Staking: Where Do the Rewards Come From?

Staking makes it possible to earn rewards for taking part in securing certain blockchain networks. However, it is not an automatic yield for merely holding a cryptocurrency. Rewards are linked to the work of validators, the rules of the specific network and sometimes also transaction fees. Before taking part, it is important to know where the rewards come from, who manages the funds and when they can be withdrawn.

How staking works

Blockchains using the Proof of Stake (PoS) mechanism rely on validators to verify transactions. Validators check blocks, take part in reaching agreement in the network and may propose new blocks. They earn rewards for properly performing their duties, but they may face penalties for violating the rules. In the Ethereum network, a validator's participation is tied to depositing ETH. Individual blockchains, however, use different rules.

Where rewards come from

Rewards can arise from issuing new units of the cryptocurrency or from part of the transaction fees. With Ethereum, for example, the basic component of the transaction fee is destroyed by burning, while the priority fee may go to the block proposer. Additional income may be related to the ordering of transactions in a block. The offered percentage therefore need not be fixed and sometimes also includes temporary bonuses from the provider.

What APR and APY mean

APR usually denotes an annual rate without ongoing reinvestment of rewards. APY, on the other hand, takes into account the assumption that the rewards earned keep growing. Neither figure guarantees a future result. It is important to check the fees and find out whether the app shows the gross or the net yield. For example, at a model rate of 4 % per year and a commission of 10 % of rewards, a deposit of 10 ETH leaves a net reward of 0.36 ETH for the year, provided the rate does not change and no other costs arise.

More cryptocurrency does not automatically mean profit

Rewards are usually credited in the cryptocurrency, whose price can change significantly. If we have 100 coins at 1,000 CZK each and gain four more through staking, but the price meanwhile falls to 700 CZK, the entire position is worth only 72,800 CZK. The number of coins has grown, but the CZK value has fallen. The result may also be affected by the growth of the total supply of the given cryptocurrency.

How to take part in staking

One option is to run your own validator. In Ethereum, activating one requires at least 32 ETH as well as technical infrastructure. Other routes are delegation, using a staking pool or a service that runs a validator on the client's behalf. With Cardano, for example, standard delegation of ADA does not lock the coins and the network does not apply slashing to this stake. These conditions, however, do not automatically apply to other networks. With an intermediary, it is essential to know who controls the keys and who bears any losses.

Liquid staking and availability of funds

Some services issue a so-called liquid staking token (LST) for the deposited funds, which represents a share in the staked position. Such a token can be transferred or sold under certain conditions, but its price may deviate from the value of the underlying asset. Smart contract and operator risks are also added. Even with ordinary staking, withdrawal need not be immediate: it may depend on the network rules, queues and the provider's terms.

What the main risks are

Besides price fluctuations, there is a risk of technical outages, operator errors or losses caused by violating the network rules. In Ethereum, a serious rule violation can lead to slashing, meaning the removal of part of the deposit and the termination of the validator's activity. A brief connection outage, however, does not automatically mean slashing. When using a service, there is also a risk associated with its security, the custody of funds and the withdrawal conditions.

Staking is not the same as lending

With staking, rewards are tied to securing and operating a PoS network. With crypto lending, by contrast, the yield comes mainly from interest paid by borrowers. These are therefore two different mechanisms with different risks. Bitcoin, for example, does not use native Proof of Stake; if a service offers yield on BTC, it is necessary to find out how it actually generates it.

Conclusion

Staking can be a way to gain additional units of a cryptocurrency and take part in the functioning of a blockchain. The offered annual rate, however, represents only part of the overall picture. The asset's price, fees, the method of custody, validator risks and the availability of the deposited funds are also decisive. Before taking part in staking, we should understand where the rewards come from and under what conditions we can get our deposit back.

This text is for informational and educational purposes only and does not constitute investment advice. Crypto assets are volatile and you may lose the entire amount invested.