Discover how to generate passive income by locking digital assets on the network.

The fundamental thing you need to understand

The process of locking cryptocurrencies to participate in the validation of a blockchain network is becoming an increasingly popular alternative to earn profits while contributing to the functioning of the ecosystem. This mechanism works only on blockchains that adopt the Proof of Stake (PoS) consensus system, among which we find Ethereum, Solana, Cardano, Avalanche, Polkadot, and Cosmos.

In exchange for your participation, you receive additional cryptocurrency rewards. However, it is crucial to understand that there are significant risks: from exposure to price volatility to potential technical penalties or security issues on third-party platforms.

Difference between the traditional system and the new consensus

Why did Proof of Stake emerge?

The PoS mechanism emerged in 2011 as an efficient response to the Proof of Work (PoW) used by Bitcoin. The main distinction is that PoS does not require resource-intensive mining activity. Instead, networks select validators based on the amount of coins they hold and stake to the network, rather than their computational power.

This approach is significantly more environmentally friendly, dramatically reducing energy consumption compared to traditional mining.

How does cryptocurrency staking operate on PoS chains?

The general operation follows these steps:

Stage 1 - Participant Selection: Validators are chosen based on various criteria: the volume of locked coins, the duration of the lockup, and often, random factors that ensure decentralization.

Stage 2 - Transaction Verification: The selected validator checks that all transactions are legitimate and comply with the network protocols.

Stage 3 - Block Aggregation: Verified transactions are grouped to form a block that is incorporated into the distributed ledger of the blockchain.

Stage 4 - Profit Distribution: The participant receives a portion of the transaction fees and, in certain cases, new coins generated by the protocol.

Available modalities for participants

Based on your technical experience and available capital, you have multiple options:

Independent Operation: Requires you to run your own validator node. Offers maximum control but demands deep technical knowledge and significant responsibility. The risk of losing funds due to slashing penalties is considerable if you make operational mistakes.

Through exchange platforms: Many exchanges offer this simplified function, eliminating technical complexities. This model is known as “staking as a service” and is the most accessible option for beginners.

Delegation to third parties: You can transfer your stake to a trusted validator or specialized service that handles the technical aspects. Certain altcoins integrate this option directly into their wallet applications.

Collective grouping: Multiple investors combine their resources in pools, increasing selection probabilities without the need to run their own infrastructure. This alternative is especially advantageous for those who do not have sufficient volumes for minimum requirements.

Collective Pools: Operation and Benefits

A pool groups multiple holders who unify their validation power, significantly increasing the chances of being selected as validators. Participants receive compensation proportional to their contribution to the common fund.

This structure greatly benefits small investors who would otherwise not meet the minimum amounts. However, thoroughly researching the reputation of the pool is essential, as fees, security policies, and transparency can vary significantly between providers.

Traditional Locking vs. Liquidity Maintained Locking

The innovative liquidity model

A recent trend allows you to retain access to your assets while generating profits. Unlike conventional locking where your funds are completely immobilized during the staking period, this new methodology maintains your operational capacity.

The typical mechanism issues derivative tokens that represent your locked assets. For example, some services issue an equivalent token that you can trade or use in other protocols without affecting your compensation flow.

Specialized DeFi platforms also offer variants where no derivative token is generated, maintaining native locking with available liquidity, as happens with ADA on the Cardano network.

This innovation allows you to enjoy participation benefits without sacrificing flexibility in managing your portfolio.

Reasons to Participate

Yield Generation: Your inactive assets generate continuous rewards, transforming them into significant long-term passive income sources.

Strengthening networks: Your participation directly contributes to the security, stability, and proper functioning of blockchain ecosystems.

Influence on decisions: In numerous networks, participants gain voting rights, allowing you to influence future developments of the protocol.

Positive environmental impact: This method consumes minimal energy compared to alternatives like mining, aligning with sustainable practices.

Profitability Assessment: Is it really worthwhile?

Generally yes, particularly if you are a long-term investor and wish to support specific projects. However, potential returns and exposure to risks vary depending on the chosen cryptocurrency and platform.

A DeFi platform that offers extraordinary returns but lacks robust security mechanisms poses a potential danger: your funds could be stolen or lost completely. Market fluctuation is another risk factor that often erodes or surpasses the gains achieved.

Fundamental risks you should consider

Price volatility: If the value of the cryptocurrency you are participating in experiences a significant drop, it is likely that your validation earnings will not offset the losses in the value of the asset.

Slashing penalties: As a PoS validator, you must ensure correct operation. Malicious behavior or technical issues in your node result in penalties that reduce your staked funds.

Concentration of power: If few validators accumulate the majority of participating coins, centralization arises which compromises the security and decentralization of the network.

Infrastructure Failures: Certain types of blocking immobilize funds for specific periods. Errors in smart contracts or software can cause loss of access or indefinite freezing of assets.

Exposure to intermediaries: By delegating to third-party services, you entrust your funds to third entities. Security breaches or platform hacks expose your capital to considerable risk. DeFi applications present parallel risks when they request full access to your crypto wallet.

Step-by-step guide to get started in 2024

Step 1: Select a cryptocurrency with PoS support. Research specific staking requirements and compensation structure for that network.

Step 2: Set up a compatible wallet. Choose established and reliable options that allow you to manage your private keys securely.

Step 3: Start your participation by following the instructions of the chosen network. You can perform personal validation, delegate to a professional validator, or join a community pool. Remember that interface wallets are access tools, not protocol controllers. Focus on mature blockchains like Ethereum and Solana, conducting thorough research before committing capital.

Calculation of Your Expected Earnings

Compensations vary based on multiple network factors:

• The volume of cryptocurrencies that you contribute to the lock
• Uninterrupted participation time
• Total amount of coins participating in the network
• Transaction fees and protocol inflation rates

Blockchains with predetermined structures facilitate profit projections. Compensations are typically expressed as annual percentage yield (APR), allowing you to calculate expected profits.

Liquidity of blocked funds: can I access them?

In most cases, yes. You should be able to recover your assets at any time, although the exact mechanisms vary between platforms. In certain services, early withdrawals result in partial or total loss of accumulated earnings.

Carefully check the specific policies of the platform you are using. The Ethereum upgrade in 2023 marked an important milestone, allowing staking withdrawals on that network. Since then, Ethereum participants can automatically receive their earnings and withdraw locked assets whenever they wish.

Limitations: why don't all cryptocurrencies allow it?

The blocking is exclusive to blockchains with a PoS mechanism. Cryptocurrencies like Bitcoin operate under PoW and do not offer this option. Even within PoS ecosystems, not all assets enable staking, using alternative methods to incentivize validation.

Conclusion

Participating in networks by staking assets represents a legitimate opportunity to generate income while strengthening blockchain ecosystems. The key is to fully understand the risks: market fluctuations, security issues with intermediaries, technical penalties, and infrastructure vulnerabilities. With careful selection of your participation method and in-depth research of the protocol, you can effectively contribute to the ecosystem while potentially generating sustainable passive returns.