By Peter Bergman (MoneyAmped.com)
The Bitcoin network has important protection through mining. Many modern cryptocurrencies use an alternative consensus mechanism called proof of stake (PoS).
This refers to the process of users participating in staking. Its essence is simple – users transfer their cryptocurrency assets to the network to facilitate the validation of transactions on the blockchain.
Staking serves an essential purpose beyond mere altruism. Asset users contribute significantly to the overall functionality of the network. By participating in staking, a person is entitled to a reward. This is usually in the form of the cryptocurrency that is being staked.
This guide will cover the first steps to help you get started as a cryptocurrency staker.
What Is Staking, and Why Is It Important?
Staking is storing a certain amount of cryptocurrency in a wallet to support blockchain network transactions and receive rewards in return.
Blockchain is a decentralized transaction accounting system with no central authority to maintain it.
A proof-of-work (PoW) blockchain, such as Bitcoin, uses a mining process to provide reliable confirmation of transactions. It involves using powerful computers to solve complex cryptographic puzzles in a competitive race. The mining process consists of using expensive equipment and significant electricity consumption. These features make it unaffordable for most people.
Proof-of-stake (PoS) networks like Cardano and Ethereum have introduced a new mechanism to protect their networks. This mechanism involves a process called staking. This process involves depositing funds into the network, replacing the traditional proof-of-work (PoW) consensus mechanism.
The Essence of Proof of Stake
The Proof of Stake consensus mechanism involves assigning validators based on the amount of cryptocurrency they have on their node. The cryptocurrency asset can be pledged personally by the validator or delegated through their node by other users.
Similar to incentivizing miners for their computationally intensive efforts, validators are rewarded with cryptocurrency when depositing their cryptocurrency. Those who delegate their cryptocurrency to a validator receive a proportionate share of the reward based on the stake amount (excluding the validator’s claim).
Benefits for the Investor
Staking represents a financially attractive opportunity for crypto investors who prefer to hold their assets rather than engage in frequent trading, regardless of the size of their capital. The beauty of staking lies in its complex mathematical underpinnings, and its practical application requires minimal technical knowledge.
What Are the Staking Options Available for Cryptocurrencies?
Here is a quintet of the top-ranked cryptocurrencies according to their market capitalization and average rates of return.
- The Ethereum token (ETH) rose in value by 4.1%.
- The current market performance of Cardano’s native token, ADA, reflects an increase of 3.24%.
- The Solana token (SOL) is up 6.5%.
- Polygon (MATIC) has a current yield of 6.5%.
The variability of yields is platform dependent and is subject to fluctuations depending on the number of validators involved in the network.
In cryptocurrency, different betting methodologies and the provision of staking as a service (SaaS) are standard.
In the cryptocurrency space, betting can be divided into two different methods.
One possible approach is to act as a validator by running your node. This approach requires a degree of bootstrapping. A reliable and resilient technical base is needed to ensure the integrity of the network. In addition, the skills to manage the validator node autonomously are essential. The minimum staking threshold for coins is often quite significant. To participate as an Ethereum validator, a minimum of 32 ETH is required.
How Is the Staking Process Handled?
In cryptocurrency, staking is often done by delegation, where you entrust your coins to a validator with the necessary infrastructure. Validators are responsible for maintaining the nodes. These validators receive a commission from the staking fees as compensation for their efforts. The task is pretty straightforward.
A booming sector known as staking as a service (SaaS) has recently emerged. Among them are several well-known software-as-a-service (SaaS) businesses:
- Staked
- Figment Network
- MyContainer
- Stake Capital
- Stake.Fish
It’s important to understand that delegating cryptocurrencies is not the same as handing them over to a validator. As a responsible crypto investor, you should always maintain as much control over your assets as possible. After all, any crypto investment is a risk.
Generally, you do not need to act on your rewards, as they are automatically reinvested. Some staking platforms offer the option to opt out of compounding dividends if one has concerns about the concept.
Participating in Staking Through Cryptocurrency Exchanges
Validators can offer their clients staking services through the user interface of an exchange. Some of the best-known conversations include Binance, Bitfinex, Kraken, and Coinbase.
Staking options offered by exchanges vary depending on the cryptocurrencies that can be used, associated fees, and potential blockchain periods.
Some cryptocurrency exchanges, such as Kraken, prominently display staking options on their primary interface, making it easy to find this popular service. However, some cryptocurrency exchanges, such as Binance, may categorize it as “Earnings” along with other ways of generating passive income through digital asset lending.
It is worth noting that not all well-known cryptocurrency exchanges support staking. Gemini’s ‘Earn’ initiative facilitates charging interest on PoW-based cryptocurrencies like Dogecoin. However, the user will not have the option to place a stake in PoS-based cryptocurrencies.
Do Exchanges Provide This Service to Everyone, or Are There Restrictions?
Under regulatory requirements, exchanges may restrict staking activity for residents of certain jurisdictions, such as New York or Hawaii.
Staking and Taxation
Given the nascent nature of cryptocurrency, numerous tax authorities worldwide have yet to adopt an official position on its taxation. As of March 2021, Her Majesty’s Revenue and Customs (HMRC) revised its tax guidelines in the UK. They included staking along similar lines to the principles applied to cryptocurrency mining.
In 2014, the US Internal Revenue Service (IRS) guided the issue of cryptocurrency mining income. In doing so, it confirmed that mining activities would generate taxable gross income. Since mining is treated as a business activity, coins derived from mining are subject to immediate taxation as ordinary income when generated.
It should be noted, however, that this advice applies exclusively to mining, as staking remains an ambiguous area.
There is a view that staking rewards should be taxable as income as soon as they arise because they have an already established market value. However, frequent issuance of token rewards occurring per minute or second could result in significant taxable events. The Cosmos blockchain, for example, generates new blocks every six to seven seconds. This results in more than five million taxable events in a single calendar year about betting rewards.
The ongoing debate remains unresolved, so the best advice for would-be stakers is to seek the services of a tax adviser well-versed in digital asset accounting.
Prospects for Staking
The seamless integration of the staking function into cryptocurrency exchanges has gained significant traction among crypto-enthusiasts. More often than not, these crypto-enthusiasts do not have advanced technical skills or do not own substantial crypto assets. There are a growing number of such users. So, we can expect the steaming service to continue to be popular.
There is a prevailing trend in the cryptocurrency industry towards adopting share proof, driven by the condemnation of proof-of-work because of its environmental implications. Proof-of-stake promotes a more orderly and efficient process for building and expanding a new network.
