Cryptocurrency staking has proven to be a popular way for DeFi investors to generate passive income, but it can also be a bit of a gamble in times of market volatility.
Staking is a mechanism employed 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 number of tokens to the underlying protocol, and in the process of doing this, they provide computing power to the network. In return for committing their tokens to the network for a specified period, investors can earn “rewards” derived from transaction fees, which are either paid immediately or when the staking period ends.
The staked tokens act as collateral and can be “burned” or confiscated should the investor misbehave, for example by authorizing invalid transactions. The idea is that investors put up collateral so they won’t risk undermining the network because if they attempt anything silly, they will 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 biggest 261 staked assets paying out around 11% in annual yield. The exact yield depends on the network. Ethereum, for example, only pays out a 3,85% yield annually, whereas Polkadot offers a payout of 14.13%.
Staking Penalties
Like all good investments, though, staking isn’t entirely without risk. As mentioned above, most networks require that users must commit to locking up their tokens in a smart contract for a specified period of time, which can be anywhere from 30 days to a year. On many networks, like Ethereum, Cosmos and Tron, these tokens cannot be withdrawn before the minimum lock up time expires, which can be dangerous in times of volatility. After all, if the investor plans to cash out and swap their assets for fiat, and the value of the token declines, they could end up with far less than they had before, even when their staking rewards are added.
Certain networks that allow staking do allow for early withdrawals, but doing so generally carries penalties such as losing all of the yield that has been generated, or being forced to wait up to seven days. This is done to dissuade users from withdrawing their funds early.
There are other problems too. “Non-Custodial” staking, which involves using the network’s native wallet to stake tokens to the protocol, is often a complicated process that requires significant technical expertise. To help users get around this, many centralized cryptocurrency exchanges offer simplified “custodial” staking services, but this user-friendliness comes at a cost as the exchange takes a percentage of the yield generated.
Alternatives To Staking
There are some options for users who don’t want to run the risk of being forced to withdraw their tokens early and suffer staking penalties. One recent development is so-called “liquid staking”, wherein users stake a crypto asset and receive an alternative token that they can use elsewhere. On protocols like Lido, if a user stakes ETH, the native token of Ethereum, in a liquid staking protocol, they will 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. Rather than stake tokens, investors can deposit them into liquidity pools on platforms such as AAVE that other users can borrow against. Such protocols charge interest on the amount borrowed, and a proportion amount of that revenue will be returned to the lenders.
Investors can also provide liquidity to decentralized exchanges such as Uniswap, donating the capital that’s used to facilitate trades 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 enable users to generate rewards without having to stake tokens or run the risk of being penalized for making an early withdrawal. ReserveBlock is an open-source autonomous and decentralized Layer 1 protocol that aims to bring greater utility to non-fungible tokens, and it stands out for its unique “proof-of-assurance” consensus mechanism that allows any user to act as a validator and generate rewards without staking any tokens.
To become a ReserveBlock validator, users simply have to deposit a minimum of 1,000 RBX tokens in their wallet and confirm they wish to assist the network in processing transactions. The PoA consensus is a system where a pool of validators is agreed upon by all network participants. Together, the validators come to a consensus on the submission of new blocks and the transactions included within them, then act as beacons to enable the peer-to-peer transfer of said assets. Transaction rewards are then paid out to select validators in a randomized way.
While users must maintain a minimum of 1,000 RBX tokens to continue acting as a validator, they can spend their tokens at any time without suffering any penalties, meaning there’s no need to run the same kinds of risks associated with staking and lending.
ReserveBlock is a relatively new blockchain, but the RBX token can be purchased on the MEXC exchange and will be listed on March 10, 2023.
Crypto Is Perfect For Passive Income
There are many opportunities to earn passive income while holding crypto, providing investors with an enticing alternative to traditional investments. Crypto staking, lending and validating activities often payout yield that are far greater than any bank savings account can offer, but investors should always consider the associated risks and possible penalties that might be imposed if they need to withdraw their assets early.