Understanding the Benefits and the Risks of Staking Crypto

November 1, 2022
5 min
Bitcoin coins stacked next to a phone

Here is an essential breakdown of the benefits and potential risks of staking crypto, as well as everything you need to know about staking crypto.

Staking cryptocurrency is a productive way to put your crypto to work and earn a yield. By locking up your crypto holdings, you can earn rewards without exposing yourself to undue risks. Here is an essential breakdown of the benefits and potential risks of staking crypto, as well as everything you need to know about staking crypto.

What is staking?

Staking cryptocurrencies is only possible with certain types of crypto. These are called Proof of Stake coins, which facilitate their transactions through a consensus mechanism called Proof of Stake.

Proof of stake is unlike Proof of Work currencies, in which miners invest computational processing power into solving mathematical problems. This is done  to obtain crypto and validate its transactions. Proof of Stake currencies, on the other hand, let people achieve validation by being able to invest in the currency and staking a claim to part of its total supply.

Staking works by letting you claim ownership to certain amounts of a Proof of Stake crypto and then staking your tokens into that crypto's blockchain as a facilitator of transactions in exchange for percentage-related bonus rewards over time. Basically, with staking, you let your own crypto become part of the currency's blockchain validation process, and you're rewarded for that.

Staking works with Proof of Stake cryptocurrencies that rely on a consensus mechanism to validate blocks in their blockchains. Because your crypto stake is invested in the same blockchain, it helps along its validation process for transactions and creating new blocks. As a result of this investment, you're rewarded for participating.

How does staking crypto work?

Staking crypto can be a great way to earn a passive source of income. The basic process of crypto staking works as follows:

You take your crypto holdings and place them into a DeFi protocol that offers staking capabilities. Once you've done this, the network administrators will use your stake to manage or fund blockchain network functions. In return, a certain amount of rewards allocated to you based on the size of your stake, sent to you in the form of a token that you can later convert to other types of crypto or into fiat (government currency like USD) through an exchange. The above is the basic staking process, but if we get into more technical details, it can be broken down into two different types of cryptocurrency staking mechanisms:

PoS Staking

With Proof of Stake staking, stackers would normally deposit crypto into a smart contract that's locked into a PoS blockchain like Ethereum. The blockchain network will then reward stackers with periodic payments for having their crypto locked up.

PoS stackers who have invested the most are called "validators" and they often earn the highest reward amounts. The entry level to be a PoS validator can be as high as X(USD amount), which is why not everyone is able to participate at this level. If your assets are more modest, you can instead join a staking pool with other stackers and earn rewards that correspond to your deposit size with the pool.

DeFi Staking of PoW crypto

Proof of Work currencies such as Bitcoin normally can't be directly staked like PoS cryptocurrencies because they're minted in an entirely different way that relies on solving mathematical puzzles. Instead, you lock an alternative crypto token into a liquidity pool and get rewarded in Bitcoin for how your assets are used by the pool to secure the blockchain. 

One example of DeFi Staking with Bitcoin is the Stacks protocol, which lets you invest in STX tokens and create a stake for yourself in the Stacks blockchain. In exchange for this investment and its underlying decentralized finance lending transactions, you’re periodically rewarded with native Bitcoin payments.Some pools can offer impressively high annual interest rates of 10% or more on staked crypto assets. 

Benefits of staking crypto

Now that you know the basics, let’s talk about what’s in it for you. There are several major benefits to staking your crypto with either PoS or Defi protocols. The main ones are the following:

1. Passive income without selling your cryptocurrency.

Possibly the single biggest benefit of DeFi or PoS crypto staking. Basically, you're letting your crypto assets keep earning you money even if the price isn't going up and you can do so without having to sell. With some Stacking pools, you can earn as much as 10% APY native Bitcoin.

2. Possible high returns in any market

Crypto staking can sometimes result in high rewards and interest payments for your stake. Best of all, you can often earn these rewards even if the wider economy outside cryptocurrency and DeFi isn't doing so well. Also, the larger your stake in a liquidity pool or PoS network, the larger your rewards will be at each payout.

3. Minimal investment cost

While some blockchains require a very large minimum crypto stake from investors who want to participate, many don't. Instead, it's possible to start staking with extremely small amounts of money and no equipment costs except for having a computer that's constantly connected to the Internet.

Risks of staking crypto

Staking can come with some risks too, just like most parts of the cryptocurrency landscape. If you're not careful about how or where you stake your cryptocurrency assets, it's possible to lose funds in several ways. Here are some key risks:

1. Vesting periods

Many staking agreements come with a certain lock-in, or "vesting" period during which you won't be able to withdraw your crypto from the pool you've added it to. If the value of your crypto tokens drops on the market during that time, you can suffer an overall loss until their price rises again (if it does.)

2. Trust risks

Some staking pools require you to transfer your cryptocurrency to an external exchange. If that exchange has weak security or is simply dishonestly run, it can possibly lead to you losing all of your assets.

3. Hacking dangers

Some staking protocols require you to go through technical steps for configuring your wallet correctly and downloading certain types of software. If you misconfigure something during this process, you might accidentally open yourself and your assets to hackers.

Using Stacks to earn Bitcoin With the Xverse Stacking Pool

One of the easiest ways to start staking is by obtaining a crypto token called Stacks (STX) and then "Stacking" it through the Xverse Stacking Pool for a fixed period of time. In exchange for vesting your STX tokens, you as a Stacker then earn reward payments in native Bitcoin per each payout period. A stacking cycle occurs each time a new Bitcoin block is mined, which takes approximately two weeks. You can check the status of a current cycle, including an estimated minimum reward, at stacking.club/cycles/current. Stackers can select to lock their STX in up to six consecutive cycles before having to miss one cycle. With each cycle, your Stacks stake gets rewarded depending on its size. These rewards normally amount to as much as 10% APY (per year) on your original STX stake investment. Stacking STX helps improve the security and consensus of the Stacks blockchain through a unique mechanism called Proof of Transfer (PoX).

Xverse wallet supports the above process by being compatible with both the Bitcoin and Stacks blockchains, letting you earn annual interest on your Stacks investment with zero fees. Start staking with as little as 100 STX through the Xverse app一downloaded here or through the App store for iOS or Google Play for Android devices.

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