Staking
What is DeFi staking?
DeFi staking works through smart contracts, pieces of code representing automated financial agreements between two or more parties that offer excellent incentives for crypto enthusiasts willing to stake (lock-up) their assets and engage in a more active presence in the network.
DeFi staking aims at encouraging long-term participation in a blockchain network. This article will help you to understand how you can use your cryptocurrency assets to generate passive income and participate in securing the network, validating nodes, and verifying blocks and transactions.
DeFi staking is the process of locking crypto assets into a smart contract in exchange for rewards and generating passive income. The crypto assets that can be staked are fungible tokens or non-fungible tokens (NFTs), and the rewards usually correspond to earning more of the same. It’s a great way to incentivize cryptocurrency investors to hold on to their assets while earning high interest.
DeFi staking is more attractive to investors who can benefit from higher rewards than a traditional savings account. Yet, it comes with higher risks coupled with more considerable challenges the crypto markets unveil, such as the well-known volatility across the board and network security of novel blockchains.
This new financial tool has become increasingly popular because it doesn’t require particular trading or technical skills, and investors' most significant challenge might be choosing the right and secure platform.
Unlike proof-of-work (PoW) blockchains, which use extensive computational power to verify blockchain transactions, DeFi staking is based on proof-of-stake (PoS) networks where transactions are verified by validators who are the principal stakers of the network.
How does DeFi staking work?
Staking is inherently related to PoS blockchain networks where users lock up a specific amount of the platform’s native tokens or coins and become validators. PoS blockchain protocols rely on validators to secure the network and verify transactions and blocks; therefore, these validators play a significant role in the ecosystem.
Validators who stake their assets to secure the network are incentivized to perform diligently and are tasked with reliably validating transactions and blocks or risk losing a portion or all of their staked assets.
Staking may require high stake deposits, which can be unattainable for participants. For example, when Ethereum switches to a PoS consensus mechanism, the need for validators to participate will be 32 Ether (ETH), which is a significant investment. For this reason, validators as a service and staking pool emerged as DeFi staking service providers to allow more people to participate without incurring substantial financial conditions.
Staking pools allow people to join other crypto investors to raise staking capital. Participants can then deposit any amount of tokens to a staking pool and start earning passive income proportional to the amount on their holdings.
Why is DeFi staking used in crypto?
Staking is an essential component of PoS blockchain platforms to provide security to the network, and it’s helpful for reasons that benefit both the staking platform and the participant or the staker.
DeFi staking is crucial in PoS governance to validate or “mine” transactions and blocks. Although PoS consensus mechanism details vary among different chains, the basis of such a system of validators is common in most PoS management processes.
Staking also helps cryptocurrency exchanges and trading platforms provide liquidity for specific trading pairs and is a great way to attract new customers. Staking can be an excellent way to increase your cryptocurrency holdings.
Additionally, users receive compensation for the tasks their staking carries out in exchange for locking crypto assets. DeFi staking, on the other hand, involves more engagement in DeFi actions such as securing crypto assets into smart contracts and becoming a block validator for a specific DeFi protocol. Whether you become a validator yourself or join a staking pool, allocating all or some of your assets in DeFi staking can be rather rewarding.
Advantages of DeFi staking
We pointed out that both benefits and drawbacks of DeFi staking might be different for the staking platforms and the stakers. Stakers enjoy a straightforward way of earning passive income, higher rewards than a bank savings account, and direct participation in a project’s mission and the network’s security and advancement.
On the other hand, the benefits of DeFi staking for staking platforms include relying on stakers (validators) to provide security and proper workflow. A large amount of staked native tokens also delivers the necessary liquidity to help a business thrive. In addition, compared to PoW, PoS brings the benefit of a lower environmental impact.
Disadvantages of DeFi staking
Despite the benefits of staking however, it doesn't come without it drawbacks.
The first downside is that it requires giving up control of assets in order to uphold network security. While staking supports the blockchain it's being staked on, it means that you don't have as much flexibility as to how you can use your assets.
Additionally, if the price of the token you're staking drops significantly, the drop in value could negate any rewards you may have received from staking the token. For this reason, it's important to stake assets in which you have a long-term conviction in.
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