You must have heard something about decentralized finance (DeFi). We all believe DeFi is our future, right? But most of us think this future is pretty distant. Well, it’s not. You should definitely know what DeFi staking is and how you can profit from it right now.
Crypto staking isn’t something new. It has been around since the Proof-of-Stake (PoS) consensus mechanism first appeared.
In contrast to the Proof-of-Work (PoW) model used by Bitcoin, where validators prove their deeds with mining, in PoS this role is taken by stakes. You kind of lock your tokens as a deposit. And in case you cheat or act with malicious intent you will lose your stake.
Many popular cryptocurrencies, like Cardano and Solana, use the PoS model because it does not require mining with high energy consumption. Even Ethereum – the biggest rival of Bitcoin to date – is switching to PoS in the near future.
But staking is not limited to PoS in the crypto world.
DeFi institutions have widely embraced staking. And it is steadily becoming a popular crypto tool.
And if you want to earn with crypto, DeFi staking is a concept you should really be familiar with.
Let’s take a look at DeFi staking – what it is and how to profit from it. Spoiler alert – no financial background required.
What is DeFi?
Decentralized finance, or DeFi, is a relatively new term that came to life in 2018. Though of course, if someone tells you that DeFi was born at the very moment the first Bitcoin transaction was completed, that would be true.
Bitcoin introduced the idea of blockchain with native cryptocurrency and the ability of peer-to-peer transactions. That was the beginning of DeFi.
But later the main development of DeFi was done on Ethereum, the first programmable blockchain with smart contracts and decentralized apps (known as dApps).
Smart contracts exist to ensure that on-chain transactions run according to standards and protocols. As such, predefined actions execute when predefined conditions are met.
As for dApps, they exist to ensure that users get to interact with blockchains.
So DeFi is basically a concept that allows existing services of traditional finance to be decentralized.
The first and the most noticeable merit of such a decentralization is the ability to eliminate countless middlemen attached to the traditional financial system.
If you are to transfer some assets to somebody via traditional finance, there will always be a third party involved.
And that means you always pay enormous fees (remember that Western Union takes up to 15% for every currency transaction?) and have to wait till the system works (ah, those working hours in the banks).
Let’s say you use your credit card to buy a bottle of beer in a local store. The transaction goes from the merchant to an acquiring bank. The latter forwards the card details to the credit card network, which needs to clear the charge and request a payment from your bank.
If your bank approves the charge, it sends the approval back to the network via the acquiring bank to the merchant. Of course, along the way, all entities involved charge their fees.
Basically it means that sending money actually costs some money.
Not to mention that this process can be pretty slow.
That is especially true when we look at loan applications.
Banks control you money
And there is something else you should not forget about.
Banks are fully controlling your money. They can block your accounts at any time. Your cards might nor work in some countries.
Lending, borrowing, trading, savings, and buying derivatives are all mechanisms of traditional finance.
You don’t own your money. You kinda need somebody else’s agreement if you want to spend the money you actually think you own.
Ideally, DeFi can solve all these problems.
What is DeFi Staking?
Now we have figured out what DeFi is. Let’s cut to the chase. So, what is DeFi staking?
Well, there are two different interpretations of DeFi staking.
One is quite technical. It means staking crypto assets in order to become a validator in a layer-1 blockchain or a DeFi protocol. Basically it means locking fungible or non-fungible tokens (NFTs) into smart contracts. By doing that users earn rewards for the duties their staking performs.
The second one is much more broad as it refers to all sorts of DeFi activities that involve a temporary commitment of crypto assets.
How does DeFi Staking work?
The easiest thing to do if you want to try DeFi staking is locking a specific amount of native tokens or coins to become a validator in a PoS blockchain network.
That is possible in Cardano, Polkadot or Solana networks, for example. Ethereum is making a highly anticipated switch to PoS this year, and you can take advantage of that also.
Validators who stake their assets are inclined to perform their duties properly to avoid the risk of losing a portion of or even their entire stake. And they are also encouraged by DeFi staking rewards. Which in case with Ethereum can reach 5-12% of interest depending on the amount of your stake.
Other usages of DeFi Staking
Besides, staking as a way of securing a network, there are other possibilities.
Staking can serve to provide liquidity for specific trading crypto pairs. It also helps to ensure that the value of a certain project or cryptocurrency doesn’t drop.
If you have a certain amount of networks’ native token staked it means that quite a large number of users actually trust the network.
