Staking is one of the most popular ways to create a passive income stream through cryptocurrencies. Like a savings account, staking lets you earn 5-20 percent every year, depending on the amount and type of token you are staking. One of the easiest ways to start staking (especially for retail investors) is through a staking pool. As the name suggests, a staking pool allows people to ‘pool’ their resources to boost their chances of being rewarded.
However, to understand staking pools, we must first understand what staking is and how it works.
What is staking?
Staking is a simple process wherein you dedicate (stake) some of your tokens towards the blockchain’s development. In exchange, the blockchain provides you with a percentage reward on the number of tokens you have invested (staked). It is important to note that staking is only possible on blockchains that employ the ‘proof-of-stake’ consensus mechanism. These include blockchains such as Tezos, Cardano, Ethereum 2.0, Cosmos, etc.
Most blockchains employ a consensus mechanism to verify the network’s transaction data. It is a process where several network users (nodes) work together to authenticate transactions, bundle them into blocks, and add them to the blockchain. Generally, all the users in the network can choose to become nodes as long as they meet specific requirements.
For instance, the Bitcoin blockchain employs the proof-of-work consensus mechanism. Here nodes must possess high-performance computers to participate in the transaction verification process. On the other hand, with the proof-of-stake consensus mechanism, users can qualify as transaction validators by locking in (staking) a certain amount of the blockchain’s native currency. The network will then choose validators based on the amount of crypto they have offered to stake. The more you stake, the higher your chances of becoming a validator. Then, every time you validate transactions and add a new block to the blockchain, new coins would be minted and given to you as a reward.
The logic here is simple — the staked tokens act as a guarantee — they ensure that the validator will carry out their job to the best of their abilities and without any malicious intent. If a block is formed with invalid transactions, the network may burn a certain amount of the user’s staked tokens. On the other hand, if the block is successfully added, the blockchain will mint new coins and reward them to the validator. The rewards are usually proportionate to the number of coins you have staked.
Why do we need staking pools?
The minimum amount of tokens required to begin staking is very high in most cases. For instance, on Ethereum 2.0, you need to stake 32 ETH to stand a chance to become a validator. That amounts to roughly $100,000 worth of coins. As you can imagine, not many investors have that many coins lying around to stake. This is where a staking pool comes in.
Users who do not have enough coins to meet the minimum threshold can enter a staking pool. Here, several users combine their coin contributions, thus allowing them to participate in the staking activity, even if they do not have the minimum amount of coins on their own.
The pros and cons of staking pools
Staking pools allow smaller retail investors to participate in the staking activity and earn a passive income. It is much better than just leaving your cryptos in a wallet waiting for prices to appreciate. Instead, you can put your tokens to work by investing them in a staking pool.
However, the rewards earned through a staking pool are generally lower than you would make as an individual validator. This is because the staking pool might take a cut of the rewards. Moreover, the rewards are divided and distributed amongst all the users in the pool based on their contributions. As per a recent report, you can make an annual percentage yield of 6 percent staking ETH independently, but a staking pool will only get you 4-5 percent.
How to find and enter a staking pool
There are several staking pools available for different cryptocurrencies. Most notable crypto exchanges also have staking pools that you can enter. However, like every other asset class, you should do your research before joining a pool.
The best platforms will post regular updates about the pool’s performance. Go through these performance reviews before selecting a staking pool. Also, try not to enter a saturated pool; you would have to share the rewards among thousands of other users. For instance, some staking pools, like the Sunshine Stake and Pilot Pool, have over 50 million Cardano (ADA) staked tokens from hundreds of thousands of users worldwide. Also, every pool usually has a membership or entry fee; make sure you consider that before joining.
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(Edited by : Shloka Badkar)
First Published: IST