Introduction
Bitcoin was founded on the idea of replacing trust with cryptography, effectively removing the need for third-party approval of transactions. Since the notorious Bitcoin whitepaper, every development in the crypto space has been administered with that trustless ethos in mind.
Even when storing your bitcoin, it’s advised to do so on a wallet where you own your keys (private key, seed phrase, etc.) to avoid the risks of malicious, negligent, or unsecured wallet service providers. This comes, however, at the cost of convenience where the less trust you have for third parties, the less convenient it will be to use your bitcoin.
Staking cryptocurrencies also operates on that trust-convenience trade-off spectrum. If you stake crypto in a decentralized way, you trust third parties less, but exert more effort into the activity. If you stake via a custodian, you are opting in to complete third-party reliance and centralized control of your assets (which technically, the centralized entity actually owns), but the activity is extremely easy to perform.
I can’t tell you what is best for your unique situation; I can only inform you of the trade-offs from relative advantages and disadvantages. So before you make a decision about how you want to stake your assets, you should understand how decentralized versus custodial staking stack up against one another.
What is Staking?
Staking is part of the Proof-of-Stake (PoS) consensus protocol that verifies transactions and releases more coins/tokens into the ecosystem. It’s like mining Bitcoin, but much less computationally stressful, quicker, and typically easier to do. PoS requires validators, known as nodes, to delegate or stake their crypto as proof that they will act honestly when verifying transactions. If they break the rules, typically their staked crypto gets slashed (taken away from them); however, once they verify a transaction, they get rewarded in the blockchain’s native cryptocurrency.
Initially, staking was solely a way to participate in the security of a network and get rewarded for it. It still is; however, with the emergence of decentralized finance (DeFi), many other ways have been developed to stake digital assets where staking isn’t necessarily focused on validation but on other activities like governance or reward pools to get tokens into circulation. The following explanations will focus on staking through validation and delegation.
Decentralized Staking
Decentralized staking largely takes two forms. It can be staking to act as a validator as described above, in which rewards would come in exactly the amount that the protocol describes them to. Or it can be delegating your crypto to certain validators through staking applications or pools where you stake and can still own your crypto, but you don’t do the work of running a node to secure the network.
Staking as a validator is the most difficult and trustless way to stake cryptocurrency. Typically, running a node is not an easy task; operating validation software is technically complex and resource-intensive. However, if one can handle the difficulties of becoming a validator, their reward will be the highest possible described by that protocol, they will be contributing to the security of the network in the purest form, and they will have trusted no one at any point in the process.
A much easier way to stake your assets is to delegate them to a validator. Many protocols support delegation where holders can delegate the right to stake their assets while maintaining control of their assets (that are sometimes subject to unbonding periods, or time before a full withdrawal is allowed). Delegators choose the validators they want to stake with who have a reasonable fee for their service and a good enough reputation of not misbehaving, though it’s good to be mindful that not all validators are equal. Some misbehave more frequently than others which can put the validators and delegator assets at risk of slashing depending on the protocol.
The safest way to perform any of these decentralized forms of staking, where you maintain access to your assets, would be from a hardware wallet like Ledger. Similar to many non-custodial wallets, you handle your own private keys; however, the Ledger hardware wallet is a separate entity from your laptop or phone (the device you typically use as a crypto wallet), giving a potential hacker fewer vectors to attack from. Ledger is replete with tutorials for exactly how to stake assets on its hardware wallet.
Custodial Staking
Custodial staking is similar to delegation, except you don’t actually own your crypto. Exchanges that offer their users a staking service offer a form of custodial staking. The famous phrase, “not your keys, not your coins,” applies to custodians, like exchanges. Because the custodian has your private and public keys, you can only transact with your crypto if they allow you to.
When you “stake” with an exchange, the exchange is staking your assets, skimming a percentage of your rewards off the top (not telling you how much they are taking), and giving you the rest. This differs from decentralized delegation not just because you don’t own your crypto, but because you don’t pick who is staking your assets and you’re giving the exchange — an already dominant entity in any ecosystem — more power in the given blockchain’s network, further centralizing said blockchain.
Staking via a custodian requires you to trust that the custodian will secure your assets appropriately and that it will act in a way that will not jeopardize your activity. More than a few times we’ve seen exchanges like Binance halt withdrawals out of their platforms, citing dubious excuses like a “large backlog.” Not all custodians have acted in questionable ways like Binance, but you never know if they will at some point.
With all the risks to your assets that are inherent in trusting custodians, custodial staking is the most simple path to pursue. There’s no need to remember a seed phrase or long private key, only a password that can be retrieved. This is ideal for people who don’t trust themselves not to lose vital information and want an easy-to-follow process for staking.
If staking through an exchange, once you make a trade, there’s no need to offload tokens to a different application or wallet; you will typically be able to stake from within the exchange application, and when you’re ready to liquidate into fiat and onboard that money into your fiat checking account, the process couldn’t be smoother. Based on what you’re comfortable with, you will have to choose between trustless security, convenience, or a combination of the two as you engage in staking activities.
View the comparison below to better understand the benefits and risks of decentralized and custodial staking that contribute to the trust-convenience trade-off spectrum.
