anymore.
- Price convergence and flattening. Even retail traders focusing on highly consistent strategies such as triangular arbitrage or DCA may not make money due to price stabilization which happens frequently due to instant reaction from marketplaces around the world.
Many other risks affect retail traders who want to make money by actively participating in the market since it is impossible to make correct predictions all the time. To protect market positions, one must correctly identify risks and hedge against them. It is possible to do that by using only traded financial instruments, but staking crypto coins is also a good way of hedging.
What is staking a coin?
When you want to support your favorite network or make money consistently, you may opt to staking your coins instead of holding long-term market positions that may not pay out as you expect. For example, the price of Ether may not change for a long time forcing you to lose money on an “idle” market position.
In such scenarios, receiving a fixed premium on your investments is a much better deal. When combined with potential increase in price, it makes it a safer investment mechanism for many investors. Staking is rewarded by the network based on your participation, transaction frequency, and other metrics. The current reward for staking Ethereum is 5.35% annually.
While high compounding interests may seem lucrative, they are mathematically capped at certain levels meaning that you will enjoy only marginal increases by choosing annualized compound interest over simply using simple annual interest rate. Rewards are fixed and can be easily forecasted.
This way of investment is similar to depositing your money in a bank. Usually, interest rates do not outpace inflation meaning that many investors prefer using their capital to buy other financial assets instead of just storing their money. The same logic is applied in staking. While fixed rewards are quite attractive to many users, the risk of price deflation is something that many have to carefully consider before locking in their assets.
The definition of staking crypto is that you give your tokens to the network to create a node that will act as a validator for the rest of the community. Tokens cannot be used for other purposes for the whole duration of your staking contract. The mechanism may slightly differ depending on which network you are supporting.
Previously, we mentioned that only two networks support the PoS mechanism, but it is not entirely true. Other blockchain platforms may also offer staking programs with lucrative rewards, but the longevity of such investments is what should be contemplated before risking your assets. Both Ethereum and Cardano are time-tested platforms backed by huge communities. The same cannot be said about some other networks.
What is staking coins? It is a method of using your crypto tokens to participate in a network instead of just using it for utility.
How to stake crypto
Each network has its own set of rules and instructions that define the staking process. However, the step-by-step process is similar for all of them:
- Purchase tokens issued by blockchain networks using the PoS architecture. Ethereum, Cardano, Solana, BNB chain, Polygon, and Tron are all viable options.
- The tokens must be transferred to a cryptocurrency wallet. You cannot simply use them from the exchange account. On the other hand, some CEX platforms offer SaaS products.
- All wallets have instructions and guides on how to start staking your tokens. In some cases, individual users may need to install a node on their device to become validators.
The entry price for staking can be quite high. For example, you will need 32 ETH to get started on the Ethereum network which is a huge sum for any individual investor. At the current price, 32 ETH will cost you about $57,600 with staking earning you $3,000 annually. It sounds like a great investment opportunity considering that the token may also go up in price considerably.
So, how do you stake crypto? While the main way to stake is still through a dedicated process adopted by your chosen blockchain network, you may be intimidated by the necessity to run a node or simply be short on money to become a stake owner. Fortunately, you have several options.
How to stake cryptocurrency in 2023
Several options are available to crypto investors interested in staking their tokens.
1. Delegate the technical part of the process. If the only thing that stops you from staking coins is the lack of technological knowhow, you may partner with someone who can setup a node and run it around the clock. It may be beneficial to do so if you have a large enough portfolio to cover overheads with profits from fixed annual rewards.
2. Use staking-as-a-service. SaaS is a specialized product aiming at people who do not have either time or knowledge to run nodes. The service is similar to trust fund as you need to transfer your funds to an escrow account or directly to service providers.
3. Participate in staking pools. In most cases, individual investors do not have enough money to run their nodes independently. Pulling together resources is a much better way to invest. Pools also work with node operators relieving their participants from the necessity to install software and monitor the node performance.
4. Work with your CEX platform! Many centralized exchanges like Binance and ByBit offer staking programs. The former even has its own staking platform called BNB chain where you also can participate. Exchanges often have interesting staking initiatives differing in rewards and risk.
Choosing any method is a good way to start, but each has its own downsides and upsides. Another important issue to consider is that many investors are looking at staking as a hedging mechanism to protect some of their market positions. For example, people with long-term BTC holdings may also stake their ETH to capitalize on the potential market shift toward PoS.
Remember that staking is not just an idle part of your portfolio. It must be there for a reason. At the same time, do not rely on staking as your bread winning strategy. Fixed returns are great for holders of large portfolios, but may be less lucrative to retail traders interested in making money right here and right now.
Depending on your risk tolerance and investment style, you may increase or decrease the portion of your overall portfolio dedicated to staking.
Calculating rewards for staking
Each platform has its own system to calculate rewards per added block which are added to the pool from which returns are paid out to stake holders. Many factors may affect the calculation: validation times, transaction sizes, wealth of nodes, and more. However, you can usually find a calculator on websites of blockchain networks offering staking to their users.
Multiple websites are tracking current and implied staking rewards on different blockchain networks allowing investors to identify interesting investment avenues quickly. What you should do is compare different staking platforms to each other and search for options that suit your portfolio profile. In some cases, choosing something with higher returns is referable. In other scenarios, staking in a more reliable project is a better idea.
