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June 20, 2024

What Is Crypto Staking & Is It Safe?

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What Is Crypto Staking & Is It Safe?
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Discover the essentials of crypto staking. Enhance security, earn rewards, and understand the pros and cons with our in-depth guide.

Crypto staking is a way to improve the security of your favorite cryptocurrencies and earn some extra rewards as an added benefit. In this article, we’ll provide a quick introduction to staking and explain its advantages and drawbacks.

Before we explain what crypto staking is, we need to understand Proof-of-Stake. Let’s first quickly explain the topic of consensus and the different methods blockchains implement to achieve it.

Blockchains and consensus

For a blockchain to be functional, all nodes in the network must reach a consensus about the current state of the network and the history of transactions, without having to rely on a single source of truth. 

There are different ways for a decentralized network of blockchain nodes to achieve consensus, but the most commonly used consensus mechanisms fall either into the Proof-of-Work (PoW) or Proof-of-Stake (PoS) category.

Proof-of-Work

Satoshi Nakamoto’s ingenious implementation of Proof-of-Work was one of the main reasons why Bitcoin was able to reach much greater success than previous attempts of creating a decentralized digital currency. 

On blockchains using PoW, miners compete with each other to become the first to solve a resource-intensive mathematical problem (these computations are usually performed by highly specialized computers). 

The miner who finds the solution first has the privilege of adding the next block to the blockchain and collects a "block reward" in exchange for their efforts. As competition grows, cryptocurrency mining becomes extremely energy intensive, as miners need an ever-increasing amount of computing power to stay competitive.

While PoW is still used by Bitcoin and other major cryptocurrencies (examples include Litecoin and Bitcoin Cash), newer blockchain projects tend to choose Proof-of-Stake consensus.

Proof-of-Stake

PoS, which was pioneered by Peercoin in 2012, takes a fundamentally different approach to achieving consensus. In PoS consensus mechanisms, the network participant to add the next block to the blockchain is selected based on their holdings of the blockchain’s underlying cryptocurrency. The larger a participant’s stake is, the more likely they are to be selected.

PoS mechanisms implement penalties such as “slashing” to punish validators that act against the rules of the protocol, for example by trying to pass off a double-spend transaction as valid or trying to alter the history of transactions in other malicious ways. When a validator is penalized a portion or the entirety of their stake is removed from them. 

Essentially, PoS consensus assumes that validators having skin in the game will incentivize them to act in the network’s best interest.

What is staking?

The term “staking” refers to temporarily locking up some of your cryptocurrency on a Proof-of-Stake blockchain in order to improve the security of the network and earn rewards in return. For example, you can stake ENJ to help secure Enjin Blockchain and earn rewards, which are paid out in ENJ.

Depending on the specific PoS consensus mechanism, it can be possible to stake cryptocurrency even if you don’t directly operate a validator or participate in block production. 

In these PoS variants, users can “delegate” their stake to a validator that participates in the block production process and earn a share of the rewards earned by the validator. Such variants of PoS are sometimes referred to as Delegated Proof-of-Stake (DPoS), but they can also have other names or are simply referred to as Proof-of-Stake.

Enjin Blockchain is an example of a PoS blockchain where users can delegate their tokens to a validator, instead of having to maintain the infrastructure for block validation and production. This makes it very simple to get started with Enjin staking directly from your Enjin Wallet app.

Realistically, most regular cryptocurrency holders will choose delegation over operating their own validator, as it is much more convenient and requires less technical knowledge. However, the downside of delegation is that the validator you’re delegating your tokens to will take a cut of the rewards, so your rewards will typically be lower compared to running your own validator.

Some blockchains (perhaps most notably Ethereum) don’t have a delegation mechanism. However, there are workarounds such as liquid staking tokens and custodial staking that still allow everyday users with limited resources or technical knowledge to participate in staking and earn rewards.

Another important aspect of staking is that your tokens typically cannot be used for any other purpose while they’re being staked. If you want to send your tokens to another wallet, for example, you will need to unstake them first.

What Is Crypto Staking & Is It Safe?
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Is staking safe?

