In the crypto world, staking is widely discussed as it allows cryptocurrency holders to earn passive income using the coins and tokens they possess. However, prior to selecting any staking alternatives, it is crucial to comprehend their significance.
The concept of staking in the crypto realm is solely possible because of the dynamics within proof-of-stake blockchain networks. This consensus mechanism is commonly used nowadays and offers a power-efficient substitute to proof-of-work, enabling blockchains to safeguard themselves against malicious actors.
In these networks, validator nodes play a crucial role in maintaining the blockchain by validating new blocks of transactions and permanently adding them to the blockchain. As a result, they earn rewards from the network. However, to participate, validators must first stake a substantial amount of their own cryptocurrency within that network. For instance, in Ethereum, validators are required to stake 32 Eth to begin, which may pose a challenge for many. This is why this blockchain is called "proof-of-stake" as validator nodes must prove their stake before they can take part. The reason for this requirement is security. Since there is no identification process for becoming a validator, the network needs its own mechanism to prevent these nodes from tampering with the network. By requesting a "staking deposit" from validators, the blockchain can use the staked cryptocurrency as a motivation for ethical conduct and a deterrent against fraudulent activities.
Validators receive rewards from the network for their contributions, which include computing power and resources, since they are the ones responsible for keeping the network operational for its users. Moreover, they can accomplish all of this while retaining control of their staked coins, which are deposited in the blockchain's smart contract, ensuring that although they are committed, they are never under the control of anyone else.
To summarize, staking rewards are distributed to validator nodes in proof-of-stake blockchains as they contribute their efforts and computing power to assist the blockchain in functioning correctly.
If you wish to avoid the financial and technical obligations of becoming a validator, there are a few indirect staking alternatives available. These involve delegating your coins to a validator, who will carry out the process on your behalf.
Delegating your coins has the advantage of lowering the barriers to entry for earning passive income. You do not need any equipment or a significant initial investment to participate, as someone else will handle the technical aspects of the job.
There are two types of staking options available: non-custodial and custodial. Non-custodial implies that your coins will remain in your own crypto wallet for the staking period, while custodial requires you to relinquish control of your coins to a custodian during the staking period. Understanding the difference between these options is essential, especially if self-custody is important to you.
Additionally, there are noteworthy variations in terms of the rewards you can earn and the transparency of the overall process.
Delegation is a feature of certain blockchain networks that enables holders of the network’s native coin to contribute their coins to a validator node, allowing the delegator to earn a percentage of the rewards generated by that node. By delegating their coins, delegators help validator nodes by increasing their chances of being selected by the network to perform work. This means that delegators can earn rewards without having to become a validator themselves.
Delegating through a validator node is non-custodial, which means that your coins will remain in your own crypto wallet, allowing you to retain control over your funds via your private keys. You can remove your staked coins from the protocol at any time, in compliance with the fixed, initial bonding period set by the protocol. However, this type of staking requires you to trust the validator you’re using to do its work honestly, as errant behaviour by the node could result in a decrease in your rewards.
On the positive side, validator services typically offer a high degree of transparency regarding the percentage of rewards offered, fees charged, and reputation of the validator node based on previous activity. The rewards earned for delegating your coins to a validator are proportional to your stake, and you'll pay a small commission to the validator as a service fee for maintaining the node. Fees vary depending on the validator and the protocol, but are clearly stated upfront, allowing you to understand the yield before bonding your coins.
Custodial staking refers to the process where a custodian, such as a staking provider or centralized exchange, stakes cryptocurrencies on behalf of the owner. Just like traditional banks use their clients' funds to earn extra revenue through rehypothecation, staking providers and centralized crypto exchanges may offer to stake your coins and share the rewards with you. By consolidating assets from numerous users, these services can operate a large number of validator nodes with high throughput.
Staking through an exchange or provider is possible even for those without prior experience. There is no minimum deposit requirement and no need to concern oneself with the technicalities of staking, as the custodian and validator node will take care of those. However, in exchange for this convenience, you will relinquish control of your coins. By using a custodial staking service, you will need to transfer your cryptocurrency to a third-party wallet. As a rule of thumb, it's important to remember that you do not own the coins if you do not control the keys. Consequently, you will be unable to select which validator node to stake your coins with or withdraw them before the predetermined time period expires. Opting for this alternative will result in the least amount of rewards since centralized exchanges and providers charge fees for offering this service, ultimately decreasing the final yield for the end user. Although the process is straightforward, you will be required to pay a premium for the convenience it offers. Additionally, it may be challenging to determine the exact percentage the platform takes from the original staking reward. On the bright side, there is no risk of slashing associated with this option, as the platform bears the responsibility.
By staking cryptocurrencies, individuals can earn passive income from their idle assets. The level of control, participation, and potential rewards can differ depending on the staking method selected.