You can have your cake and eat it in the cryptocurrency world. What I mean by that is that you can buy cryptocurrency and hold onto it -- but you don't have to wait until you sell to lock in rewards. Instead, there's a way to generate passive income. It's called staking.
And as of just recently, you can stake your holdings of crypto giant Ethereum (CRYPTO:ETH). So, should you give it a try? Let's take a closer look at exactly what happens -- and if it's a good option.
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A new development
Ethereum staking is a new development. The world's second-biggest cryptocurrency originally used a proof of work consensus mechanism like market giant Bitcoin. This means, to validate transactions on the network, computers have to perform complex tasks. This uses an enormous amount of energy and time.
As part of Ethereum's upgrade, it's switching to a proof of stake consensus mechanism. This means validation power is given to computer nodes according to their Ethereum holdings. These validators put up their stake as a collateral of sorts. You can stake as an individual. But that's complicated. First, you have to commit at least 32 Eth (that's worth more than $98,000 according to today's price ) to stake. Then, you should have some technical knowledge and have a computer running at all hours to potentially validate transactions.
If that sounds intimidating, no need to worry. There's another option. You can stake your holding through a staking pool. This means you allow a validator that pools holdings from various investors to include your holding. And you don't have to commit a huge amount of Eth. More good news: The validator does the work. And you reap the rewards. You can do this through various staking services -- or even through cryptocurrency exchange Coinbase Global. For instance, Coinbase says you can earn as much as 5% APR on your holdings by staking through its pool.
The risks of staking
All of this sounds great. But there are a couple of risks that come along with staking. One negative point is that when you stake your holdings, they're tied up for a certain period of time. That means, if the value of Eth rises or falls during that time, you can't sell to lock in gains or prevent further losses. You have to wait until the lockup period is over.
There is also the risk of slashing. This happens when the network destroys some of a validator's tokens if that validator doesn't follow the rules. If this happens to your staking pool, you can lose some or all of your investment.
So, let's get back to our original question. Should you stake your Ethereum holdings now? When investing in cryptocurrency, I always say, "Don't invest more than what you can afford to lose." Now, I'll say the same thing about staking. And of course, it's important to research staking pools well before deciding to commit your holdings. I like the idea of going with an exchange like Coinbase.
If you accept the risks, though, staking can be a great way to put your cryptocurrency to work for you. It's an opportunity to benefit in the near term through passive income -- while holding onto the investment for the long haul.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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