The following is intended to act as a beginner’s guide to staking. By no means is every aspect covered and none of the following should be taken as investment advice. Staking can be risky, but there are ways we can limit the risks if caution and due diligence is carried out. If you are a cryptocurrency investor and you have yet to dabble in the potential rewards offered in staking, then this is for you. Now is the perfect time to begin to understand this process, with the cryptocurrency markets in ‘extreme fear’, once again new opportunity sits on the horizon in this space. So, let us begin.
What is Staking?
Staking offers a way for cryptocurrency holders to put their digital assets to work in return for rewards. The act of staking cryptocurrency is comparable to high-yield savings account in the traditional financial system. Just as a bank offers a pre-determined length of time to lock your money up, invest it and dish out rewards as outlined by the banks contract, when you stake cryptocurrency a smart contract locks up your funds and invests them and dishes out rewards at a rate determined by the contract.
All cryptocurrencies using the Proof-of-Stake(PoS) mechanism typically offer staking facilities and this is because of how the PoS mechanism is designed to efficiently function. So before I go any further into staking, we should just touch on Proof-of-Stake and what exactly it is.
What is Proof-of-Stake?
Traditional crypocurrencies like Bitcoin & Monero use what is called a Proof-of-Work(PoW) mechanism to secure, validate and ensure the integrity of the blockchain, which, if you are still unsure about, is basically the transaction history, but rather than having to verify the entire transaction history every time, a new block is created with the most recent transactions and added to the existing chain of blocks (blockchain). PoW blockchains are maintained by anyone who wants to offer up their processing power to the network. All participants are rewarded for their efforts in new currency that is generated following the successful validation of each new block to be added to the blockchain. The more processing power you can offer, the larger proportion of the reward you will receive.
Proof-of-Stake works very differently and is being touted by environmentalists as the solution for Bitcoins growing carbon emmisions, I totally disagree, but that is a topic for another time. The Proof-of-Stake mechanism was first introduced in a paper by Sunny King and Scott Nadal in 2012. Sunny King went on to release the first ever use case of this mechanism with Peercoin, though the project still used PoW for coin distribution.
Then came Blackcoin in 2013 which did away with PoW altogether. If you haven’t heard of either, it’s because neither of these projects stood the test of time very well, but they did begin the development of the PoS concept.
Probably the first major use case of PoS, and one which is still around today, is Bitshares. Bitshares was developed and released in 2014 by the brainchild behind Steem, EOS and the upcoming Fractally Project, Daniel Larimer. Originally released under the name ProtoShare(PTS), Bitshare’s is the Worlds first DEX offering. Anyone can create a smart asset, also known as a Bitasset, and use it to represent anything. For the most part, these smart assets have been used to create tokens that are pegged to other cryptocurrencies.
Bitshares was the first project to use Delegated Proof-of-Stake (DPoS). DPoS mitigates the potential negative impacts of centralization through the use of witnesses. In a delegated proof of stake system, stakeholders build consensus according to their amount of stake in a cryptocurrency system. The mechanism is by no means perfect though, while the original developers promoted DPoS as a solution to the centralization risks surrounding PoS, many believe DPoS actually encourages centralization. To fully understand the risks and limitations of DPoS or PoS would require far more space than this newsletter has, but for now, I hope a basic understanding is forming in your mind.
Since Bitshares, more and more currencies are based on the PoS mechanism, rather than the PoW mechanism. Even Ethereum, which was originally designed as a PoW blockchain has begun moving over to a PoS consenus mechainism.
Here comes the important piece to understand about PoS.
Just like Proof-of-Work blockchains like Bitcoin require miners to process transaction and maintain the networks security, Proof-of-Stake blockchains require Validators.
Validators still require processing power, their nodes must remain online to process and ensure the integrity of the chain, but rewards are not issued based on processing power, but rather by how much ‘skin in the game’ they have. Each validator has to lock up a minimum number of coins and the more they lock up, the higher the reward.
This ‘skin in the game’ helps to reduce the chance of a 51% attack on the network, as such an attack would be highly costly to the attacker. As they attack the network their staked tokens would be significantly devalued.
Typically, the cost to become a validator is very high. So not dissimilar to how bitcoin mining pools work, whereby multiple miners all work together in an attempt to win the block reward, validators create staking pools. Staking pools work by allowing multiple token holders to stake their tokens and share a proportion of the rewards from the validator.
This is the simplest form of staking your crypto.
Rocket Pool is currently the leading staking pool platform for Ethereum, it’s trustless and decentralised.
Other platforms like Lido allow the staking of other assets like Polygon, Solana, Kusuma and (believe it or not, even as I’m writing this) LUNA.
I just mentioned a couple of staking platforms. Here is a more comprehensive table of staking platforms available for various cryptocurrencies.
Ethereum, Solana, Polygon, Kusuma, Luna
Ethereum, Polygon, Polkadot, Solana, Cardano, MoonRiver, Chainlink, Mina, Kusuma, Flow, Cosmos, Tezos, Juno
The above list is all staking platforms securing the network, but there are other forms of staking.
As well as staking tokens into a validators pool to help secure the network of a token, there is liquidity staking. Typically offered by exchanges, both centralized and decentralized.
In liquidity staking, the staker locks up their tokens into a liquidity pool. These funds are then available for the exchange to trade with. Often you will have to stake a pair of tokens, for example, $100 worth of MATIC and $100 of USDC. The pair of tokens would both be locked up and made available for traders on the exchange. You are then rewarded a percentage of the trading fees applied to the traders by the exchange.