Note that annualized returns are only estimations for networks that use monthly compounding interest. While the difference between annual interest rates and monthly compounding rates are negligible in most cases, it can be quite impactful for larger portfolios.
You must understand staking rewards meaning that each project should be analyzed individually and compared to other similar projects. Note that you should consider multiple factors including price changes, market situation, project longevity, and more.
How to pick the right staking project?
Portfolio management is the most important aspect for many investors interested in the crypto industry. It is a good idea to focus on diversifying your investments across multiple asset classes. Cryptocurrencies themselves should be a separate part of your portfolio with other components chosen to offset risks associated with tokens, highly speculative assets.
Within the crypto portfolio, you need to identify strong and weak elements from the risk point of view. Both risky and safe investments can pay off well. However, the outcome is usually more optimistic for portfolios that utilize a combination of both to reach certain equilibrium between profitability and risk. Achieving the right balance can be tricky, but it is possible with the variety of assets available to crypto investors.
Ask yourself several questions:
- Do I have a risky investment in my crypto portfolio? Projects that are highly speculative and promise to go “to the moon” are often money-grabs and may not have the legs to bring in profits in the long run. On the other hand, having leveraged market positions is also a risky investment.
- Do I have safe investments? Instruments that perform consistently while bringing in small profits are often employed by newcomers. While you should have something like DCA buying, GRID bots, arbitrage bots, and long-term market positions on mainstream coins, they should never occupy an overwhelmingly large portion of your portfolio.
- Is there a balance between these two types of investments? You may not need to stake your assets if there is already equilibrium regarding risk and rewards. If different assets in your portfolio protect each other, dedicating a significant portion of it to staking is not a wise decision.
- Should I stake my crypto tokens? Imbalance between risky and safe investments should be addressed and it can be done with staking. If you have many leveraged long-term positions, having a fixed return on some portion of your capital is a good idea. When the amount of safe instruments outweighs everything else, consider staking in a risky project with sky-high annual returns.
Benefits of staking crypto
Before committing to buying tokens to stake, carefully consider advantages and disadvantages of this investment method. First, let’s talk about upsides.
- You can earn rewards consistently. Running a node is a good way to build passive income channels that provide rewards for validating transactions in fees or tokens.
- Make networks more secure. Validators honestly operating within any given ecosystem increase the level of safety for all users. You will directly support and promote security.
- Make it more decentralized. One of the biggest fears of many crypto enthusiasts regarding both PoW and PoS is the risk of centralization with just several large stake holders controlling the whole network. By creating more validating nodes, you promote decentralization.
- Think about the environment. The impact of proof-of-work networks on the nature is quite high. Bitcoin network alone 127 terawatt of energy annually which is more than some developed countries consume during the same period. PoS is 99% more efficient and allows networks to scale better.
- Participate in governance. While Ethereum stakes do not give you much power, some networks give their individual stake holders voting rights. You can directly participate in the development of such projects!
Downsides of staking crypto
Multiple inherent risks are associated with using staking as an investment avenue. Consider them before buying a stake.
- Technological risks are quite high. The necessity to run a node is the biggest limiting factor for many individual investors interested in staking. Software failures, issues with hardware, and even the level of your technical expertise affect the efficiency of staking.
- Slashing is a thing. Some networks employ harsh penalties for validators who deviate from normalized behavior within the network. It is possible that your stake will be removed from the project if you break its rules.
- Centralization is also a risk. A big investor with a large stake can assume control over the whole network leaving other stake holders hanging without any idea what will happen next. It is especially dangerous for platforms where stakes give your governance rights.
- Market volatility can destroy your investments. Retail traders can quickly liquidate their market positions to avoid further losses during periods of volatility. The same cannot be said about stake holders who have to wait until their stakes are released. Market volatility can wipe out such investments.
- The general uncertainty surrounding many staking platforms. We don’t have to worry about giants like Ethereum and Cardano, but other networks employing the PoS mechanism are less trustworthy and many not survive the next “crypto winter”. It means that you never really know what will happen to your stake in the blockchain network within a single year let alone decade.
Choosing the right balance
Note that benefits of staking crypto are often about having faith in the future of the industry as a whole and its separate parts represented by blockchain networks with the proof-of-stake mechanism. The biggest advantage is that you have a good grasp on the amount of money you can earn within a quarter, six months, or a year.
The consistency of rewards is what should be the main focal point that must be contemplated. Are you ready to accept the high risk of market volatility and hope that your tokens will not lose value during the staking period? Do you believe that the accumulation of network-specific rewards is a good investment in the long run?
Many downsides of staking are the reason why many retail traders prefer focusing on other investment activities like:
- Copy trading. Newcomers often choose to simply follow experienced traders who demonstrate good return rates. It is a good option for people without any prior exposure to the crypto market. In many ways, social trading is better than SaaS.
- Automated trading systems. Many investors understand the value of automation in the crypto space where the market operates around the clock and every second of hesitation matters. Some automated trading systems significantly outperform human traders.
- Holding long market positions. Using strategies like distributed cost average for mainstream coins such as Bitcoin, Ether, or Tether can be a very reliable option for many crypto investors. Just holding on to tokens gives you more flexibility.
The main takeaway
Staking is a great investment choice for many investors who are looking for new diversification options or ways to offset specific risks. However, staking should be used only when it is definitively more beneficial than just holding tokens or using tools like automation to generate profits.