What is staking in decentralized finance and how to start using it.
Decentralized finance (DeFi) has emerged as a game-changer in the financial sector, revolutionizing the way we perceive money and financial systems. At the heart of this transformation is the concept of staking, which enables individuals to earn passive income and access rewards that were previously exclusive to traditional financial institutions.
Is DeFi the goldmine of the 21st century?
DeFi represents a shift from traditional financial systems to protocols and platforms operating on the blockchain. Its key elements include smart contracts, digital assets, dapps (decentralized applications), and protocols. The aim of DeFi is to remove intermediaries and establish a financial environment where users have complete control over their assets and transactions, and the community decides on its future direction. Over the last few years, DeFi platforms have experienced significant growth in both numbers and the total value locked in them. This growth is due to the promise of open access, transparency, and the potential for high returns.
Is there staking in the traditional financial system?
Banks are centralized organizations where people can deposit money into savings or checking accounts. When you keep your money in a savings account, you can earn interest.
However, this system offers only modest income and is centralized, which means the bank’s management can track the flow and amount of funds at any time, and even limit your access to your own money.
Staking in DeFi – a flight of fancy and a path to wealth
Staking in DeFi offers a modern alternative to the traditional banking system. Instead of using banks, you can deposit your digital assets into a digital vault. While your funds are “locked” in the protocol, you earn rewards or interest.
DeFi has been around for several years, and like any ecosystem, decentralized finance is constantly changing and evolving.
In today’s environment, two types of staking can be distinguished. There’s the original form of staking as it was intended, and then there’s a modified version that still allows for passive income on existing assets while retaining the essence of staking.
Initially, there were validators involved in traditional staking.
Staking was traditionally used to secure the blockchain network. Network validators, who validate transactions and create new blocks, would lock a certain amount of digital assets as a guarantee of their integrity. Staking can be done directly by the validators or delegated to others.
Delegated staking involves token holders entrusting their staking power to a network node responsible for maintaining the network. This means that users lock their tokens to support the node, rather than the validators directly.
The Evolution of Cryptan: What Else Is at Stake in DeFi
If we consider staking in a broader context, we start to move away from the original noble goals of validators. Instead, we look at ways to generate passive income in decentralized projects by locking up existing funds for interest.
### Providing Liquidity
Users deposit their tokens into pools on decentralized exchanges. In return, liquidity providers earn commissions on trades that use their funds.
### Farming
Users strategically engage with various DeFi protocols, contributing their assets to different pools and farms to maximize returns based on current incentives. By investing their assets in liquidity pools, users receive LP tokens, which represent their share of the pool. Certain LP tokens can also be staked in special farms to earn a percentage of income.
### Benefits of DeFi Staking
**1. Diversified Income**
Whether through traditional staking or its extended forms, your earnings are often several times higher than what you\’d get from bank deposits or other traditional financial systems.
**2. Meaningful Contribution**
Direct and delegated stakers enhance the security and efficiency of the blockchain.
**3. Accessible to Everyone**
DeFi allows broader participation in financial transactions—from direct staking to providing liquidity—without intermediaries. The minimum amounts required for staking are significantly lower than those for bank deposits with competitive interest rates.
### Drawbacks of DeFi Staking
While staking in DeFi has numerous advantages, it’s essential to approach it with caution. As the DeFi ecosystem evolves, certain issues and concerns arise.
**1. Centralization of Validators**
Delegated staking can lead to many users concentrating their staking power in a small number of well-known validators. This may create moral and ethical conflicts, as it risks centralizing control among a few popular validators, undermining the principle of decentralization.
**2. Vulnerabilities in Smart Contracts**
Smart contracts, which underpin DeFi platforms, can have coding vulnerabilities. Such flaws may expose stakers to potential hacking risks and the loss of funds.
**3. Impermanent Losses**
This concern is particularly relevant for liquidity provision staking. Impermanent losses occur when the price ratio of tokens in the liquidity pool changes compared to their value at the time of deposit, sometimes resulting in lower income than expected.
**4. Challenges for Farmers**
Interacting with multiple protocols to maximize staking revenue can lead to various pitfalls. Mistakes may result in losses or missed opportunities.
**5. Price Volatility**
Fluctuations in cryptocurrency prices can impact staking rewards. A decrease in token prices may reduce overall profitability.
**6. Legal Considerations**
From a legal standpoint, DeFi exists in a gray area. While many operations familiar to crypto enthusiasts may not be regulated, it\’s crucial to stay informed about jurisdictional regulations to avoid potential legal issues.