What is staking?

What is staking?

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 crypto users, knowing that staking is a way of earning rewards while holding onto 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. 

How does staking work?

If a cryptocurrency you own allows staking — current options include Ethereum, Tezos, Cosmos, Solana, Cardano and others — you can “stake” some of your holdings and earn a reward over time.

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. 

Why do only some cryptocurrencies have staking?

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. 

  • Cryptocurrencies are typically decentralized, meaning there is no central authority running the show. So how do all the computers in a decentralized network arrive at the correct answer without having it fed to them by a central authority like a bank or a credit-card company? They use a “consensus mechanism.” 

  • Many cryptocurrencies — including Bitcoin and Ethereum 1.0 — use a consensus mechanism called Proof of Work. Via Proof of Work, the network throws a huge amount of processing power at solving problems like validating transactions between strangers on opposite sides of the planet and making sure nobody is trying to spend the same money twice. Part of the process involves “miners” all over the world competing to be the first to solve a cryptographic puzzle. The winner earns the right to add the latest “block” of verified transactions onto the blockchain — and receives some crypto in return. 

For a relatively simple blockchain like Bitcoin’s (which functions a lot like a bank’s ledger, tracking incoming and outgoing transactions) Proof of Work is a scalable solution. But for something more complex like Ethereum — which has a huge variety of applications including the whole world of DeFi running on top of the blockchain — Proof of Work can cause bottlenecks when there’s too much activity. As a result transaction times can be longer and fees can be higher.

What is Proof of Stake?

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 stake their tokens. 

  • 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. Stakers also help establish which blocks are valid. 

  • The exact implementations vary from project to project, but in essence, users vote their tokens to ensure the security of the blockchain. Their staked tokens act as a guarantee that they are acting in good faith and as a disincentive to violating the protocol rules.

What are the advantages of staking?

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 is also a way to contribute 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.

What are some staking risks?

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.

How do I start staking?

Staking is generally open to anyone who wants to participate. That said, becoming a full validator can require a minimum number of tokens, 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.

But for the vast majority of participants there’s a simpler way to participate. Via an exchange like Coinbase, you can contribute any amount you wish, without needing to purchase or operate expensive validator hardware. Staking is available to most Coinbase customers in the U.S. and many other countries.

Learn more about staking on Coinbase