As with many things in the cryptocurrency industry, staking can be a complicated or straightforward matter, depending on how many levels of the understanding you want to tap into. For many investors and traders, knowing that staking is a way to earn rewards for holding certain cryptocurrencies is key. But even if you only want to earn some staking rewards, it is useful to understand at least a little about how and why it works this way.
How does staking work?
If a cryptocurrency you own allows staking — current options include Tezos, Cosmos, and now Ethereum (via the new ETH2 upgrade) — you can “stake” some of your holdings and earn a percentage rate reward over time. This usually happens via a “staking pool” which you can think of as being like an interest-bearing savings account.
The reason your crypto earns rewards while staked is that the blockchain puts it to work. Cryptocurrencies that allow staking use a “consensus mechanism” called Proof of Stake, which is the way they ensure that all transactions are verified and secured without a bank or payment processor in the middle. Your crypto, if you choose to stake it, becomes part of that process.
What is DeFi?
Short for decentralized finance, DeFi is an umbrella term for peer-to-peer financial services on public blockchains, primarily Ethereum. DeFi (or “decentralized finance”) is an umbrella term for financial services on public blockchains, primarily Ethereum. With DeFi, you can do most of the things that banks support — earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more — but it’s faster and doesn’t require paperwork or a third party. As with crypto generally, DeFi is global, peer-to-peer (meaning directly between two people, not routed through a centralized system), pseudonymous, and open to all.
Why is DeFi important?
DeFi takes the basic premise of Bitcoin — digital money — and expands on it, creating an entire digital alternative to Wall Street, but without all the associated costs (think office towers, trading floors, banker salaries). This has the potential to create more open, free, and fair financial markets that are accessible to anyone with an internet connection.
What are DeFi Benefits?
- Open: You don’t need to apply for anything or “open” an account. You just get access by creating a wallet.
- Pseudonymous: You don’t need to provide your name, email address, or any personal information.
- Flexible: You can move your assets anywhere at any time, without asking for permission, waiting for long transfers to finish, and paying expensive fees.
- Fast: Interest Rates and rewards often update rapidly (as quickly as every 15 seconds), and can be significantly higher than traditional Wall Street.
Transparent: Everyone involved can see the full set of transactions (private corporations rarely grant that kind of transparency)
How does it work?
Users typically engage with DeFi via software called Dapps (“decentralized apps”), most of which currently run on the Ethereum blockchain. Unlike a conventional bank, there is no application to fill out or account to open.
Here are some of the ways people are engaging with DeFi today:
- Lending: Lend out your crypto and earn interest and rewards every minute – not once per month.
- Getting a loan: Obtain a loan instantly without filling in paperwork, including extremely short-term “flash loans” that traditional financial institutions don’t offer.
- Trading: Make peer-to-peer trades of certain crypto assets — as if you could buy and sell stocks without any kind of brokerage.
- Saving for the future: Put some of your cryptos into savings account alternatives and earn better interest rates than you’d typically get from a bank.
- Buying derivatives: Make long or short bets on certain assets. Think of these as the crypto version of stock options or futures contracts.
What are the downsides?
- Fluctuating transaction rates on the Ethereum blockchain mean that active trading can get expensive.
- Depending on which of the apps you use and how you use them, your investment could experience high volatility – this is, after all, new tech.
- You must maintain your own records for tax purposes. Regulations can vary from region to region.
What is a Cryptocurrency?
A cryptocurrency is a form of payment that can be exchanged online for goods and services. Many companies have issued their own currencies, often called tokens, and these can be traded specifically for the good or service that the company provides. Think of them as you would arcade tokens or casino chips. You’ll need to exchange real currency for the cryptocurrency to access the good or service. Cryptocurrencies work using a technology called a blockchain. Blockchain is a decentralized technology spread across many computers that manage and records transactions. Part of the appeal of this technology is its security.
Why Are Cryptocurrencies So Popular?
Cryptocurrencies appeal to their supporters for a variety of reasons. Here are some of the most popular: Supporters see cryptocurrencies such as Bitcoin as the currency of the future and are racing to buy them now, presumably before they become more valuable Some supporters like the fact that cryptocurrency removes central banks from managing the money supply since over time these banks tend to reduce the value of money via inflation Other supporters like the technology behind cryptocurrencies, the blockchain because it’s a decentralized processing and recording system and can be more secure than traditional payment systems Some speculators like cryptocurrencies because they’re going up in value and have no interest in the currencies’ long-term acceptance as a way to move money
How Can I buy Cryptocurrencies?
While some cryptocurrencies, including Bitcoin, are available for purchase with U.S. dollars, others require that you pay with bitcoins or another cryptocurrency. To buy cryptocurrencies, you’ll need a “wallet,” an online app that can hold your currency. Generally, you create an account on an exchange, and then you can transfer real money to buy cryptocurrencies such as Bitcoin or Ethereum. Coinbase is one popular cryptocurrency trading exchange where you can create both a wallet and buy and sell Bitcoin and other cryptocurrencies. Also, a growing number of online brokers offer cryptocurrencies, such as eToro, Trade Station and Sofi Active Investing.
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