Cryptocurrency staking has proven to be a popular method for DeFi investors to generate passive income, but it can also be a bit risky during times of market volatility.
Staking is a mechanism used by a number of popular cryptocurrency networks, including Ethereum, Solana, and Cardano, to process and validate transactions. The way it works is that crypto investors pledge a set of tokens to the underlying protocol, providing computing power to the network in the process. In exchange for locking their tokens to the network for a period of time, investors can earn “rewards” derived from transaction fees paid either immediately or at the end of the wagering period.
The stacked tokens serve as collateral and can be “burned” or confiscated if the investor misbehaves, such as authorizing invalid transactions. The idea is for investors to post collateral so they don’t risk undermining the network because if they try something stupid they’ll lose their own tokens.
Not every cryptocurrency uses staking. For example, Bitcoin relies on a different consensus mechanism to validate transactions.
Crypto staking can be very profitable, with the average reward rate for the top 261 staking assets paying out around 11% annualized returns. The exact yield depends on the network. Ethereum, for example, only pays out 3.85% annual returns, while Polkadot offers a 14.13% return.
Staking Penalties
However, like all good investments, staking is not entirely without risk. As mentioned above, most networks require users to commit to locking their tokens in a smart contract for a specified period of time, which can range from 30 days to a year. On many networks, such as Ethereum, Cosmos, and Tron, these tokens cannot be withdrawn before the minimum lock time expires, which can be dangerous in times of volatility. If the investor plans to cash out their assets and exchange them for fiat and the token falls in value, they could end up with far less than before, even adding to their staking rewards.
While certain networks that allow staking allow early withdrawals, this generally comes with penalties, e.g. B. with the loss of the entire yield achieved or a waiting period of up to seven days. This is done to discourage users from withdrawing their funds early.
There are other problems too. “Non-custodial” staking, which uses the network’s native wallet to stake tokens for the protocol, is often a complicated process that requires significant technical expertise. To help users get around this, many centralized cryptocurrency exchanges offer simplified “custody” staking services, but this ease of use comes at a price, as the exchange takes a percentage of the revenue generated.
Alternatives to staking
There are a few options for users who don’t want to risk being forced to withdraw their tokens early and suffer staking penalties. A more recent development is what is known as “liquid staking”, where users stake a crypto asset and receive an alternative token that they can use elsewhere. On protocols like Lido, when a user stakes ETH, Ethereum’s native token, in a liquid staking protocol, they receive a token known as “staked ETH” or stETH, which can then be deposited into other DeFi protocols to earn rewards elsewhere, or traded for a regular cryptocurrency such as BTC or USDC.
Crypto lending protocols are another alternative. Instead of stake tokens, investors can deposit them into liquidity pools on platforms like AAVE, where other users can borrow. Such protocols charge interest on the amount borrowed, and a portion of this income is returned to the lenders.
Investors can also provide liquidity to decentralized exchanges like Uniswap by donating the capital used to facilitate trading on the platform. In this case, users will receive a portion of the transaction fees charged by the DEX, but note that some pools may also have a minimum deposit period.
More recently, newer blockchain networks have emerged that allow users to generate rewards without having to wager tokens or risk being penalized for early withdrawal. ReserveBlock is an open-source, autonomous and decentralized Layer 1 protocol that aims to bring greater utility to non-fungible tokens, and features a unique “Proof-of-Assurance” consensus mechanism that allows anyone Allows user to act as a validator and generate rewards without wagering tokens.
To become a ReserveBlock validator, users simply need to deposit at least 1,000 RBX tokens into their wallet and confirm that they want to help the network process transactions. PoA consensus is a system where all network participants agree on a pool of validators. Collectively, the validators come to a consensus on the submission of new blocks and the transactions they contain, and then act as a beacon to enable the peer-to-peer transfer of those assets. The transaction rewards are then randomly paid out to selected validators.
While users must hold at least 1,000 RBX tokens to continue acting as a validator, they can spend their tokens at any time without incurring penalties, meaning they don’t have to take the same risks that come with staking and lending.
ReserveBlock is a relatively new blockchain, but the RBX token can be bought on the MEXC exchange and will be listed on March 10, 2023.
Crypto is perfect for passive income
There are many ways to earn passive income while holding crypto, giving investors an enticing alternative to traditional investing. Crypto staking, lending, and validation activities often yield payout yields far greater than any bank savings account can provide, but investors should always consider the risks involved and the potential penalties that may apply if they are forced to withdraw their assets early.
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