Even the most ardent crypto HODLers have their eyes on the growing list of passive income protocols in Web3—and understandably so. HODLing crypto is a popular long-term strategy, but it doesn’t generate returns until users sell at a profit. So, for traders not planning to transfer virtual coins for a long time, why not earn a little extra while maintaining that prolonged position? Enter crypto staking—particularly crypto staking pools.
In this guide, we’ll explain crypto staking, staking pools, and their benefits and risks. We’ll also explore how these pools work.
What is staking in crypto?
To understand why crypto staking pools exist, let’s take a step back and review how cryptocurrency staking works. Blockchains using a proof-of-stake (PoS) consensus mechanism require nodes to lock cryptocurrency on-chain in order to participate in transaction validation. At regular intervals, a PoS algorithm chooses a node on the network to broadcast and publish a new batch of crypto transactions and distributes crypto rewards to the successful validator.
Each PoS blockchain uses different criteria and mechanisms to select validator nodes, but the chances of receiving these opportunities increase the more cryptocurrency a node puts at stake. Since nodes with higher crypto amounts have a greater financial incentive to follow the rules, PoS algorithms tend to associate them with greater reliability.
Also, many PoS blockchains welcome two types of stakers on their networks: validators and delegators. Validators have to meet high minimum requirements for crypto collateral (e.g., 32 ETH on the Ethereum blockchain) and constantly run the blockchain’s software to ensure the validity of transactions. Delegators, conversely, send the crypto they want to stake to a designated validator to enjoy partial PoS rewards without the responsibilities of full node validation.
What is a crypto staking pool?
A crypto staking pool is a collective fund where participants combine their cryptocurrency to contribute to transaction validation on a PoS blockchain. Since these pools hold large quantities of crypto assets, they have greater odds of confirming multiple blocks of crypto transfers daily and receiving staking rewards.
Plus, crypto staking pools typically have low minimum requirements, making passive income more accessible to traders who don’t have enough capital to meet the minimum requirements for validator nodes. Each crypto trader who delegates funds to a staking pool receives earnings in their digital wallet proportional to their share of the entire pool.
How do staking pools work?
A crypto staking pool’s basic architecture and responsibilities involve the following three factors:
Collect and store cryptocurrency from individual traders.
Validate cryptocurrency transactions on a PoS blockchain.
Distribute crypto rewards per each member’s contribution.
While all crypto staking pools fulfill these three criteria, each has distinct design elements and offers users unique features.
Centralized crypto staking
Some centralized crypto staking providers offer staking as a service with an intermediary like a centralized cryptocurrency exchange (CEX) or a crypto custodian serving as the pool’s operator. These third-party-controlled platforms often include user-friendly interfaces, insurance protections, and automated reward distribution. However, they put traders at risk of counterparty vulnerabilities since the intermediary holds each user’s digital assets in custodial crypto wallets.
Decentralized crypto staking
Decentralized staking pools use blockchain-based technologies like self-executing smart contracts and decentralized autonomous organizations (DAOs) to remove centralized intermediaries from staking procedures. In a decentralized staking pool, the control over staking activities is distributed across a participant network on a blockchain rather than concentrated in the hands of a single entity. Some decentralized finance (DeFi) staking pools offer participants unique rewards, such as liquid staking tokens (LSTs), which are synthetic representations of the staked cryptocurrencies a user deposits into a pool.
For example, the LST Staked Ethereum (stETH) mimics the market price of Ethereum (ETH), and it’s issued to each trader who stakes ETH on Lido Finance’s liquid staking protocol. Traders can use stETH across DeFi for other trading or passive income strategies, and stETH tokens work like receipts to redeem ETH on Lido.
While decentralized staking pools remove counterparty risk and open new possibilities for digital finance, they still expose traders to hacks and smart contract vulnerabilities, and there are zero insurance protections in decentralized protocols.
Benefits of staking pools
Crypto pools succeed thanks to a simple—yet powerful—premise: There’s strength in numbers. The pooled assets in these accounts make transaction validation more likely, increasing the odds of consistent crypto rewards for participants. Plus, each of these pools welcomes low crypto deposits, opening doors for crypto traders interested in passive income streams.
Increases accessibility to staking: Staking pools allow crypto traders to participate in staking regardless of their portfolio size. Many staking pools have low minimum deposits, making it possible for traders to stake as much or as little crypto as they like.
Offers a consistent passive income opportunity: Unlike actively staking as a validator node, staking pool participants can sit back and watch their staking rewards steadily grow. If crypto traders don’t plan to sell PoS cryptocurrencies soon, joining a staking pool provides attractive rewards for minimal effort.
Provides convenience and ease of use: Pool operators handle the technical aspects of staking, so participants don’t need to worry about learning complicated processes like setting up a node, managing staking parameters, or dealing with security concerns. Plus, many staking pool platforms—especially staking as a service provider—have an intuitive interface to make monitoring and claiming rewards straightforward.
Democratizes crypto staking: Traditionally, PoS mechanisms favor traders with large crypto positions (aka whales), increasing their chances of receiving rewards and taking over governance proceedings. Staking pools provide a level playing field by bringing more traders onto PoS networks and unlocking the possibility for decentralized governance protocols like DAOs.
Risks of staking pools
Crypto staking pools offer traders an alternative way to generate income, but they’re not without risks. Anyone curious about joining a crypto staking pool should review the common concerns with these pools and their prospective operator’s reputation and stipulations.
Slashing penalties: While staking rewards incentivize good behavior, slashing discourages bad behavior on PoS blockchains. If a PoS blockchain enforces slashing penalties, validators risk losing part or all their staked funds if the protocol determines they made a mistake or acted maliciously. This risk of lost funds extends to depositors in a staking pool if an operator neglects their responsibilities.
Lock-up periods: Many staking pools impose lock-up periods where participants must wait a few days or weeks for a withdrawal request to clear. These temporary freezes ensure PoS blockchains’ security and stability but reduce liquidity for depositors. If crypto traders need fast access to their funds and aren’t comfortable making a long-term commitment, staking isn’t the best passive income opportunity.
Counterparty risks and code vulnerabilities: In centralized staking pools, participants rely heavily on the competence of intermediaries to secure their funds responsibly and take care of the technical responsibilities of staking. Traders don’t have to worry about centralized counterparties on decentralized staking pools, but they still have to trust the security of the protocol’s underlying code.
Pool fees: Joining a staking pool isn’t free. Even on decentralized protocols, traders usually need to pay a percentage of their staking rewards to the pool operator for their services. For an accurate estimate of the potential earnings from a staking pool, traders must factor these fees into a cost analysis model before deciding which pool to join.
Explore all Web3 has to offer on dYdX Academy
Crypto staking is just one of many exciting passive income opportunities in the crypto economy. For more tips on safely exploring all Web3 offers—including crypto lending, mining, and liquidity pools—check out the expert tutorials on dYdX Academy. dYdX also offers eligible traders access to decentralized derivatives trading for Bitcoin and altcoin perpetual contracts. Stay up-to-date on dYdX’s latest features and upgrades on our official blog, and wlstart trading on dYdX today.
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