Staking on well-established blockchain platforms is generally considered safe. However, there are some things you should keep in mind when deciding whether to stake a cryptocurrency or not.

Do you think the cryptocurrency you want to stake is a good hold regardless of staking?

When choosing the best crypto to stake, it’s important to consider multiple factors and not just the amount of tokens you’re expected to earn.

Staking rewards are typically expressed in APY, i.e. how much you would earn if you staked for one year. So, if you staked 1,000 tokens for a year and earned a 10% APY, you would end up with 1,100 tokens after a year. 

It’s important to understand that staking APYs refer to the rate at which you’re expected to earn tokens, not money. If the price of the token you’re staking declines enough to offset the rewards you earn from staking, you can still end up with a loss in dollar terms even if you’re staking. For example, if the Ethereum price declined by 10% against the US dollar in a year but you earned 5% on your ETH in staking rewards, you would still be down in dollar terms.

Another important aspect of staking to keep in mind is that staking rewards can fluctuate over time. Typically, rewards will be higher when a lower percentage of the token’s supply is staked, and vice versa. You can use various online tools to see the reward history of the cryptocurrency you’re interested in staking to get an idea of how volatile its staking rewards are.

What are the barriers to staking and unstaking?

Depending on the specific implementation of Proof-of-Stake the cryptocurrency is using, there can be major differences between the ease of staking and unstaking. 

In some cases, there can be a buffer period between you staking your tokens and the tokens starting to earn rewards. Additionally, some staking protocols don’t release tokens back to the user’s control immediately when the user wishes to unstake their tokens, but impose a waiting period before the tokens become available. 

This is an important consideration if you need quick access to your cryptocurrency. If you want to spend or transfer your tokens to another wallet, you will need to unstake your tokens first. In some cases, it can be a good idea to leave a portion of your tokens unstaked so you can access them instantly.

Enjin allows for Liquid Staking. If you want to unstake your ENJ, the wallet will attempt to find liquidity to directly swap your staked ENJ for unstaked ENJ tokens. This bypasses the normal lock-up period, allowing users to immediately unstake and use their tokens. If there is not enough liquidity, you will have to wait for an unbonding period to complete before you can access your ENJ tokens again. The unbonding period lasts around 28 days.

Is the validator you’re looking to stake with reputable?

If you’re looking to stake by delegating your tokens to a validator, you should do some research on the validator you’re considering instead of just blindly picking the validator that’s offering the highest rewards at the moment. Choosing a validator with a long history of successful participation in the network will reduce the risk of losing tokens to slashing or other penalties. When staking with Enjin Blockchain, users can stake directly with a nomination pool, which handles the selection of validators.

Different uses of the term “staking”

In the cryptocurrency space, you will sometimes see the term “staking” used to describe concepts that have nothing to do with achieving consensus on a Proof-of-Stake blockchain. 

There’s a growing trend of using the word “staking” to describe any type of scheme or program where users passively earn income by temporarily locking up their cryptocurrency. For example, cryptocurrency lending programs where users can earn interest by lending out their cryptocurrency are sometimes referred to as “staking”.

This loose usage of the term “staking” can cause some confusion among users who don’t have a lot of knowledge about cryptocurrency and blockchain. Before choosing to lock up your crypto in any program that advertises itself as “staking”, make sure to do some research so you understand what’s happening in the background and how the rewards are being generated.

The bottom line

Proof-of-Stake is an environmentally-friendly and efficient way of achieving consensus on blockchains. In the coming years, we will likely see PoS blockchains continue to increase their share of the cryptocurrency market.

Participating in staking on PoS blockchains is much simpler than mining on PoW blockchains, and you can earn some rewards even if you don’t hold a large amount of crypto. If you’re a long-term holder of a cryptocurrency that runs on a Proof-of-Stake blockchain (for example ENJ), you should strongly consider staking it. 

In most cases, staking has more benefits than downsides compared to simply holding the cryptocurrency in your wallet, but it’s important to understand that there are some risks involved with staking as well.

About the Guest Author:

Peter has been covering the cryptocurrency and blockchain space since 2017, when he first discovered Bitcoin and Ethereum. Email: peter.wind@coincodex.com

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