What Is Crypto Staking? Advantages & Risks

Cryptocurrencies offer various opportunities to investors and enthusiasts to participate and earn from a new emerging financial system. Some people prefer to trade actively, some others prefer to buy and hodl. However, there are also other ways to earn from crypto, and if you have a decent budget, you can consider crypto staking as a reliable source of income. But what is crypto staking, and what are its advantages and risks?

Crypto staking is the process that allows holders to participate as validators in Proof of Stake (PoS) blockchains by locking up their assets for a certain period and getting rewarded with additional cryptocurrencies. For example, consider you’re staking 100 SOL (currently worth around 132$ per coin: 100 SOL = $13,200) for 365 days, with the current APY (Annual percentage yield) of around 6%, after 1 year you’ll get additional 6 SOL, worth $792 at the current rate. However, you must consider that cryptocurrencies are volatile, so in a year, the price of SOL can increase or decrease, bringing both advantages and risks. 

In this detailed article, we’ll explain how crypto staking works and what the advantages and risks are associated with it, also providing a step-by-step guide and a comparison between various cryptocurrencies to understand the differences between locking periods and APY staking rewards. Let’s start!

How does Crypto Staking work?

When you stake your crypto assets, you’re essentially locking them in the blockchain network, making them unavailable for trading, increasing the stability of the network and the price, and contributing to validating transactions on the blockchain. You’re basically playing an important role in securing Proof of Stake networks and earning a passive income by simply hodling and locking your cryptocurrencies.

Unlike Proof of Work (PoW) networks, such as Bitcoin, which relies on energy-intensive mining to solve complex problems, validate transactions, and ensure network security, on Proof of Stake (PoS) networks, you don’t need expensive hardware with high computational energy. Conversely, in PoS, the actors that validate transactions are called validators, and they “just” need to stake their holdings to be selected and earn rewards. Consequently, we can define PoS as more environmentally sustainable compared to PoW, even if it also has some disadvantages that we’ll explore later.

There are various types of staking depending on the blockchain protocol. In some systems, validators must run dedicated nodes that require technical expertise and infrastructure, and consequently, you need a consistent budget in cryptocurrencies to start staking. However, in most blockchain networks, there are more accessible options like staking pools or staking through exchanges, where participants can contribute with smaller amounts of crypto and still earn rewards without having to manage the technical aspects.

Is Crypto Staking Profitable?

Crypto staking can be profitable, especially if you’re staking a large amount of cryptocurrencies, considering that you can earn usually around 5-15% yearly, depending on the blockchain and asset. The rewards generated yearly depend on various factors, including the staking rewards of the blockchain (APY), the volatility of the token, the lock-up periods, the compounding rewards, the network inflation, and the network fees.

Factors influencing crypto staking rewards

The factors, including the rewards of crypto staking, are:

1. Staking rewards (APY) of the specific blockchain 

Each blockchain network has its own staking reward structure. Networks like Ethereum, Solana, or Cardano offer different annual percentage yields (APY), usually ranging from 4% to 20% or more, depending on network conditions and your level of participation. Here we report a table with the current APY (updated: 11 September 2024) of the most popular PoS blockchains:

2. Price volatility

Another major factor influencing staking rewards, however, is the price volatility of the asset. In fact, even if you earn a percentage on token staked, the rewards are distributed in the form of the cryptocurrency staked, and it means that if the value of the token drops, consequently, your rewards (and the overall value of your assets staked) decrease. However, volatility could be also beneficial if, conversely, the value of the token increases, consequently amplifying your returns on the investment and the overall value of your assets. It clearly underscores a potential risk of crypto staking, but also a potential advantage, depending on market trends.

3. Lock-up periods

Many staking programs come with lock-up periods, during which your staked assets are frozen and cannot be sold or traded. This can be a double-edged sword: while you may earn rewards during this time, you also risk missing out on opportunities to sell if the market moves unfavorably. Some networks offer flexible staking options, where you can unstake your assets at any time, but these often come with lower rewards compared to fixed-term staking. Here we report a table with the unstaking period you need to wait before being able to withdraw your assets, depending on the blockchain: 

4. Compounding rewards

Compounding could be a good way to maximize your crypto staking rewards: It means that the rewards are automatically or manually added to your already staked assets, exponentially increasing your rewards over time, even if slowly. Some platforms and blockchains automatically implement auto-compounding, such as Solana, while others, such as Cosmos, require your manual intervention to add the rewards to staked assets. Compounding your rewards could be particularly effective if you’re planning to stake assets over a long period, such as years. However, if the blockchain or platform requires a manual transaction, it comes with associated fees, so evaluate them first.

5. Network inflation and token issuance

Even if you get additional cryptocurrencies through staking, you must consider the overall token economy of the blockchain since some of them have inflationary models and issue new tokens constantly, consequently increasing the supply, reducing the scarcity, and decreasing the potential growth rate of the price of the asset. It’s essential to understand the tokenomics of the asset you are staking to assess whether inflation might erode your profits in the long run. It’s your own responsibility to DYOR (Do your own research) before staking any cryptocurrencies.

6. Network fees and infrastructure costs

Other factors to bear in mind are transaction fees and infrastructure costs. For example, if you’re staking your cryptocurrencies through a staking pool using an external validator (meaning that you entrust staking to a full-node that takes care of the infrastructure and technical complexities associated), there are associated fees that impact your overall profitability, taking a percentage of your earnings. In case you run your own node, there are additional infrastructure costs, such as electricity and hardware maintenance, which need to be considered when calculating net profits.

Advantages and Risks of Crypto Staking

As you understand in this guide, there are various advantages and risks in crypto staking that you should carefully evaluate to have a complete overview and make conscious decisions.

