DeFi Part 6: Earning Staking Rewards

In the previous installment of this series, we talked about DeFi lending and how you can earn passive interest from it. However, exposing your portfolio to the risks of cryptocurrencies for single-digital annual returns may not be the most appealing proposition.

That’s where staking and other DeFi investment methods come in. For today’s article, we’ll explore staking and see why this method may offer the most attractive ratio of risk to reward for some investors.

So without wasting any time, let’s jump right in.


Table of Content

  • Understanding Staking and the Growing Need for It
  • Exploring the ROI of DeFi Staking
  • The Dark Side of Staking
    • Impermanent Loss
    • Locked Funds
    • Hefty Startup Costs
  • Is Staking the Right Call for You?
  • Key Takeaways

Understanding Staking and the Growing Need for It

The price action of any asset can be distilled into the difference between supply and demand. This universal formula is applicable to cryptocurrencies just as much as any other asset class.

The more people try to sell a cryptocurrency, the more its value drops. This is how market crashes happen. When people see an undeniable trend in skyrocketing sell volume, their immediate reaction is anxiety followed by the sale of their own assets.

To prevent this outward flow, so to speak, many cryptocurrency creators came up with a novel idea: rewarding people to hold their cryptocurrency.

That’s what staking is in a nutshell. By locking your funds in a smart contract for a predetermined period of time, the network rewards you an annual percentage yield of the same token. For instance, if you stake your ether (cryptocurrency on the Ethereum network), you’ll earn more ether tokens as a reward for your commitment.

To ensure long-term holding, staking typically requires a lockdown of funds for at least a few months and sometimes to the tune of several years too. However, it’s always done with the consent of the user. To incentivize longer holding, cryptocurrency creators offer higher reward rates for longer contracts.

Exploring the ROI of DeFi Staking

The amount of staking rewards can vary wildly from network to network. Established players like Ethereum 2.0 and Solana can get away with smaller staking rewards because of their brand name and the overall stability of the project.

As of this writing, the staking rewards for Ethereum 2.0 and Solana are 4.83% and 5.86% respectively. Furthermore, people have already staked a combined $67+ billion worth of assets among these two networks alone.

At the same time, emerging projects offer far higher levels of staking rewards to grab the highest share of the market. For instance, as of this writing, Crypto.com’s token is offering a 14.81% annual return rate and has a little under $2 billion in staked value. Similarly, Polkadot is offering 13.98% annual rewards with almost $12 billion locked through staking.

The Dark Side of Staking

While staking is considered to be one of the safest forms of DeFi investments, it still carries multiple risks. Here are the three primary ones that you need to consider.

1. Impermanent Loss

With staking, you cannot get paid in stablecoins as the rewards are always paid out using the native token of the network. For instance, if you stake ether, the Ethereum network will reward you with extra ether tokens only.

This means that if the price of ether drops 50% over the next few weeks, your ~5% annual yield will become meaningless.

2. Locked Funds

No matter how bad the market might get, you’ll be locked in a contract and your funds will remain frozen. Although this may not be as bad as it sounds since markets have always recovered and went on to make new highs. This could be the extra push you need to control your trigger finger and stay put for the long run.

3. Hefty Setup Costs

Most projects require a prohibitively massive commitment before you can start raking in the rewards of staking. Ethereum, for instance, requires 32 ETH to become a validator on its Beacon Chain. At today’s exchange rate of over $3,000, that works out to roughly $100,000.

However, it is possible to circumvent this issue by joining a staking pool. These projects allow people to pool their funds together and then take a cut of the staking rewards proportion to their ownership of the pool. However, staking pools often take a cut of their by taxing transactions.

Is Staking the Right Call for You?

The answer depends on a variety of factors, ranging from your risk tolerance to activity level preference. Staking is 100% passive and has a mild risk profile compared to other DeFi investment methods.

However, where this option excels is when you believe in the underlying project.

As an example, if you believe that Ethereum will continue to grow in value and you want to hold its native crypto ether, then staking is the perfect solution for you. That’s because while you’re waiting for the price to appreciate, you can stake your ether tokens and earn passive rewards along the way.

Key Takeaways

  • Decentralized projects offer staking rewards as an incentive for users to hold on to their tokens instead of selling them
  • The riskier a project is, the higher its staking rewards
  • If you believe in a cryptocurrency and plan on holding it for the long term, it’s usually a good idea to earn some passive returns by staking it

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