Why you should use Staking?

Benjamin D. - Founder

Simply buying and selling crypto assets can generate profits for you through price increases. Going one step further, simply owning these digital assets can generate profits for you. You can thus profit from price increases and asset multiplication. This is made possible by staking.

How you can use Staking for income?

To get incomes from Staking you must provide a deposit in a token (a digital representation of an asset) to the network. Don't be afraid, you're not giving away any money. You just leave it in the network for a period of time so that it can guarantee at least a stable value for the network. For this period you receive interest. Just like on a traditional bank account. As long as the money is with that institution, you get interest.

In the field of DLT (distributed ledger technology), this can happen in several ways:

  1. You operate a server yourself as a contribute to the network and "store" your deposits there.
  2. You participate together with others in an association of interested parties (a so-called pool).

For a pool to work, all participants must be sure that their money will not disappear. If you provide such a server yourself, you are the one who has to guarantee this. Your server will pay penalties or simply not get any interest if it is unstable or has too many down times.

It is much easier to participate in a pool, because there are large companies behind it, which have specialized in the permanent accessibility of their servers. You can just create an account and simply participate. For providing this service the company keeps a part of the interest as profit.

Another way is to participate in staking through a smart contract. You can enjoy several advantages: It is decentralized and you don't have to trust any company and also give away much less profits of your interest. You will trust the code of a smart contract.

If you want to learn more about the risks with smart contracts, read more at Smart Contracts.

Advantages of staking for your financial assets

Staking can give you additional security and protect you from possible losses in terms of price dumps. This happens when the interest rate is large enough to cushion you against some loss. If you earn 40% interest on your investment and the price drops by 15% over the same period, you still have profits to book. In addition, if prices rise, you can be happy that you now own 40% more of your asset.

It is very likely, that if prices are starting to fall significantly, the interest paid in the pool will increase. This is because to keep people incentivized to join the pool to provide liquitidy to the network.

How does Staking work?

A distributed ledger (also called blockchain) works like a cash book, where it is recorded who owns how much funds. Banks and also stock exchanges work with this. They have to protect themselves from the outside against someone wantonly changing this cash book and being able to change the accounts in their favor.

In a distributed network with many participants, this process takes place in a decentralized manner, in contrast to a bank or stock exchange, which must protect a general ledger against many participants. But you can create trust in the distributed ledger by allowing everyone to confirm who really owns how much.

Distributing this ledger to all participants costs each individual space on his hard drive and also time his computer needs to reconcile with everyone. This process takes place automatically, a work that Distributed Ledger Technology (DLT) virtually takes away from us. But no one wants to work for free and provide it's computing power, so they are rewarded for participating in the networking process.

Two main ways have been found to do this:

  1. Security through power costs (the effort to forge the ledger consumes more power than participating positively) - the so-called "proof of work" (e.g. Bitcoin).
  2. Security through deposits (the individual's own funds in the network ensure its continued existence) - the so-called "proof of stake" (e.g. Ethereum2, Cardano, Binance Smart Chain).

General risks in Staking

In order for you to use Staking, a DLT is required that is also based on the Proof-Of-Stake (PoS) mechanism. This carries a higher risk than a large Proof-Of-Work network like Bitcoin. Think of this risk as using Paypal versus your bank account.

Your bank account is safer in the custody of your assets than a payment processor like a Paypal account. Still, that doesn't mean you can't use a payment service provider. After all, no one would think of storing all their assets there. So if you are looking for maximum security because you want to store your total assets, a large PoW network is the safer option (e.g. Bitcoin). But just the use of PoW does not make one network more secure than another. Above all, the number of participants tells something about the security. So always pay attention to how the network you use secures your assets.

Specific risks in staking

As with any investment, staking has its own specific risks that depend on several factors.

  1. How big is the overall network in which you are staking?
  2. Do you have your own server (full node) or do you entrust your deposits to an external company?
  3. Do you use a smart contract for staking and how secure is it?

The most relevant risk is that of a loss due to price crashes, which you are exposed to even without staking. However, staking is a mechanism that can protect the network from such scenarios. This is because when users pledge a deposit to the network for a period of time, they are usually not sold and support the price. However, you rarely have to promise a time guarantee of your deposits. The mere prospect of profit in staking is usually incentive enough.

In addition, there are risks caused by errors in the smart contract itself. This is a real risk. However, it very rarely occurs in reality. In the cases where this occurred, it was a chain of many different smart contracts that generated profits that the user was not entitled to. The difference is that this was not illegal at any point. Unfortunately, such scenarios are also known from the banking sector. Of course, such scenarios should not be adopted in new technologies, but they did happen.