Decentralized staking is less convenient, but if you’re responsible, it’s more secure, risk-averse, and trustless. Custodial staking comes with many risks that stem from having to trust custodians — who are often big corporations — although it is very convenient and simple. Depending on where you stand among money-hungry traders and DeFi & crypto maximalists, how you approach staking will be very different.
Examples
Popular blockchain protocols that allow users to stake include Ethereum 2.0, Solana, Algorand, Polkadot, and Cosmos. Some offer staking only associated with validation and others offer staking for activities like governance. I will explain a couple of the different types of staking for Ethereum 2.0, Algorand, and Cosmos.
Ethereum 2.0 and Liquid Staking
Liquid staking is another, sort-of-decentralized approach to staking. Lido Finance is a good example of a liquid staking solution for ether in Ethereum’s transition to Ethereum 2.0. It offers ether holders the chance to stake their assets and circumvent the strict requirements for becoming a validator and staking ether: validators are required to stake 32 ETH (~$147K), high technical proficiency is necessary to set up the validation system on one’s PC, and to avoid penalties for absence, the system must run 24/7.
Liquid staking is only sort of decentralized because it requires you to trust Lido to allocate your ether to certain validators while they give you a 1:1 transferable wrapped version of your staked ETH amount known as STETH that you can use within the Ethereum ecosystem. While Ethereum limits those with less than 32 ETH to only custodial staking, it encourages those with 32 ETH or more to become a validator themselves. This could potentially further decentralization if those with 32 ETH or greater decide to stake their own assets.
Because Ethereum is in such an odd phase of transitioning from a PoW consensus protocol to a PoS, it’s a bit difficult to find a comprehensive guide for staking ETH if you’re not sure what path to pursue. For those interested in Ethereum staking, check out Staking Rewards’ ultimate Ethereum 2.0 staking guide that details many different ways you can stake your ether.
Cosmos and Delegation
Cosmos offers decentralized staking through delegation. I stake on the Cosmos ecosystem through the Keplr wallet, which can integrate into a Ledger hardware wallet, increasing security. Many other ATOM holders delegate directly through Ledger, taking the most active approach to security.
Delegation either through Keplr or Ledger is largely the same one-click process (one-click once you navigate to the correct webpage, of course): find a validator you like and click delegate. When delegating, you must choose a validator that you find suitable. A few factors will be important when selecting a validator like fees (how much they take from your portion of staking rewards), past performance (no consistent history of getting funds slashed), and assets under management.
You want to delegate to someone who does not take too many fees (10% is high) or someone who does not take zero fees (0% may be indicative of some restructuring for that validator and is too good to be true — you want reliability). When looking at past performance, you want to see that a validator does not have a history of slashing and that they frequently get chosen to validate blocks. When considering assets managed, going to a validator with too few assets will lessen your chances of receiving awards, and going with the biggest validator only centralizes the network further. Based on what is important to you and your risk tolerance, delegate to a validator that you feel confident in to consistently perform validation duties.
Algorand and Governance
ALGO holders can stake and receive rewards on Algorand by participating in governance. To be an Algorand governor, you must do three simple things: sign in with your wallet and commit a certain amount of your ALGOs to the upcoming governance period, vote in all sessions in the period, and claim rewards when the period ends. Governance on Algorand is very decentralized as users can use any type of Algorand wallet — Ledger hardware wallet included.
Unlike validation (and sometimes delegation) staking, participating in governance has no risks. It is possible for you to miss out on the rewards; however, you are not at risk of losing your staked amount to slashing. To ensure you are eligible to claim rewards at the end of a voting period, you must vote in all sessions during that period and keep your wallet’s minimum balance from dropping below the amount of ALGOs you committed for that specific period. So if you committed 250 ALGO to the most recent governance period, there can be no time from when you committed to the last day of governance that your wallet has less than 250 ALGO.
Staking through governance on Algroand is very safe, decentralized, and fulfilling for those who like having a direct say in the direction of a project that they are involved in. As of yet, I have not seen any custodians offering governance on Algorand, though it is likely they participate in it themselves with users’ funds. Binance US halted ALGO withdrawals about two months ago just as the governance commitment period was nearing its end. (It cannot be determined with certainty whether this was to prevent individuals from offloading ALGO to governance wallets; however, users could have avoided this custodial risk by simply utilizing a non-custodial wallet.)
Conclusion
Generally, the point of decentralized staking, for delegation/validation or other DeFi activities, is for you to participate in the crypto economy as an individual, as a holder of your own keys. This takes the centralized risks out of finance and security that hinder people’s freedoms. Custodial staking restricts you from many activities in the world of DeFi, limiting you to activities in the custodian’s platform. Although decentralized staking appears to be more beneficial, it requires more personal responsibility and effort than doing simple activities via a custodian.
Again, the route you ultimately go down to explore the world of DeFi and participate in staking is your choice and should be based on what you’re comfortable with within the trust-convenience trade-off spectrum. I don’t run validation nodes — though I have before — but I like being exposed to more activities and actually owning my crypto. Custodians like KuCoin get hacked, but I still use them for certain activities, like staking smaller cap tokens that don’t have their own DeFi ecosystems yet, but that partner with institutions.
Occasionally, I choose convenience, but mostly, I subscribe to trustlessness and personal responsibility. Others might be different and just want simple exposure to crypto without digging too deep — both types are understandable. So… Who are you? What do you want from the digital asset space? And how do you want to stake your digital assets?