c DeFi: Crypto staking - Digital Stade

DeFi: Crypto staking

DeFi: Crypto staking

Crypto staking generally refers to “putting your money in something and expecting to get more money.” For legal reasons, these are sometimes not called interest accounts, savings accounts, or investment funds, though on a functional level they resemble such products.

This article will cut through the crypto terminology and explain, in plain English, precisely what staking means and how to get started. Note that most staking activities are highly unregulated, and lots of funds turn out to be scams, hacked, or negligently run. Plus, it often paid returns out in cryptocurrencies, which themselves are sparsely unregulated and often highly volatile.

 

Types of DeFi staking

 

Staking

As mentioned above, the purest form of staking involves locking a set amount of crypto assets to become a validator in a Proof-of-Stake (POS) blockchain network.

Unlike Proof of Work consensus algorithms, where ensuring transaction validator requires a lot of energy-intensive computational work, POS relies on validatory that have vested interest in the success of a network through their staked crypto assets. Validatory have to perform their duties diligently, otherwise, they face the risk of losing a portion or even the entirety of their stakes. In addition, validatory are eligible to receive staking rewards for creating and validating blocks, which further motivates good behaviour.

Undoubtedly, the most high-profile POS blockchain currently is Ethereum, which is transitioning from Proof of Work to Proof of Stake as part of the eth2 (Ethereum 2.0) project. Other notable examples include Polkadot and The Graph.

At its most basic level, the staking process boils down to an interested party posting a ‘bond’ (stake) to become a network validator, which makes that party eligible for staking rewards. The problem with this direct approach to staking is that the staking requirement is often quite high. For example, to become a validator on eth2’s Beacon Chain, you need to post 32 ETH, which is a hefty investment. Because of this, most individual investors are typically priced out of staking opportunities.

Fortunately, there has been an emergence of staking service providers that allow people to circumvent the steep financial requirement. First, we have the so-called staking pools, which allow people to join forces with other crypto investors in order to raise staking capital. The system enables people to deposit any amount of tokens to a staking pool and starts earning passive income based on how much of the pool’s total holdings their deposit accounts for.

Alternatively, users can also turn to a crypto exchange, since most major centralized and decentralized exchanges offer DeFi staking services.

 

Yield farming

While lending and borrowing platforms provided the first strong use case for decentralized finance, yield farming showcased DeFi’s true power. The term refers to the practice of moving crypto assets between multiple Defi staking platforms to maximize returns. Essentially, people make their assets available to a lending protocol or a liquidity pool and they earn passive income as interest, as well as a percentage of the revenue generated by their platform of choice. However, they can easily redirect their assets to other pools and platforms to chase more lucrative rates of return.

Of course, investing in unique assets to maximize your earning potential or hedging against unexpected risks is one of the central investing strategies in traditional financial markets, as well. However, DeFi staking enables never-before-seen flexibility, as the combination of 24/7 access to markets, smart-contract-driven automation and lack of intermediaries allows for investors to jiggle between multiple DeFi protocols with little to no downtime. Such a level of flexibility creates plentiful opportunities for forming various DeFi staking strategies.

 

Liquidity mining

Liquidity mining is a subcategory of yield farming that involves providing crypto assets to liquidity pools. These pools are crucial for enabling trading without intermediaries on the type of decentralized crypto exchange (DEX) known as an auto market maker (AMM). A typical liquidity pool comprises the two assets that make up a particular trading pair – for example, ETH/DAI – and uses an algorithm to ensure that the value of the asset is always equal to the value of the other. This means that the pool dynamically adjusts the prices of the assets to account for any changes in their respective values that might have occurred because of trades. To put it in our ETH/DAI example, a purchase of ETH would decrease the amount of ETH in the pool while increasing the amount of DAI. To counter this, the pool increases the price of ETH relative to DAI.

At its core, this entire system relies on liquidity providers who make their assets available to liquidity pools. For that, liquidity providers can receive various financial incentives, including a percentage of the fees collected by the pool. Some DeFi staking platforms also include their own tokens in their reward programs. As we’ll see below, DeFi protocols need to have robust reward programs in order to make staking economically viable for liquidity providers.

 

Earning passive income with DeFi Staking 

For example, some people earn as high as 23% plus APY (annual percentage yield) for staking the Binance Coin. There are also those that stake Algorand (ALGO), Kava (KAVA), Texas (XTZ), Cosmos (ATOM), and even Tron (TRX) to earn up to 12% APY directly into their Trust wallet.

DeFi staking is the process of "locking" your crypto tokens into a DeFi smart contract in order to earn more of those tokens in return. It is akin to having a fixed deposit with your bank, and the bank pays you interest on your money deposited with them. Most times, the token used for staking is the native asset of the blockchain protocol, like DOT, with the Polkadot blockchain protocol. 

By locking/staking your crypto asset in a DeFi system, you have become a part of the validators for the network. Every proof-of-stake blockchain protocol relies on these validators to ensure the security of the protocol. Therefore, ensuring that no one cheats the system rests on these validators. In return, it will reward these people who have staked a part of their token to secure the network for their actions.

For example, if an Ethereum holder locks/stakes his token into the Ethereum 2.0 smart contract, he will earn an additional ETH for his role in ensuring the network's security by enforcing the underlying consensus rules. Because the entire process is automated, it does not demand manual oversight. Once you have deposited or staked your token into the smart contract, the proof-of-stake mechanism will handle the rest from that point onwards. All you can do after that is to periodically claim your rewards for staking. 

Aside from the direct token reward for staking these tokens, the tokens also earn a percentage of the revenue accrued by the products and services offered by the platform. For example, stakers earn a share of the fees from swaps on liquidity pools.

For Ethereum 2.0, the minimum requirement for staking is 32 ETH. However, some DeFi platforms use a special pooling mechanism where people can stake far fewer tokens. Most of the decentralized exchanges (DEXs) that use the Automated Market Maker (AMM) model allow users to stake their native tokens. A few examples include Uniswap (UNI token), PancakeSwap (CAKE token), Plasma.finance (PPAY token), to mention but a few.

 

Conclusion

The concept of DeFi staking gains traction globally. As a result, more platforms and protocols provide this functionality, leading to healthy competition and innovation. Some providers opt for a varied rewards scheme, whereas others want to focus on cross-chain support. Both concepts are valid, albeit combining the best of both worlds will be a more significant fundamental change.

Compared to keeping money in a savings account, choosing DeFi staking is almost a straightforward decision. It has better rewards and support for assets that cannot fluctuate in value, like stable coins. Once cross-chain support becomes more ingrained in these solutions, there will be more interesting offerings to choose from putting one's money to work in a low-risk or risk-free manner is what the mainstream needs to pay attention to cryptocurrencies.

Although DeFi staking is a great way to earn passive income, watch for the risks involved in staking. There is the risk of impermanent loss, hackers, and so on. Therefore, before you stake your token on any DeFi platform, ensure you have weighed the risks involved.

The aforementioned drawbacks reflect the fact that DeFi is still a novel concept that needs to be further developed and fleshed out. There are still some challenges that need to be addressed, especially because blockchain technology is still far from mature. Yet, even at this early stage, DeFi staking has shown that it has great potential and could provide a viable alternative to traditional investing.

NB: Please conduct your own thorough research before making any investment decisions.

If you appreciate what we do here on DigitalStade,
consider sending us an appreciation token;

You can:

  • abeg tag us whatever you feel we deserve. Our abeg tag is @digitalstade
  • patroen us @digitalstade

We are thankful for your never ending support.

What are your thoughts?


Oof. I'm sorry, buddy. But you've got to be a stadian to be granted the ability to create a comment!

Comments