Explainer

What Is Crypto Staking and How Can You Earn Passive Income From It?

Learn what crypto staking is, its different types, its risks, when you should consider it, and how you can earn passive income from it.
Average read time:
5
minutes
Key Takeaways
  • There are two main ways of staking crypto: PoS Staking and dApp Staking.
  • PoS Staking refers to when your tokens are staked to a validator responsible for maintaining chain security for a particular network.
  • dApp Staking is when a specific protocol offers yield returns in exchange for you locking your tokens into their smart contracts.
  • The risks in staking your crypto assets include: market risks, security risks, and smart contract risks.

What is crypto staking?

In simple terms, crypto staking is a form of investment where you can earn passive income by simply locking your cryptocurrencies on specific platforms for a specific period of time.

There are two main ways of staking crypto:

Proof-of-Stake (PoS) Staking

PoS, or Proof-of-Stake, staking is the type of staking that is more commonly known and talked about. It is when you stake your crypto tokens to a validator on a blockchain network. The validator, in turn, is responsible for maintaining chain security on said network. As the number of tokens staked to the validator increases, so does the security and value of the blockchain.

Decentralized Application (dApp) Staking

dApp, or Decentralized Application, staking is a simpler form of staking in which the rewards are provided by the protocol that wishes users to lock their crypto assets into smart contracts. As the tokens generate rewards, the terms of the smart contracts are automatically fulfilled.

How can you earn passive income from staking crypto?

While a user’s journey in staking crypto might be simple, the actual mechanics are complicated. If one were to break it down in a simpler level however, you could say that when you stake your crypto, $OM for example, it enters a pool where it can be used to generate additional cryptocurrencies, similar to an interest-bearing savings account.

Through crypto staking, projects encourage users to lock up and hold their tokens in exchange for an opportunity to earn yield to reduce selling pressure. In fact, the tokenomics of most cryptocurrency projects set aside a portion of their maximum cryptocurrency supply to cater to this reward opportunity for users.

PoS Staking

PoS chains utilize validators as markers of authenticity of on-chain data. To make sure that the validator plays an active role in securing the chain, an economic incentive is used to encourage users to stake their tokens. The rewards received by the validator is split among its stakers, and the chance of producing the next block is directly proportional to the stake per validator.

dApp Staking

Cryptocurrency projects that launch their own native tokens often incentivize users to stake, and therefore lock, their tokens for the long term by offering yield. This way, selling pressure is reduced. The yield is included in the tokenomics and can be often seen as ‘ecosystem rewards’.

What are the risks in crypto staking?

As with anything in technology, or the world in general, crypto staking is not without its risks. They can be split into three main categories: market risks, security risks, and smart contract risks.

Market Risks

The crypto market is volatile and therefore, the value of the staked tokens may differ based on external market conditions. Since the yield is often generated in the native token, a drop in the token price can easily affect the user’s investment.

Security Risks

Some projects may not follow the appropriate risk measures to secure the funds that have been entrusted to them by the users. For PoS chains, this also includes the risk of slashing, which happens when a validator does not perform its duty of securing a blockchain. In this situation, all the tokens staked to the validator are eligible to be slashed. Therefore, it is crucial that you stake your PoS tokens only to validators whom you trust.

Smart Contract Risks

If a project has not audited its smart contracts properly or if it inadvertently has generated an exploitable contract, then funds inside the smart contract are at risk. In the case of dApp staking, those funds are provided by users who lock up their tokens in exchange for a yields.

When should you consider staking your crypto?

You should consider staking your cryptocurrencies if:

  1. You firmly believe in the project. Since the yield you receive from staking is generally paid out in the project’s native token, receiving more tokens of a project you do not believe in is futile.
  2. You know what the terms of staking are. Each staking service has its own lock-up periods, tokenomics, and yields. As a user, you must be aware that you know the terms properly before locking up your tokens.
  3. You are comfortable with volatility. While crypto offers the attractive possibility of huge rewards, its relatively larger volatility also makes it susceptible to huge losses. If your risk tolerance is low or if you have limited financial resources, it would most likely be better to not engage in crypto staking.
IMPORTANT INFORMATION

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the author and the comments, opinions and analyses are rendered as of the publication date and may change without notice. There is no guarantee that any forecasts or predictions made will come to pass. The information provided in this material is not intended as a complete analysis of all material facts or circumstances regarding any country, region or market. All investments involve risks, including possible loss of principal.

Risk management does not imply elimination of risks, and not all investments are suitable for all investors. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by MANTRA to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. Data from third party sources has not independently verified, validated or audited. MANTRA accepts no liability whatsoever for any loss arising from use of this information; reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Any products, services and information in this material may not be available in all jurisdictions and are offered local laws and regulation permit. Please consult your own financial professional or legal advisor for further information on availability of products and services in your jurisdiction. Please also see the disclaimer which is found at the bottom of this website under the heading “Important Disclosures”.​

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