In 2017 DeFi emerged to provide a true financial alternative. People could now trade peer-to-peer using Uniswap or lend their crypto assets using Aave. This novel technology provided so many ways to earn a passive income it was incredible.
In this article, we will be focusing on one facet of DeFi, Staking. I will be explaining this bleeding-edge technology and all the benefits it brings. So without further ado, let’s jump right in.
What is DeFi Staking?
DeFi staking is a process where users lock up tokens in exchange for rewards. With cryptocurrency, this is usually done to secure the network. Once staked, validators verify transactions and are provided compensation in return.
How does DeFi staking work?
DeFi staking allows users to lock up their funds in return for rewards. This is done using the proof of stake (PoS)mechanism. PoS relies on validators to verify transactions and secure the network.
To incentive good behavior the network implements slashing. This term refers to the seizing of the staked funds by the smart contract if the validators do not perform the required tasks.
Staking rewards are determined by the lockup period and the rates set by the blockchain. In the case of Ethereum staking is upwards of 5%. During the staking process, the validator’s funds are locked up in a smart contract. This can be anywhere from a few days to weeks.
This leads me to my next point. Delegation. Users can avoid the lockup period by delegating their tokens to a validator. Essentially, they assign their tokens to a validator in exchange for a cut of the profit.
Advantages of DeFi staking
The main benefit of DeFi staking is the passive income it provides. With rewards upwards of 10%, staking is a serious alternative to traditional savings accounts. If you want to learn more about passive income, click here.
Not to mention, It’s a relatively lower risk when compared to other DeFi alternatives like lending and yield farming. Although there are smart contract failures and hacks, they are less prominent.
Thirdly, when compared to the proof of work mechanism that bitcoin uses. PoS is less energy intensive and considerably cheaper as it does not rely on mining. In most cases, a user only needs a standard computer to validate the network rather than an expensive mining rig.
Lastly, staking leads to a more active community. Everyone’s incentives are aligned with the goals of the project. People are encouraged to perform well and ultimately if the network is more secure they will likely get a higher return on their investment.
The first risk of staking is slashing. If a validator does not perform the required tasks then a percentage of their staked funds are seized. In turn, this can also affect users who delegated to them. The second risk is liquidity risk. As your coins are locked up they are extremely illiquid. This can prove problematic due to the volatility of the market. Users cannot quickly respond to the change in price.
The last risk is nothing new, hacks. If you interact with a fake website or shady smart contracts your wallet may get compromised. Research is key. Find reputable projects and don’t fall for the common scams. The best way to protect yourself from hacks is using a hardware wallet. The one that I recommend is the Ledger Nano X. Click here to check out my review.
Overall, DeFi staking is an excellent way to earn passive income. It’s certainly interesting technology that aligns community incentives and provides a robust ecosystem. However, it does come with risks.
From slashing to hacking, it is important you do your research to find reputable projects. Ultimately, if you want to earn some extra cash then staking is probably one of the better options in the DeFi ecosystem.
Thanks for reading. If you want to learn about Decentralized insurance then click here.