In a nutshell: ‘When an investor supplies liquidity to a pool, that individual makes money by allowing others to use that liquidity for transactions. The investor supplying the liquidity earns a percentage of every trade.’
Providing liquidity for decentralised exchanges like Uniswap is the most common way to take part in this. You can add to an existing liquidity pool, or create your own.
However, centralized exchanges like Binance, Kucoin and MEXC also allow its traders to add to their own centralised liquidity pools.
Below is a table of some of the more trusted liquidity pools:
|Uniswap||Ethereum, Polygon, Arbitrum, Optimism||uniswap.org|
|Balancer||Ethereum, Polygon, Arbitrum||Balancer.fi|
|DeFi Chain||Ethereum, Bitcoin, Doge, USDT and many more….||defichain.com|
|Sushi Swap||Ethereum, Polygon, MoonRiver, MoonBeam, Telos, Binance, Harmony, Avalanche, Gnosis, Celo, Fantom, Arbitrum and more……||sushi.com|
There are dozens, if not hundreds, more platforms you could use, however as with anything in the crypto-space, there are many scams. Just because a website looks legit and appears to offer all the necessary tools to stake your crypto, does not mean they are honest contracts. So be very careful about using new and unknown service providers, because once you sign the contract, whatever that contract’s true purpose is will run.
Next up, yield farming. Yield farming is the most risky staking option of choice, as the functionality of the contract is often far more complex typically using a combination of the following:
- Liquidity provider: Users deposit two coins to a DEX to provide trading liquidity. Exchanges charge a small fee to swap the two tokens which is paid to liquidity providers. This fee can sometimes be paid in new liquidity pool (LP) tokens.
- Lending: Coin or token holders can lend crypto to borrowers through a smart contract and earn yield from interest paid on the loan.
- Borrowing: Farmers can use one token as collateral and receive a loan of another. Users can then farm yield with the borrowed coins. This way, the farmer keeps their initial holding, which may increase in value over time, while also earning yield on their borrowed coins.
- Staking: There are two forms of staking in the world of DeFi. The main form is on proof-of-stake blockchains, where a user is paid interest to pledge their tokens to the network to provide security. The second is to stake LP tokens earned from supplying a DEX with liquidity. This allows users to earn yield twice, as they are paid for supplying liquidity in LP tokens which they can then stake to earn more yield.
When you lockup your tokens in a yield farming contract, the tokens may be used for a combination of the previously mentioned staking purposes, as well as lending, trading and various other things. Potential gains are very high, but as are the potential losses. Tread carefully and try to stick to tried and tested yield farming plans.
Most of the liquidity provider platforms stated earlier also offer yield farming. You can check out Sushi Swaps Yield farming pools here.
Dummies Guide to Staking on Uniswap
It would be very hard to explain the process of staking for every single platform out there. Each platform may have a slightly different process, though most will not be too dissimilar to the following guide. In this example, we use Metamask as the connected wallet. There are other compatible wallets out there, but again most will not be dissimilar in usage.
Here, we will provide liquidity for the MATIC/ZKP pairing:
- Go to the Uniswap website
- In the top right corner, look for Use Uniswap
- Click on Connect Wallet (top right corner)
- Select the Metamask option and connect it to Uniswap
- In this example I have entered in a small amount of Matic from my wallet in the top box, this will automatically enter in the amount of ZKP tokens required to create a liquidity stake pairing.
- Click the Approve $ZKP button and your metamask wallet will pop up with a request to sign the contract.
- If you are sure you wish to proceed, click Confirm
- You have now successfully entered your tokens into the liquidity pool and will begin receiving rewards.
Staking at is simplest form is no more risky than the holding, assuming the contract is tried and tested. However, when the contract becomes more complicated, and additional tokens come into play, such is the case with many platforms like Lido for example, well the risks begin to grow.
With Lido, you can commit various tokens for staking, when you stake your MATIC tokens for example, you in return get stMATIC tokens. These stMATIC tokens are issued to you based on your MATIC stake share of the pool at the time of staking. The value of stMATIC is algorithmically controlled to reflect the size of the staking pool and the value of MATIC.
It appears to all work fine and billions of dollars have been successfully staked, unstaked and suitable rewards have been applied, but as we have recently seen with LUNA, when environments change, so can the functionality of what seemed like a perfectly good piece of code.
The more complex a staking contract is, the higher the risks. Typically, these complexity and risk attributes correlate with stated APR values. If something is advertising returns of 75% annually, the complexities of the contract are likely vulnerable to risks under various environmental conditions.
I personally like simple liquidity contracts in well used DEX platforms like Uniswap. They are simple, the rewards are consistent and the risk is relatively low in comparison to some of the more lucrative staking platforms out there.
I’d suggest speaking to others in the space before committing to any contract you are unsure of, reach out on our element group and myself, or someone else will help where we can.
Staking is a perfectly viable way to put your HODL bags to work. It can provide you with a steady passive income while you sleep and with minimal risk depending on the staking service you use.
How much exactly you can profit will depend on your risk appetite. If you are interested in staking your assets, be sure to not jump in to the first high return promise you find.
Please ask about first, get in touch with us on our discussion group over on Element for advice and guidance where needed. I will always be more than happy to help where I can.