Ethereum Staking Explained: How You Can Earn Passive Income

In order to understand Ethereum staking, it’s important to reflect on ETH’s evolution since it was introduced in 2015.
Since its inception, the popularity of Ethereum can be attributed to its role as a blockchain-based decentralized network that gave rise to impressive concepts such as smart contracts and decentralized applications.
Given the explosive adoption of the applications built upon its network, investors have profited by the demand of Ether that fuels the ecosystem. 

Despite its favored position with blockchain developers, there have been key members of its community have been focused on introducing a key ingredient needed for its next stage of evolution: staking. 

What Does Staking Mean?

Staking is the process of holding cryptocurrencies in a smart contract on the blockchain in order to validate transactions, add them to the blockchain, and return for awards.

For Ethereum 2.0, staking of a solution to two of main criticisms of its networ: scalability and accessibility. The challenge arises when the volume of activity and transactions exceed the transaction processing speed of the Proof-of-Work model. 

With Proof-of-Stake, Ether owners will be able to offer their holdings as collateral for the use of verifying transactions and earning passive income for their participation. 

What is Proof-of-Stake?

Proof-of-Stake is a consensus mechanism that works with validators, who are participants on a blockchain network that validate transactions and add blocks to a blockchain. Validators stake their coins so as to have a chance to be selected to validate block transactions. Once selected, the validators are awarded for validating block transactions.

Proof of Work vs Proof of Stake, PoW vs POS, What is Proof of Work, What is Proof of Stake, What is PoW, What is PoS
Source: Quora

What are the Benefits of Ethereum Staking?

Proof of Stake comes with several advantages over Proof of Work: cost-efficiency and decentralization.

A key criticism of Proof-of-Work is the significant amount of energy required to operate the computing resources, such as factories full of high-powered computers and servers, to validate transactions and add them to the blockchain. In fact, the University of Cambridge calculates that Bitcoin which utilizes Proof-of-Work, uses as much electricity as the country of Switzerland annually. 

In contrast, Proof-of-Stake does not require sophisticated equipment to operate the blockchain. The environmental impact has been lauded by academics, governments, businesses, and investors around the world. 

Furthermore, proof-of-stake is considered to be more decentralized than Proof of Work. Due to the growth of mining pools, which provide miners a greater chance of solving complex equations associated with transactions, Proof of Work is proving to be more centralized as the power is concentrated to the owner of the mining pool. 

What Does Staking Mean for Investors?

The most significant benefit of Ethereum staking is the passive income that you can earn just from holding Ether and leaving your computer connected to the internet while running the Ethereum 2.0 platform.

What Does Staking Mean
Source: Ethereum staking

Keep in mind that when you stake Ether, you will lock up your holdings – often referred to as a “lock-up period” – for a set amount of time. As such, you cannot sell your Ether if the market crashes and will instead have to face any losses.

There is also the possibility that a smaller downturn in the market could negate any profits from staking. Depending on the staking method that you utilize, such as staking pools, it’s important to be mindful of any person or group who control your Ether during the “lock-up period.”

Minimize that last risk by only participating in well-respected staking pools.

What are Staking Pools?

Similar to how mining pools have emerged on Proof-of-Work blockchains, staking pools have gained a foothold for existing and upcoming Proof-of-Stake networks. 

A staking pool has multiple people working together to be a single validator for staking. The key benefit Staking pools allow people to combine their cryptocurrencies to increase their chances of being selected to be validators so as to earn staking rewards.

Some exchanges run their own staking pools, where they deposit submitted user funds into a wallet used explicitly for staking. With the official launch of Ethereum 2.0, you can expect to see exchanges such as Coinbase and Gemini to offer staking services to investors on their platforms. 

In Summary

Ethereum staking is the process of holding Ether in a smart contract on the Ethereum blockchain in order to validate transactions, add them to the blockchain, and return for awards.

While Ethereum will not be the first blockchain to deploy staking, the impact of Ethereum staking will be felt by the vast number of projects and developers who build on its network. For investors, staking will offer an exciting opportunity to generate passive income on their ETH holdings.