Imagine kicking back while watching a great movie and making money the entire time. That's exactly what passive income can enable you to do.
There are several alternatives for generating income that doesn't require an ongoing effort on your part. Staking cryptocurrencies is one approach that's gaining momentum. Here's why staking Ethereum (ETH 1.34%) could be an absolutely brilliant way to earn passive income.
Staking is only supported on blockchains that use the proof-of-stake consensus mechanism. These blockchains allow you to commit your tokens to support the verification of transactions. In return, you receive rewards.
Ethereum started out on the proof-of-work model, which doesn't support staking. However, the introduction of the Beacon chain in December 2020 paved the way for staking Ether tokens. This chain is scheduled to merge with the Ethereum mainnet this year, bringing staking to the entire Ethereum network.
Just how much can you make staking your Ether tokens? It varies based on which cryptocurrency exchange you use and the length of time you stake your tokens. However, the returns can be quite impressive.
As of the time of this writing, the highest annualized yield available for staking Ether is 10.1%. Binance offers this especially juicy yield for a staking period of 120 days. It's easy to find other exchanges with yields of between 4% and 8% for shorter periods. These yields are more attractive than those offered by most dividend stocks.
The other side of the coin
With the opportunity to earn double-digit annualized yields, why wouldn't everyone want to stake Ether tokens? The primary drawback is your ability to sell is restricted.
Cryptocurrency exchanges typically require you to lock up your Ether tokens for a predefined period when you stake them. Even at the end of the staking period, you might not be able to immediately sell. Some exchanges have "unstaking" periods that can last for several days.
This inability to sell can be especially problematic when the tokens are rapidly falling in price. We've seen this exact scenario play out in recent days. Ethereum has dropped more than 30% over the past week.
It's quite possible that a downturn could be an extended one. While staking could cushion your losses to some extent, the yields won't be nearly enough to offset major losses like we've experienced this month.
Taking the long-term view
This is essentially the same challenge that investors in dividend stocks face. You can't sell your shares of the stock and still receive dividends. It's possible that the stock could fall a lot more than you make from the dividends.
That's why investors are attracted the most to dividend stocks of companies with solid long-term prospects. The stock price might decline over the short term, but investors expect it to at least tread water (and preferable increase) over the long term.
Anyone considering staking Ether tokens should adopt the same mindset. If you don't believe in the long-term prospects for the cryptocurrency, staking Ether tokens is an ill-advised move.
It's a different story, though, if you think that the Ethereum blockchain has staying power and that Ether remains a great investment over the next several years. If this view proves to be correct, staking Ether could truly be a brilliant way to make passive income.