If you’ve been following the cryptocurrency space recently, you’ve probably heard terms like “staking,” “farming,” and “liquidity pools,” but a trend that’s been growing popular lately is the concept of staking pools.
Staking has become an increasingly popular avenue for both large and small investors to put otherwise idle funds to work, and it’s becoming increasingly important to the blockchain infrastructures that underpin a wide variety of digital assets.
So what are staking pools, and what are the risks and benefits of these new investment vehicles?
How Does Staking Work?
Cryptocurrency staking can take on several different forms and serve multiple purposes, but the concept generally revolves around locking up digital assets to support the security, functionality, or liquidity of a blockchain project.
To incentivize staking tokens, stakers typically receive rewards in the form of newly minted coins, transaction fees associated with the blocks they help to validate, or discounts on a platform’s products and services.
As more blockchains eschew the classic proof-of-work consensus mechanism for the faster and more sustainable proof-of-stake protocol, staking has become an attractive way for investors to passively earn income from their digital assets.
Here’s a look at how staking works on Ethereum, which just migrated to PoS to become the world’s most widely adopted proof-of-stake network:
Instead of miners competing to validate blocks with powerful hardware, Ethereum stakers can lock up ETH in a staking contract and earn rewards for helping to secure the network.
To get started with ETH staking, aspiring stakers have a number of options:
- Solo stake at home: This method involves depositing 32 ETH to activate a validator and running an Ethereum node that’s connected online.
- Stake as a service (SaaS): SaaS is similar to solo staking, except that responsibility for node operation is given to a third party.
- Participate in a staking pool: Staking pools allow users to collaborate and combine their ETH to allocate a collective 32 ETH needed to run a validator.
- Stake on a centralized exchange: Perhaps the easiest method, centralized exchange (CEX) offers a staking service to minimize the amount of oversight required to stake your ETH. While it is straightforward and accessible, staking with a CEX requires you to give up control of your funds.
Each method has its own tradeoff and offers different benefits depending on the user.
In return for staking their ETH, stakers earn staking rewards, which are paid out from transaction fees or newly minted ETH. The amount of staking rewards that a staker earns depends on a number of factors, including the amount of ETH they have staked, the length of time they have staked for, and the overall staking rate.
The network uses a number of factors to choose which node will validate a block, and having a significant amount of staked ETH gives a node a better chance of being chosen. But what if you’re an independent investor without as much capital as larger whales and institutions? Are you excluded from the action?
This is where staking pools come in.
What is a Staking Pool?
Similar to the concept of mining pools on proof-of-work blockchains, where users combine computing power to increase their chances of earning block rewards, participants in proof-of-stake platforms can also combine resources to pool their staking power and increase their chances of being chosen to validate blocks.
Staking pools are groups of stakers that come together to pool their resources and increase their chances of being selected to validate blocks, and in turn, earn staking rewards. These rewards are then distributed among the participants according to the amount they have staked. This approach has a number of advantages, especially for smaller stakers.
First, by pooling resources, staking pools allow stakers with less capital to come together and have a greater chance of being selected as validators. Second, staking pools can offer stakers more flexibility in how they earn rewards.
For example, some staking pools may choose to pay out rewards on a daily basis, while others may wait until the end of a staking period to distribute rewards. This allows stakers to choose a pool with the lock up period and payment schedule that best suits their needs.
In order to participate in staking pools, there are plenty of decentralized platforms which offer pooled staking, including Lido, Rocket Pool, Ankr Staking, and more.
The Purpose of Staking Pools
The primary purpose of staking pools is to increase the chances of stakers earning rewards. But staking pools can also offer a number of other benefits, including:
Reduced risk: By spreading the staking capital across multiple stakers, staking pools can help to reduce the risk of individual stakers losing their entire stake if they are chosen to validate a malicious block.
Improved ROI: Staking pools typically charge a small fee for their services, but this fee is often offset by the increased rewards that pool participants earn. As such, stakers can potentially earn a higher return on investment by joining a staking pool.
Increased participation: By allowing stakers with less capital to participate in staking, more people can get involved with the network validation process.
Risks of Using a Staking Pool
While staking pools offer a number of benefits, there are also some risks to consider before joining one. First, staking pools typically require participants to trust a third party pool operator with their funds. This means that if the pool operator is malicious or incompetent, stakers could lose their entire stake.
Cryptocurrency staking is still a new concept, and as such, there is a lack of regulation around staking pools. This means that stakers could be at risk of being scammed by malicious pool operators. It’s important to do your research before joining any staking pool, and only use pools that have a good reputation.
One larger scale risk to consider is the potential for staking pool centralization. If a small number of staking pools control the majority of staked assets, this could lead to centralization of power within the blockchain’s network. While this is currently not a major concern, it’s something to keep in mind as staking pools become more popular.
Using a Staking Pool
If you’re thinking of joining a staking pool, there are a few things to keep in mind. First, make sure to do your research and only join pools that have a good reputation. Second, be aware of the risks involved, and don’t stake more than you can afford to lose.
Finally, remember that staking pools are just one way to earn staking rewards. If you’re not comfortable with trusting a third party with your funds, you can always choose to stake your assets on your own.
Whether you decide to join a staking pool or stake your assets on your own, staking is a great way to support your favorite blockchain projects and earn some passive income.
If you’re interested in learning more about staking, the FTT DAO blog hosts a wide range of educational articles and resources to get you started. You can stay up to date with the latest news and analysis from across the cryptocurrency industry by following FTT DAO on Twitter.