Glossary
What is Staking in Crypto? Token Staking Explained
What is Staking in Crypto?
Staking crypto is the process of accumulating and holding tokens. Staking often generates rewards in the form of additional tokens. This process is similar to earning interest on a savings account, where users receive a return for holding their funds.
Staked tokens are usually locked up for a specific period, during which they are used to validate transactions, participate in , or provide in decentralized finance (DeFi) platforms. The higher the number of crypto staked, the greater the influence and rewards. Staking can be done by individual users or delegated to a staking pool or validator.
Some platforms have a minimum staking requirement, while others allow users to stake any tokens. Similarly, the staking rewards can vary based on the network’s rules, token supply, and participation rate.
Staking - Key Concepts
- Proof of Stake (PoS): Staking is a key feature of PoS blockchains, where users validate transactions and secure the network by staking tokens.
- Staking Rewards: Users earn rewards for staking tokens, which can be used to participate in governance or sold on the market.
- Staking Pools: Users can delegate their tokens to staking pools or validators to earn rewards without running a node.
- Lockup Period: Staked tokens are usually locked up for a specific period, during which they cannot be transferred or traded.
Proof of Stake (PoS) Staking
Networks like Ethereum 2.0, Cardano, and Polkadot use PoS consensus mechanisms that rely on staking to secure the network. In PoS blockchains, validators are ‘randomly’ selected to create new blocks and validate transactions. Users must stake a certain amount of crypto as collateral to become a validator.
Validators are rewarded with transaction fees and newly minted tokens for their work. However, if a validator acts maliciously or fails to validate transactions, they can lose their staked tokens.
Proof of Stake is more energy-efficient than Proof of Work (PoW) consensus mechanisms, as miners don’t need to solve complex mathematical puzzles. Instead, validators are chosen based on the number of tokens they hold.
Staking Rewards
Staking rewards can vary depending on the network’s rules and token supply. Some networks offer fixed rewards, while others have variable rewards based on performance. These rewards work as an incentive for users to participate in securing the network and maintaining its operations.
The rewards include transaction fees, newly minted tokens, or governance tokens. They can then be sold or reinvested in the network to increase the staking amount and earn more rewards.
Neo Compound Staking
The Neo blockchain rewards users who own NEO with GAS tokens. Users can convert their GAS tokens into more NEO, increasing their stake and rewards. This process can be done manually or automatically through the Neo Compound platform.
CNeo (Neo Compounder) is a wrapped version of Neo that automatically compounds the GAS rewards back into NEO. This works by automatically swapping the earned GAS for NEO and adding it to the user’s staked amount.
Staking Pools
While some platforms require users to run a node to stake tokens, others use a simpler approach called staking pools. Staking pools are smart contracts that allow users to delegate their tokens to a pool or validator to earn rewards without running a node.
This approach is frequently used with locked periods, where users can’t withdraw their tokens until the lockup period ends. Depending on the network’s rules, the time frame can vary from a few days to several months. In general, the longer the lockup period, the higher the rewards.
Yield / Token Farming
Staking pools can also seen as a form of , where users earn rewards by providing liquidity to swap pools. When liquidity providers stake their tokens in a pool, they receive a share of the transaction fees. This process is similar to staking, but users provide liquidity to decentralized exchanges instead of validating transactions.
Staking Risks
Highly volatile markets can affect staking rewards, as the value of the staked tokens can fluctuate significantly. If the token is locked up for a long period, users may miss out on selling opportunities or face losses if the token’s value decreases.
Users should also be aware of the risks associated with staking pools, such as smart contract vulnerabilities, exit scams, or malicious actors. Platforms may offer high rewards to attract users and then disappear with their staked tokens. Similarly, high rewards can be unsustainable and lead to inflation or token devaluation.
Staking may also involve delegating control of the tokens to a third party, which can be prone to hacking or mismanagement. Users must evaluate the risks and rewards before staking their tokens and choose reputable platforms with a good track record.
Staking Governance
Voting power is often tied to the number of tokens staked, giving users a say in the network’s governance. However, if a small group of users holds a significant portion of the tokens, they can control the network’s decisions and policies. This can lead to conflicts of interest, centralization, and unfair governance practices.
If a few large holders collude, they can manipulate the network’s rules and decisions to their advantage. Users who have their tokens staked or locked may suffer the consequences of these decisions. On the other hand, if the network is decentralized and has a wide distribution of tokens, governance decisions are more likely to be fair and transparent.
Lockup Period
A lockup period is when staked tokens are locked up and cannot be transferred or traded. This removes liquidity from the market and ensures users don’t withdraw their tokens before the staking period ends. A lockup period can help stabilize the token’s price and prevent users from selling their crypto at the first sign of volatility.
During the migration from Ethereum to Ethereum 2.0, users had to lock up their ETH tokens for over two years. This process incentivized users to participate in the network’s upgrade and secure the blockchain while reducing the circulating supply of ETH.
Early Withdrawal Penalties
Some platforms allow users to withdraw their staked tokens before the lockup period ends, but they may incur penalties for early withdrawal. This penalty can be a percentage of the staked amount or a reduction in the rewards earned.
The flexibility to withdraw tokens early can benefit users who need liquidity or want to exit the staking pool. However, the penalty discourages users from withdrawing their crypto prematurely.
