#Staking is an income earning method where investors earn passive income by committing to hold crypto assets backed on the Blockchain network for a certain period of time. While staking is seen as a method of generating income in a narrow definition, when expanded, it can be defined as an extremely important process that supports the security and working principle of Blockchain networks.
While the security of Blockchain networks is ensured through staking, the transactions in the network are also verified in a healthy way. Investors earn staking rewards for keeping their assets on the Blockchain network.
The staking model can be compared to banks' deposit accounts in traditional finance. Bank customers earn interest income by keeping funds for certain maturities. The robustness of a Blockchain using the proof of stake (PoS) consensus mechanism is directly proportional to the amount of crypto assets staked. In the banking system, the stronger the deposit structure of a bank, the stronger the financial health of the bank.
Staking, as the name suggests, applies to Blockchain networks that use the proof of stake consensus mechanism. The largest networks using this consensus mechanism are Ethereum, which switched to this system last year, and Cardano, which has been using the proof-of-stake model for a long time.
How does the staking system work?
For staking, it is first necessary to have a local presence of Blockchain networks that use the PoS mechanism. Thanks to validators, individual investors who want to earn income with their crypto assets can stake their assets without having to have technical knowledge.
Validators, on the other hand, distribute the staking reward at certain rates from the income they earn to other participants in the pool, under the conditions of locking assets in the Blockchain network and participating in network verification.
The first method to engage in staking activity in the cryptocurrency industry is to establish a validator known as a “node” on the relevant Blockchain network. Technical knowledge is needed to implement this method and the staking process must be followed carefully. Because Blockchain networks release updates to the network from time to time, and validators must follow these updates and apply them to their networks at the right time. Otherwise, they face risks such as a security vulnerability in their nodes and not being able to continue their staking activities.
Another method for staking is to join validators established by experts or companies. In this option, people can stake their crypto assets and maintain control of their assets without the need for technical knowledge. At this point, the staking service offered by many cryptocurrency exchanges makes it easier for long-term investors to earn passive income while keeping their assets in central exchanges.
People with average knowledge in the field of crypto may prefer to participate in the staking programs of decentralized platforms by keeping their assets in external wallets. This method is often used to benefit from competitive interest rates in staking transactions, but high returns also come with some risks.
Platforms called staking pools are very useful for small investors who cannot meet the minimum requirements for staking to evaluate their assets. For example, a user who wants to engage in staking activity on the Ethereum network must have at least 32 ETH to establish a node. However, thanks to staking pools, small investors can stake even very low amounts of ETH assets.
What are the benefits of staking for investors and Blockchain networks?
Investors who engage in staking activities in the crypto market can earn more interest income than they would in the traditional market, by taking certain risks. This method is considered very useful for long-term investors to invest their assets in a system with a certain return instead of keeping them idle.
In addition, investors who engage in staking activities by locking their assets in the Blockchain network also contribute to making the Blockchain network in which they invest more secure against attacks and to process transactions efficiently.
In addition, in networks with the DAO governance model, investors have the right to participate in the management of the network with the assets they stake. Thus, users can have a say in issues such as the healthy functioning, updates and changes of the projects they invest in.
From a blockchain network perspective, staking activities are vital. As we mentioned above, the more assets are staked in a Blockchain network using the PoS model, the more resilient the network is to attacks by malicious individuals.
Another benefit of staking transactions is that it contributes to the decentralization of the network by increasing the number of participants in the verification process. The more validators there are in a Blockchain network, the less risk there is of the network being taken over by certain groups.
Apart from Blockchain networks and investors, staking activity also contributes to the environment by using low energy.
What are the risks in staking?
Investors who want to earn a regular income with staking must lock their assets for periods ranging from weeks to months, which is considered a long period for the crypto market. During this period, the investor cannot exchange or convert his assets into cash.
This brings with it the risk of a loss in value on the staking reward you will receive during periods when assets tend to decline in the highly volatile cryptocurrency market. If the investor demands his asset back in order to convert it into cash, which he thinks will be in a downward trend, he will waive the staking reward he will receive this time. Although there are staking models that provide daily income as an alternative, the returns of this type of investment style are lower than long-term models.
Another risk to face when staking crypto assets is that the assets are locked in a dishonest validator. If the validator operates outside the Blockchain network rules, they may be penalized by the network administration and lose their staking rewards. This leads to loss of income for investors using that validator.
Another risk factor that may occur in staked networks may arise from technical problems. Investors may experience problems in receiving both the assets they have locked and the rewards they have earned, as cryptocurrency printing is interrupted in cases where the network stops due to a technical problem in the blockchain network.
As a result, the model of generating income through staking is a suitable model for long-term investors who do not care about short-term price fluctuations. In addition, when staking, care should be taken to ensure that the platform to which the assets will be delivered is experienced in the sector and that the return rate promised is reasonable according to market conditions.
Investing in some platforms that try to raise funds with the promise of high returns above market conditions may lead to the risk of losing all savings. An example of this was seen in 2022 with the issuer TerraForm Labs, an algorithmic cryptocurrency pegged to the dollar. The Terra network raised billions of dollars for UST with the promise of staking returns of up to 20%. Since this return was not sustainable, after a rapid withdrawal request, the network collapsed and the Terra ecosystem caused billions of dollars of damage, dragging the crypto industry into chaos.
However, while cryptocurrencies are inherently defined as risky assets, the risk of loss should not be ignored in the transactions of generating returns in this type of asset.
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