There are two main consensus mechanisms currently used by most blockchain projects: mining and staking. They each offer their benefits and drawbacks, and in this guide, we discuss some of these selling points and causes for concern.
We will mainly focus on the staking mechanism, which has been gaining more prominence in recent years.
Most of the newer crypto projects prefer to use staking instead of mining due to the former’s benefits over the latter.
The leading smart contract platform Ethereum’s core developers have been working on upgrading the network to stop using the mining consensus mechanism and begin using staking. This shift is a clear sign that staking may be better than mining.
Additionally, we will examine the risks inherent in using staking, where to stake, and which coins are currently among the best to stake. Keep reading to find out more on staking.
Is staking like dividends?
In some sense, staking rewards are similar to dividends, but these two are not the same. For one, dividends are paid out from a company’s profits to its shareholders. If it makes a loss that fiscal year, its shareholders have to do without any payouts.
In contrast, staking rewards are paid by a network algorithm to the network’s transaction validators who have chosen to participate in its governance and block generation.
It is not about the profits that the network or the entity governing the network make but rather that stakers have opted to put their assets at risk for a chance to be a part of the network.
Another difference is the assurance that a company will distribute its profit to common shareholders through dividends. These are part of the regulations governing the operation of businesses created for a profit.
It is not the case when it comes to staking. There are no assurances about getting any rewards if one chooses to participate in staking within a given network.
Most staking networks simulate the operation of a lottery program whereby anyone who has staked their assets can win the opportunity to create a block and earn a reward for it.
And just like a lottery whereby the more tickets you buy, the greater the chance of winning, the more a validator stakes, the higher their chances of getting picked to create a future block.
The final difference between staking and dividends is that staking is an essential part of the operation of the network while dividend pay-outs are not.
A blockchain network that relies on staking cannot operate without it, which implies that the staking rewards are also promptly paid.
Read Does Staking Crypto Compound?
What are dividends?
Dividends are payouts made by companies to their shareholders as a share of the profits from the activities in which it engages. The payments are regular, usually annually, but sometimes it can be done semi-annually or biannually as the company sees fit to distribute its profits.
Dividends are a way for investors to get a return on their investment in the company. They are paid out per share of the specific stock held. It’s also worth noting that a company can have several classes of shares, and not all kinds attract a profit share.
Typically dividends are paid out to common stockholders.
Is staking interest or dividend?
Staking is similar to both earning interest and receiving dividends. For one thing, there is an expected return for all three activities once you invest.
In the case of staking, there are periodic rewards from the network on which you opt to stake in, while in the case of interest, the money you lend out or save in a particular scheme earns the lender some return.
Dividends are also returns on investment (ROI) for a shareholder who has chosen to invest in a particular company over a certain period.
Another commonality among the three concepts is a lockup period for the beneficiary to earn the return. With staking, there are actual lockup periods in which the staker is not allowed to access their assets.
Interest earners also have to store their assets for a given period to receive an interest in return, and to earn a dividend, an investor has to buy a share of a company that ties up their funds for a period to qualify to receive the dividend.
However, there are also properties of these financial concepts that differentiate them. First, there are guaranteed returns for earning interest, but this is not the case for staking or investing in a company.
If a company makes a loss, it is not expected that it will be able to distribute any dividends. For a validator staking their assets on a decentralized or semi-decentralized blockchain network, there is no guarantee that the algorithm will choose them to create a block.
There is a caveat to the above difference because staking is not a standardized activity on the blockchain scene, and different networks have implemented the mechanism differently.
Some networks reward every staker for participating regardless of whether they have created a block.
The stakers themselves might join together and pool resources to ensure they increase the chance of creating a block more often, which will regulate the rate at which they receive the rewards.
Therefore, staking is both less and more like earning interest and receiving dividends, but they are different.
Also read the difference between staking and Airdropping.
What is staking?
Staking is a blockchain consensus mechanism in which a network incentivizes the public to participate in its governance and transaction validation by promising rewards for their efforts. There are several implementations of staking, but the most popular is the Proof of Stake (PoS).