It looks similar to the way traditional finance works. If many people trust banks and keep their money there, the banking system looks stable and solid. At the moment people are starting to withdraw their assets, the banking system starts to collapse.
DeFi staking is a way to fight inflation and deflation of the cryptocurrency.
What are the benefits of DeFi Staking
Benefits vary depending on different approaches to DeFi staking and on the point of perspective.
Benefits of DeFi Staking for stakers
Staking is an easy way to earn some crypto as a passive income.
It is easy to become a staker as many platforms implement staking into crypto wallets, so it’s kinda one click away. With the interest rate in mind, rewards are normally higher than expected.
And also with smart contracts stakers are highly secured.
Benefits of DeFi Staking for staking platforms
By implementing staking blockchain networks increase liquidity of their native tokens. Also staking with an appropriate interest rate is a way of attracting new users to the platform.
Of course, platforms can also generate revenue from stakers.
How to stake your coins right now?
There are few ways you can participate in DeFi staking.
Staking with PoS
If a cryptocurrency uses a Proof-of-Stake protocol, then there are generally ways to stake the coin built into official or recommended wallet apps.
Let’s take Cardano as an example.
Cardano recommends a couple of wallets, like the Yoroi wallet. It allows you to join staking pools and easily stake your coins in just a couple of clicks.
You should take into consideration that different coins have different policies on the duration of time your stake is locked down. It means you can’t withdraw it for a certain number of days or months.
Most potential stakers are interested in Ethereum, the second biggest crypto out there.
Ethereum is going to ETH 2.0 – an highly anticipated event that will turn off mining for good as the network will totally switch to the PoS model.
However, Ethereum is kinda cruel to beginners. It requires quite a huge minimum stake – 32 ETH (more than $100,000 at the time of writing).
Unlike Cardano, there are no easy to join staking pools in the world of Ethereum. Such pools do exist, but are not that easy to join and mostly they take control of your coins.
That’s custodial DeFi staking. You actually aren’t staking by yourself, rather than giving some other entity some amount of ETH and then they stake it for you.
It might feel safe if that entity is a famous exchange like Coinbase, Binance or Crypto.com. But think of how many people might fall into the temptation to trust their coins to less trusted entities.
One more downside of custodial staking is the concentration of ETH into centralized points of control and that individuals do not control the keys to the coins they stake.
Liquid DeFi staking
Besides the widely known PoS model there is another kind of DeFi staking.
That’s a slightly different kind of passive income, though it it also involves locking crypto.
How Liquid staking works
Liquid staking is a system where you are issued a tokenized version of the coin you staked and those tokens can be transferred, stored, or spent. This method of staking usually eliminates the “freezing” of the coins you staked.
It also allows you to withdraw your stake at any time by converting your tokens back into the coin you initially staked.
This method is gaining popularity with the ETH 2.0 staking.
As I mentioned before, the minimum stake is a whopping 32 ETH. But there are DeFi institutions that allow you to participate with a much less amount of crypto.
They allow you to enter their staking pool with any amount of crypto, starting from as small as 0.01 ETH. In return they give you a token of their own.
Then this DeFi institution creates validator nodes by grouping ETH stakes given by the individuals. These nodes look as a usual validator in the Ethereum network. Though it is actually a staking pool with all its functions carried out by smart contracts.
One of the examples of such an approach is Rocket Pool with its rETH token.
What is DeFi Staking? Key takeaways
- DeFi staking is a financial technology that includes the process of locking some crypto assets for a limited period of time.
- In the Proof-of-Stake networks the main benefit of staking is security and the chain working properly.
- Cryptocurrencies are using large amounts of staked native tokens to fight inflation and prevent the price of a cryptocurrency from dropping.
- It is also worth mentioning that, compared to PoW, PoS brings the benefit of a lower environmental impact.
- DeFi staking is easy to use in case with Cardano and some other cryptos. But it is much more complicated when talking about Ethereum.
- If you are about to try DeFi staking, start with Cardano just to see how it works and to make sure the whole staking idea meets your expectations.
- Going directly to Ethereum staking requires either quite a significant investment or taking risks with rather new and yet untested staking pools.
Sources: Level Up Coding, Moralis
Disclaimer:
The opinion expressed here is not investment advice. It is provided for informational purposes only. It does not necessarily reflect the opinion of cryptolife.report. Every investment involves risk, so you should always perform your own research prior to making important decisions. We do not recommend investing money you cannot afford to lose.
