What is Crypto Staking?

Mike Halper, CFP®, MPAS®, SE-AWMA®, CDAA, CBDA

02/15/2023 08:00 AM Comment(s)

In recent days you may have come across some headlines, or actually read news articles, about staking in the crypto industry being targeted by regulators. Last week, crypto exchange Kraken settled with the SEC for $30 million and halted its staking program for its users. If you're not familiar with staking you may be wondering what it is and if it's anything that you need to worry about or if it's something you should consider for your own crypto portfolio..

A key part to understanding crypto staking is to understand blockchain. To get more insight check out Escient Financial's previous Insights articles on Digital Assets and Cryptocurrency. Once have at least a basic understand of blockchain, it's easier to understand staking.

Crypto staking is a method of validating transactions on (usually) a proof-of-stake (PoS) blockchain network by holding a certain amount of its cryptocurrency and staking it in a certain place for a certain amount of time. The staked crypto is usually deposited with a validator, whose job it is to validate transactions and write new blocks to the blockchain. This process helps secure the network, validate transactions more efficiently, and enables users to earn rewards for their contributions.

Types of Crypto Staking

There are different ways to participate in crypto staking, and each method has its own set of benefits and risks. Here are the most common ways of staking:

Solo Staking

Solo staking involves setting up a full node and becoming a validator yourself. This method is recommended for experienced users who have a deep understanding of the blockchain and are comfortable with the technical aspects of running a node. With solo staking, users can earn staking rewards directly, but they also assume all the risks and responsibilities of being a validator. These include the risk of missing out on rewards if their node goes offline and the risk of being penalized for acting maliciously on the network.

Pool Staking

Pool staking is a way for individuals to pool their resources together and increase their chances of being selected as a validator. By staking their crypto in a pool, users can earn staking rewards without having to run a full node. The rewards are then distributed among the members of the pool based on their contribution to the total staked amount. Pool staking is a good option for those who don't have the technical knowledge or resources to run a node themselves.

Exchange Staking

Exchange staking is a convenient way to participate in staking without having to run a node or join a staking pool. Many exchanges offer staking services, where users can simply deposit their crypto on the exchange and earn rewards without having to do anything else. The exchange takes care of the rest, including the maintenance of the node and distribution of rewards. While exchange staking is easy and convenient, users should be aware that they are entrusting their crypto to a third party and may be subject to exchange-related risks, such as security breaches and downtime. As mentioned in the beginning of this article, staking services offered by exchanges has come under regulatory scrutiny, and such services could be discontinued in the future. There have also been multiple centralized exchanges that have collapsed or had other issues over the past year, so locking your crypto and digital assets on a centralized exchange has additional risks.

Risks of Crypto Staking

While staking can be a great way to earn passive income and support a blockchain network, there are also several risks involved. Here are some of the most significant risks to consider:

Technical Risks

Technical risks include the possibility of missing out on rewards if your node goes offline or if there are technical issues with the network. For example, if your node goes offline for an extended period, you may miss out on rewards for that time and may also be penalized for not being a reliable validator.

Regulatory Risks

Regulatory risks refer to the possibility that government authorities may take action against crypto staking, either by banning it or by imposing strict regulations that make it difficult to participate. Right now, there hasn't been any regulations introduced or any enforcement to say that crypto staking in its entirety is not legal. However, there is still a lack of regulatory clarity surrounding the crypto industry. The regulatory environment for crypto is still evolving, and stakers should be aware of the risks and be prepared for changes in the regulatory landscape.

Market Risks

Market risks refer to the possibility that the value of the crypto you have staked may decrease, potentially reducing the returns you could have earned if you had sold it instead. With many blockchains, staking requires locking your staked assets with the validator for a minimum amount of time, including up to a year. Also, with some blockchains, there is a waiting period when you decide to withdraw your staked assets. This could be as little as 24 hours or as long as a month or even more. Market conditions can be unpredictable, and stakers should be prepared for the possibility that the value of their staked crypto may decrease.

Should I stake my crypto?

Whether or not you should stake your cryptocurrency depends on several factors and ultimately comes down to personal preference and financial goals. Here are some things to consider before deciding to stake your crypto:

Investment goals: If you're looking for short-term profits, staking may not be the best option. Staking rewards are typically paid out over a longer period of time, so it's more suited for those who have a long-term investment horizon.
Technical expertise: If you don't have a strong technical background or experience with blockchain technology, staking may not be the best option for you. Running a full node or understanding how staking pools work requires some technical knowledge.
Available resources: Staking requires a certain amount of cryptocurrency to be locked up, so you should have enough funds to meet the minimum requirements. Additionally, if you choose to solo stake, you'll need to have the technical resources and knowledge to run a node.
Market conditions: The value of the cryptocurrency you hold may fluctuate, which can impact the value of your staked holdings. You should consider the current market conditions and your risk tolerance before deciding to stake your crypto.
Regulatory environment: The regulatory environment for cryptocurrency is still evolving, and staking may become subject to additional regulations in the future. Be sure to keep an eye on regulatory developments and understand the potential risks involved.

Ultimately, the decision to stake your cryptocurrency should be based on a thorough evaluation of your financial goals, technical expertise, available resources, market conditions, and regulatory environment.

The Bottom Line

Crypto staking is a process of validating transactions on a blockchain network by holding a certain amount of its cryptocurrency. It is a way for individuals to earn rewards for supporting the network's security and stability, without having to use computing power to solve mathematical problems. There are several ways to participate in staking, including solo staking, pool staking, and exchange staking. However, there are also various risks involved, such as technical risks, regulatory risks, and market risks, which stakers should be aware of before participating. Overall, crypto staking offers an opportunity for passive income and a way to support a blockchain network, but it is important to weigh the benefits and risks before deciding to participate.

If you're wondering if staking your digital assets and cryptocurrency is right for you or if you need guidance on how to implement staking with your portfolio, feel free to...

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This content is developed from sources believed to be providing accurate information. The information in this material is not intended as investment, tax, or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Digital assets and cryptocurrencies are highly volatile and could present an increased risk to an investors portfolio. The future of digital assets and cryptocurrencies is uncertain and highly speculative and should be considered only by investors willing and able to take on the risk and potentially endure substantial loss. Nothing in this content is to be considered advice to purchase or invest in digital assets or cryptocurrencies.