In traditional finance, a popular way to generate passive income is to keep funds in bank deposits or low-risk investments in bonds. This approach allows you to build up capital and earn a stable income over the long term.
Owners of digital assets do not have these options available to them, but they can earn through steaking, a mechanism that allows them to earn rewards by participating in the security of a particular network. One of the popular projects offering steaking is Worldcoin, which attracts investors with its benefits.
In this piece, we will break down what steaking is, how it works, what benefits it can offer investors, and what risks are associated with it.
What is Proof-of-Stake (PoS)?
Proof-of-Stake (PoS) is a consensus algorithm that makes the blockchain work, validates transactions, and protects the network from attackers. It is designed as a more energy-efficient and scalable alternative to Proof-of-Work (PoW), where the security of the network is ensured using computing power.
In PoS, tokens become the primary resource for participating in consensus. Participants block their assets to become validators, and the network selects those who will validate transactions and add new blocks. The chances of becoming a validator depend on the number of blocked tokens, as well as other factors such as staking time and an element of randomness.
To ensure the loyalty of validators, the PoS algorithm uses a penalty mechanism—slashing. If a network participant violates the rules, its assets can be partially or fully confiscated.
Because of its features, Proof-of-Stake has become a staple of modern blockchains, offering an energy-efficient solution to support consensus and making participation in the network accessible to any token holder. And PoS, as mentioned above, is based on staking.
What is native steaking?
Native Stacking is the process of blockchain-stacking cryptocurrency directly into the blockchain to make it work and earn rewards. Participants in native-stacking can also become validators and help validate transactions, create new blocks, and maintain the security of the network. To participate in native staking, a special wallet and a minimum number of tokens as determined by blockchain requirements are usually required.
However, blockchain assets in steaking do not mean automatic status to validators; these network participants also need to run their own node, so the option to delegate their tokens is available for users who are unwilling or unable to do so. They delegate assets to one of the validators through dedicated platforms and receive a portion of their reward for their work.
Liquidity Staking and Restaking
Current approaches to using tokens to support the blockchain include two key areas in addition to native stacking: liquid stacking and restacking. They expand the possibilities of using tokenized assets, making the process more flexible and profitable.
For example, liquid staking stipulates that users blockchain their funds to support the network and, in return, receive liquid tokens that represent their assets. These tokens can be used in DeFi protocols to earn, trade, or invest. Thus, liquid staking solves the asset freezing problem characteristic of classical staking.
Restacking is a mechanism that allows reuse of assets already locked in steaking. It is used to provide additional networks or protocols.
For example, in the EigenLayer project, Ethereum validators can provide their stacked tokens to secure new decentralized applications, crosschain bridges, or oracles. For this they receive additional remuneration.
However, restacking also carries increased risks: validators may face sanctions if they violate the rules of additional protocols, which may result in loss of assets.
What are the benefits and dangers of steaking?
The main advantages of steaking:
- Passive income. Locked tokens continue to work for the owner, generating rewards without the need for active action. This makes steaking particularly attractive to long-term investors.
- Network support. With steering, users ensure the security and stability of the blockchain by becoming an important part of its ecosystem.
- Affordability. You don’t need expensive equipment to make money from steaking. It is enough to have cryptocurrency and use the right software.
Risks and disadvantages of staking:
- Market volatility. The value of tokens may drop sharply, resulting in losses that may outweigh the reward received.
- Technical risks. Loss of assets is possible due to errors in smart contracts, hacker attacks, or loss of access to the wallet. At the same time, risks increase when using intermediary providers.
- Inaccessibility of tokens. During the blockchain, assets cannot be used, which limits their liquidity and the ability to sell them quickly. Liquid steaking platforms are an exception.
- Slashing risk. In the event of errors or bad faith on the part of the validator, a portion of the staked assets may be confiscated as a penalty. This can affect both the user and the validator to whom the user has delegated the funds.
Many risks can be minimized with the right approach, for example, by choosing reliable providers or delegating assets to responsible validators who have a good reputation and provide a high share of remuneration. It is also mandatory to monitor the state of the crypto market and the price dynamics of the selected asset.
