A Beginner's Guide to Staking Rewards

Staking has emerged as an innovative way to earn passive income from your cryptocurrency holdings. Although trading and mining are the traditional ways of interacting with the crypto market, staking is an alternative that is financially rewarding and environmentally friendly. But what are staking rewards, and how can you earn them?

In this guide, you will learn what staking is, what staking rewards are, their benefits, and the risks associated with them.

Let’s take a look!

What Is Staking?

Crypto staking is the process of locking your cryptocurrency into a blockchain network to support the operations. By staking cryptocurrency, investors help in validating the transactions, maintaining consensus, and securing the network. For staking, the investors receive rewards in the form of additional tokens.

This technique exists primarily common with blockchain platforms that use Proof of Stake (PoS) or its other variants, such as Nominated-Proof-of-Stake (NPoS) and Delegated-Proof-of-Stake (DPoS). Different from Proof-of-Work (PoW), which requires miners to solve complex mathematical puzzles, the PoS heavily relies on investors (called validators) to be reliable and committed to the platform.

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The Mechanism Behind Staking Rewards

The Proof of Stake mechanism replaces PoW's energy-intensive mining with a more efficient system. Given below are the different elements that are part of the Proof of Stake process, with a brief explanation of how it works:

• Validators: Individuals or entities who stake tokens to participate in transaction validation.
• Selection Process: Validators are chosen to create new blocks based on factors such as the size of their stake, the length of time staked, and sometimes randomization.
• Rewards: When validators confirm transactions and add them to the blockchain, they receive staking rewards, similar to interest or dividends.
• Penalties: To ensure honesty, validators risk losing a portion of their staked tokens (a process called slashing) if they act maliciously or fail to validate correctly.

This system makes PoS not only more energy efficient but also more accessible to regular users.

How Staking Rewards Are Calculated

Staking rewards vary widely across blockchain projects. Generally, the reward rate is influenced by network participation and supply dynamics. When fewer users stake their coins, the network often increases reward rates to encourage participation. Conversely, when a majority of the circulating supply is locked in staking, the reward percentage tends to decline.

Most blockchain systems use a combination of inflationary rewards, where new tokens are created and distributed, and transaction fees are collected from network users. Validators earn a portion of both, which they then share with those who delegated tokens to them.

For example, in Ethereum’s PoS model, rewards depend on the total ETH staked and validator performance. If a validator fails to stay online or behaves maliciously, they can lose a portion of their stake through a process called “slashing.” This ensures network integrity and fairness among participants.

Over time, the effective annual percentage yield (APY) from staking can fluctuate depending on market conditions, validator uptime, and the network’s overall activity.

Important Reads: A Guide on How to Stake Ethereum for Beginners

Lock-in Period

Many platforms or crypto projects require the traders to “lock in” their holdings for a predefined period. During this staking period, the tokens are tied up and cannot be withdrawn from the smart contract or a wallet for this agreed-upon period. One risk of this restriction is that the tokens locked in cannot be sold for the duration of the lock-in period. Considering the unpredictable nature of the blockchain industry, the prices of the tokens can fluctuate in seconds, which can lead to monetary loss.

Understand Key Terms

Calculating staking reward becomes easier when you understand key terms. Let’s take a look at them:

Annual Percentage Rate (APR)

Annual Percentage Rate or APR is one of the most common terms you will come across. APR refers to the annual interest rate of an amount. In simpler words, APR indicates the amount of interest earned on an invested amount over a period of one year.

Here is an example, a 10% APR on $2,000 worth of assets stabled will result in approximately $200 in rewards after a year, assuming there are no other factors affecting it.

Annual Percentage Yield (APY)

Another term that you will come across is APY or Annual Percentage Yield. APY is also known as the absolute interest rate. The annual percentage yield represents the compound interest rate earned on an investment over the course of one year. Both APY and APR figures are calculated along with price fluctuations and liquidity to calculate staking rewards.

APY is calculated using the formula APY = (1+r/n​)ⁿ − 1. Here, “r” represents the annual interest rate and “n” represents the number of compounding periods per year (e.g., 12 for monthly).

Here is how it is calculated. Let’s consider that you have ETH with a 10% APR that compounds monthly. Using the formula above, the “r” in the equation is the 10% APR (r=0.10) and “n” is the monthly compound (n=12). Now, let’s add this data to the equation.
APY = (1 + 0.10/12)¹² – 1

APY = 1.0833¹² – 1 = 1.10470 – 1

APY = 0.1047 or about 10.47%

Popular Cryptocurrencies Offering Staking Rewards

Several major blockchain networks now rely on staking as their primary consensus mechanism. Ethereum 2.0 introduced staking as part of its transition from proof-of-work, allowing users to earn rewards by locking up ETH. Similarly, Cardano (ADA) and Polkadot (DOT) have user-friendly staking systems with relatively low entry barriers. Solana (SOL), Tezos (XTZ), and Cosmos (ATOM) are also known for offering attractive reward rates with varying degrees of risk and liquidity.

Each of these networks has its own staking architecture, but all share the same fundamental idea: rewarding participants for contributing to the system’s reliability and decentralization.

Key Takeaways

Staking rewards have given more opportunities for traders and investors to earn from their crypto holdings. These are a great way for investors to generate income while they continue to contribute to the development of the blockchain network’s ecosystem. However, much like any other financial decision, traders should understand the market conditions, project fundamentals, and market conditions.

For those traders who want to learn, staking rewards can be a powerful tool for participating in the decentralized networks and generating passive income at the same time.

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