There are few more appealing ways to make money than through passive income, and many savvy crypto investors enjoy substantial passive income by staking their digital assets. Earnings from staked crypto are much like earnings from interest or dividends, and for an investor who has confidence in the long-term success of a crypto, staking offers an opportunity to earn from 4% to as much as 20% returns on top of any increases in the crypto's price.
However, only some cryptos -- the ones that use a Proof of Stake (PoS) consensus mechanism for validating new network transactions -- offer an option for staking. In a nutshell, this is because the PoS consensus mechanism relies on participants with an invested stake in the network to validate new transactions. In contrast, blockchains like Bitcoin (BTC 0.33%) rely on a different mechanism to validate new transactions: it uses Proof of Work (PoW), which validates new blocks by relying on miners with fast-computing machines who compete to solve mathematical equations. PoW mining is not practical for most investors, since it is more complicated and requires dedicated machines. Additionally, PoW mining is not necessarily profitable unless one happens to live in an area with low-cost, renewable electricity. Staking, therefore, is accessible to more regular investors.
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What does this mean for crypto investors?
The conspicuous question that remains for investors is whether it is sensible to invest in crypto assets like Bitcoin that do not offer staking rewards. It really depends on the goals of the investor. Cryptos that do not offer staking may be uninteresting to those who are seeking the highest possible short-term returns. But other crypto investors are most interested in pursuing long-term appreciation of crypto value while holding it in offline storage, rather than actively allowing it to be used for staking.
Staking crypto comes with some risks. Staking requires you to temporarily commit your crypto to be used by the underlying blockchain network, or by an exchange. If you allow a pooled resource to stake your crypto for you, and an illegitimate validation by that staking pool is detected by the network, it is possible for some of the staked crypto to be "slashed" as a penalty -- you could lose some of your staked crypto even if it was not your fault. And when you join a staking pool, you can't be sure whether there are any other people participating who might try to perform invalid transactions. Additionally, committing to staking your crypto usually puts some time hold on it, preventing you from un-staking it instantly. This committed "hold" duration for staked tokens could force you to ride through sudden market drops that make you wish that you could have quickly reallocated your investment!
Diversifying your holdings
Consider an analogous investment decision: is physical gold a sensible investment even though it is not an interest-bearing asset? Gold investors would point to its unique financial characteristics as justification for holding some. It does not compete with other portfolio assets for highest return, although its value may increase significantly during some periods of time. Rather, gold acts as a store of value and a hedge against inflation, and it can be part of a diversification strategy that adds value because of its unique, if sometimes unspectacular, financial characteristics.
Similarly, in my opinion, many crypto investors should take advantage of staking to earn passive income, and they should hold some Bitcoin for crypto portfolio diversification. Although as an asset class, all cryptos are subject to price volatility, owning some Bitcoin adds value as the most-capitalized digital asset, and Bitcoin's price continues to climb in long-term value despite the inevitable price volatility. Amidst an explosion of innovative new blockchains and tokens that provide a broad range of financial and social use cases, the Bitcoin blockchain has continued its momentum as a platform for investment by institutions with all levels of risk appetite.
Diversification in numerous high-quality assets is a time-tested investment strategy, and like any form of diversification, holding cryptos that are implemented in different technical ways, and used for a variety of use cases, lowers the risk of losses within an investment class. It makes sense to put your eggs in several types of crypto baskets, both staked and un-staked.
