What Is Staking?
Staking is locking up crypto assets to earn a return on your principal and help secure the blockchain.
Nodes with staked cryptocurrency validate new blocks and receive a yield on their investment.
Staking is often compared to having a cryptocurrency savings account.
How Does Staking Work?
Staking cryptocurrency works similarly to a regular savings account at a bank.
You lock up your cryptocurrency and receive a return on the staked principal.
The longer you lock up your coins, the more you receive in return.
Your stake secures the blockchain by participating in finding consensus about ongoing transactions.
There are three main approaches to staking crypto:
- Staking at a Centralized Exchange: This is the simplest way. Almost all centralized exchanges (CEX) offer staking services, where you stake with the CEX and the exchange does the rest for you. You receive a yield slightly lower than if you were running your node. However, it is far more convenient.
- Running Your Own Node: With all proof-of-stake blockchains, you can run your own node. Some blockchains have higher hardware requirements than others to run a full node. In doing so, you directly contribute to the chain’s security and can receive a higher yield. Remember that running your node can be technically more challenging than delegating your stake to a CEX or another node.
- Delegating Your Stake: In delegated proof-of-stake, you can stake your coins with a node operator that does the technical work. However, you still earn a yield on your staked coins. The added risk factor of this option is to find a node that behaves honestly and will not have your stake slashed (i.e. incur a penalty).
Can You Lose Crypto by Staking?
There are certain risks to staking.
A minor risk is slashing, meaning your stake can get penalized if a node does not validate transactions correctly.
This is not a risk factor if you stake with an exchange or correctly run your node.
Moreover, finding an honest node is straightforward, but you should still be aware of the risks.
Value Fluctuations and Lock-Up Periods
Another risk factor is that your staked coins can lose value during the staking period.
Some cryptocurrencies and staking providers require you to choose a predetermined staking period during which you cannot unstake your coins.
Since cryptocurrencies are volatile, you may own more coins at the end of the staking period, but these coins have less worth.
Sometimes, there is an option to unstake if you pay a hefty penalty.
Thus, it is advised to stake only as much as you do not immediately require for other purposes.
Which Crypto Is Best for Staking?
There is no one best crypto for staking.
Except for proof-of-work coins, almost all other coins can be staked.
How profitable staking is depends on factors like:
- The Lock-up Period: The longer you commit your coins, the higher yield you will earn. However, you sacrifice flexibility if you stake your tokens for long.
- The Amount Invested: The less you stake, the lower the yield. However, the higher your staked amount, the higher the nominal returns.
- The Coin’s Volatility: Some cryptocurrencies are more volatile than others. Predicting a coin’s exact volatility is impossible, so choose the coins you feel most comfortable with for staking.
Is Crypto Staking Taxable?
Moving your coins to a staking pool or running your node is not taxable.
Whether staking rewards are subject to income tax is unclear.
If you want to be safe, you should consider receiving and selling the staking rewards taxable events and declare them accordingly.
What Are Staking Crypto Pros and Cons?
The benefits of staking crypto are the ease and convenience of acquiring new coins.
Here are some pros of crypto staking:
- Earning New Cryptocurrency: You can earn new crypto with your existing crypto stack simply by staking it.
- Securing the Blockchain: You help secure the blockchain of the coin you’re staking, increasing its value.
- Increasing the Token Value: Staked coins are not in circulation and reduce the existing supply. This can help push up the cryptocurrency’s price in periods of great demand.
The disadvantages of staking crypto are the risk of losing money through volatility and inflexibility.
Here are some cons of crypto staking:
- Staked Crypto Can Lose Value: Since cryptocurrencies are volatile, you can lose money if the value of your staked coins decreases more than the staking rewards you acquire.
- No Possibility of Unstaking: Even though some coins and providers offer the option to unstake for a penalty, you will often not be able to unstake before a predetermined amount of time.
- Crypto Taxes: Staking is subject to taxation, which means your profit margins are slimmer than the advertised staking yield. Keep this in mind when choosing a coin and provider to stake.