Advantages of crypto staking

The advantages of crypto stake are various, including the following: 

Passive income

The main advantage of staking cryptocurrencies is the possibility to earn a passive income without needing to trade. You simply lock your holding for a certain period, and you start earning additional tokens through a platform or a wallet. Even if the rewards depend on the blockchain and multiple factors, the percentage earned is often higher compared to saving accounts or bonds.

Network security and governance

By staking your crypto assets, you also earn governance power in the network, having the opportunity to vote on key decisions and contributing to the overall security and stability of the network. By locking up your assets, you also reduce the number of tokens in circulation, making it easier for the asset price to grow, with fewer tokens in circulation for trade.

Low barrier to entry

Unlike mining, which requires significant initial investment to buy expensive hardware with high computational power and energy consumption, staking requires minimal expertise and funds to start earning. Usually, there is no limit to the number of tokens you need to stake to start earning, and you can start with minimal amounts and increase them over time.

Compounding opportunities

Another benefit of staking is the potential to compound your rewards and boost your profits.

By adding rewards to already staked tokens, the APY is calculated on a new, bigger amount of tokens, leading to exponential growth over time. However, to work effectively, this strategy implies staking tokens for a very long period, typical years.

Supporting co-friendly blockchain networks

Unlike PoW, which consumes a lot of energy, Proof of Stake networks are quite eco-friendly and require significantly less energy compared to PoW. Staking cryptocurrencies is a good way to support projects focused on ESG and innovate the blockchain sector without negatively influencing the environment.

Risks associated with crypto staking

Even if the benefits might sound great, you must also consider the risks associated with crypto staking.

Price volatility and risk of losses

Even if you can earn an additional fixed percentage of cryptocurrencies, you must consider that you’re basically investing in cryptocurrencies, and, as with any other investment, there are risks associated with it. If the price of the crypto drops, you’ll see the overall value of your investment decrease. Do not only consider the APY of the cryptocurrency when starting staking but also consider the underlying value and the long-term growth potential. Stake assets that you believe will grow in the next few years by analyzing them through technical and fundamental analysis.

Lock-up periods

If you need to lock up your assets to start earning with staking, you must consider that during this period you can’t sell or trade them. It can be a significant disadvantage if market conditions change and the price of the asset drops. If you want to sell to avoid additional losses, you can’t until the lock-up period ends, and it usually means waiting for various days, depending on the cryptocurrency.

Inflation and dilution 

Some blockchains implement an inflationary system and issue new tokens continuously, increasing the supply and decreasing the scarcity of the asset. This means that even if you earn a fixed amount of rewards, e.g., 5%, if the company behind the cryptocurrency issues 5% more tokens during a year, your reward is basically canceled due to inflation. Study the token economy before starting staking.

Validator and platform risks

If you’re staking using a third-party validator or platform, as people commonly do on Ledger, for example, you must consider that there’s a counterparty risk. If the validator or platform incurs a security breach and they are staking your token, your assets are at risk. In case of a severe hack, you can even lose all your funds. Additionally, validators charge fees that erode the net rewards you receive. If you’re using a third-party validator, verify its reliability, its fees, its security protocols, and its insurance.

Step-by-Step Guide to Earn from Crypto Staking

Now, having gained the knowledge needed to understand how crypto staking works and its advantages and risks, you’re ready to stake your first cryptocurrency if you think this strategy suits your investment goals.

1. Choose the right cryptocurrency 

First of all, conduct fundamental and technical analysis and evaluate which cryptocurrency is more suited for your goals, considering also the APY, the lock-up periods, network stability, and, most importantly, the long-term growth potential. Be sure not to be trapped in cognitive bias, such as confirmation bias (you confirm a pre-existing belief without analyzing the situation objectively), and apply critical thinking to choose rationally and manage the crypto trading psychology behind this choice.

2. Select a staking method

As mentioned earlier, there are various ways to stake your cryptocurrencies, and depending on your technical skills, budget, and risk tolerance, choose the method that best suits your needs. The most common methods are:

• Running your own validator node: It requires technical skills, advanced expertise, and a significant initial investment, but it offers the highest rewards. This option is usually chosen by high-net worth individuals and financial institutions.
• Joining a staking pool: In this method, you entrust your assets to an existing validator, together with other users. There is a low entry barrier, and you don’t need technical expertise and significant funds, but consider that some rewards are eroded by the validator.
• Staking via exchanges: Some exchanges offer to stake users’ assets directly, allowing them to start with crypto staking easily. For example, on Trakx, we provide the Staked Matic Crypto Index, which allows you to get exposure to MATIC and also earn staking rewards. Additionally, for more conservative investors, we also provide the USDC Earn Crypto Index, which allows you to get fixed returns by backing USDC to US Treasury Bills.

3. Deposit and start staking your assets

Once you select the cryptocurrency and a staking method, you’re ready to start. Transfer the selected cryptocurrency or deposit fiat currency to start staking crypto assets. Then, select the staking pool or the validator and start earning rewards. The process is quite straightforward.

4. Monitor and reinvest your rewards

Once you start earning rewards, you can decide whether you want to withdraw or reinvest them. If you want to leverage the potential of compounding, then reinvest the rewards to gradually increase the staked assets and, consequently, the periodic rewards. If you want to unstake your holding, just click on “unstake”, commonly present in all the platforms, and, after the unbonding period, withdraw them to your personal wallet.

In conclusion, staking crypto can be a good way to earn a passive income. Usually, you can get 2-20% yearly on your staked assets, but consider that volatility and price swings substantially contribute to your overall portfolio performance, both positive and negative, depending on market trends and individual assets. Remember to implement sound risk management and diversify your portfolio to reduce the risks associated with a single investment. Happy staking, but prioritize DYOR (do your own research), and be conscious of the risks associated with crypto staking.