In the PoS implementation, network validators must stake a portion of their assets in a locked crypto wallet where they cannot access these assets for a given period.
Locking their assets gives them the right to participate in making decisions concerning network governance, validating, and creating new blocks.
The asset stake is used to incentivize good behavior from all participants because if they engage in malicious behavior or any activities that threaten the smooth operation of the network, they risk losing their assets.
Staking in a PoS can be compared to a lottery system in which players have equal chances of winning, and in order to increase those chances, the players have to buy more tickets.
Similarly, in a PoS staking environment, the more one stakes, the higher the chances that they will be chosen to create the next block and therefore earn a block generation reward.
Is staking and mining the same?
Staking and mining are not the same, even though they are both mechanisms in which blockchain networks achieve consensus. Staking involves putting up a portion of your assets to qualify to validate transactions and participate in the network’s governance.
On the other hand, mining is the use of computing resources to compete in solving arbitrary puzzles for a chance to create the next block.
The winner of these puzzles gets to generate a block and receive a mining reward.
From these definitions, we can pick out one difference: with mining, there is a competition of resources, while with staking, there is the use of a lottery-like system. The nature of mining leads to utilizing a large amount of energy than when staking.
Are staking rewards interest income?
Staking rewards are not interest income, although they do have some similarities. Staking rewards are payments made by a blockchain networks’ algorithm to participants who have staked tier assets for the chance to secure or vote on governance decisions.
Depending on the application of the staking algorithm, the stakers may automatically qualify to receive rewards merely by holding their assets within a wallet.
Sometimes, the token holders delegate their rights to other stakers who share the rewards from participating within the network with their delegators.
Staking can be done actively or passively if the token holder decides to directly exercise their rights within the network or delegate their duties and responsibilities, respectively.
It is the latter form of participation that may be likened to earning interest whereby the token holder invests in a staking token, holds their assets for a period while delegating their network duties but shares in the rewards.
Similarly, with interest income, the investor or saver will keep their assets within a specific account for a period of time and, in return, be rewarded with a share of the interest that the investment generates through application by an asset manager.
Is staking crypto worth it?
Yes, staking crypto is worth it, but it also depends on your participation goals. Sometimes, the staker is looking to profit from the investment, or maybe, they are looking to support the network.
Staking has several benefits, including securing a blockchain network, introducing new tokens/coins into circulation, and enabling token holders to participate in the network’s governance.
If looked at from this angle, then staking is worth it.
What are the risks of staking Crypto?
Opting to stake your cryptocurrency within a network for a chance to receive staking rewards comes with its risks which include:
Market risk: this risk is inherent in the price instability of crypto assets. Often staked assets are locked for long periods, and in that time, the asset’s value could plummet, leading to a loss.
Read Impact of Staking On Prices.
Theft/Loss risk: there is always the risk of getting hacked and losing your assets or even misplacing or losing the private key to your crypto wallet.Validator risk: it is the kind of risk faced by node operators whereby if the node inadvertently malfunctions and leads to a violation of the node operation policy, the operator could lose their stake through slashing.
What is the best coin to stake?
There are several coins in the market to stake. Here are some of the best ones according to the staking aggregator website stakingrewards.com:
Solana (SOL)
Ethereum 2.0 (ETH2)
Cardano (ADA)
Polkadot (DOT)
Avalanche (AVAX)
Where is the best place to stake Crypto?
Staking can be complicated for the average investor, and because of that, the risk of running a node can outway the potential rewards. Therefore the best place to stake is with a staking pool through a staking service such as the following:
FTX Staking; and,
Final thoughts
Staking is a great way to earn cryptocurrency while making the blockchain scene better by participating in the governance of projects. It can be compared to earning interest or dividends from a company, but it offers unique features and properties.
As we have detailed in this guide, there are several benefits to staking, but not to forget that there are also risks to be aware of before opting to start staking.
Generally, it is a rewarding activity, and if you can do it, we highly recommend looking into the platforms we have recommended and the coins we have highlighted as your starting point.
