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What You Need to Know

  • Staking is a way to earn passive income on cryptocurrency in exchange for locking it up for a period of time.
  • The IRS treats money earned through staking as ordinary income.
  • Risks of staking include exposure to crypto price volatility and illiquidity of staked assets.

As cryptocurrency continues to become more widely accepted within the mainstream investing community, both institutional and retail investors are looking at different strategies to boost their returns or find passive income within the crypto markets. One such strategy is crypto staking.

If it’s not something your clients have asked about yet, prepare for the questions to come. Nearly half of advisors said their clients asked about crypto assets in 2021, up from just 17% of advisors in who said the same in 2020, according to the Financial Planning Association. As they learn more about the space, they’re likely to ask you about crypto staking as well. This guide can help you answer their questions.

What Does Crypto Staking Mean?

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Crypto staking is the process of locking up a certain amount of cryptocurrency through an exchange or a staking pool in return for passive income in the form of interest or rewards, typically paid via that cryptocurrency. The blockchain uses that staked crypto to validate additional transactions.

In some ways, crypto staking is like buying a certificate of deposit from a bank. The bank holds onto the buyer’s assets for a period of time in exchange for interest. With staking, the blockchain keeps the assets in exchange for rewards.

How Does Crypto Staking Work?

Clients who are interested in crypto staking will first need to own or purchase a cryptocurrency that uses a proof-of-stake model to confirm transactions. Ether, Cardano and Polkadot are examples of cryptocurrencies that use proof of stake.

Then, they’ll need to commit some (or all) of their holdings to the network, for use in validating transactions. The easiest way to do this is via an exchange such as Coinbase or Kraken. If the blockchain uses that crypto to validate a transaction, the owner receives a reward payment.

(Advanced crypto traders may bypass the exchange and stake their crypto directly, but that requires significant technical knowledge and time to set up and run a node.)

Proof of Stake vs. Proof of Work

Proof of stake and proof of work are two of the most common consensus mechanisms used by the blockchain to validate transactions and bring more crypto online. Proof of work, the mechanism used by Bitcoin and the original method of validating cryptocurrency, relies on virtual “miners” around the world to process complex math problems and confirm transactions. This is a time- and energy-intensive process.

Proof of stake, on the other hand, uses existing staked crypto from network participants to validate new transactions. Crypto staking is only available for cryptocurrencies that use proof-of-stake mechanisms. The Ethereum network is transitioning from proof of work to proof of stake.

Does It Make Sense to Save With Crypto Staking Instead of a Traditional Savings Account?

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No, not for traditional savings. If a client is looking for a liquid account that won’t lose value, a traditional savings account may be a better bet. While the returns are relatively low, there’s no risk the client will lose their principal or be unable to quickly access it when the need arises.

Crypto staking, on the other hand, carries many more risks that make it a less appealing savings vehicle. The volatility of cryptocurrency means that the value of the stake itself could lose value significantly.

Risks and Benefits of Staking in Cryptocurrency

Staking in cryptocurrency has many risks that investors need to understand. In addition to volatility risk, many exchanges require that crypto stakers lock up their crypto for a certain period of time, turning it into an illiquid asset until that time period passes.

As with most investments, the higher risks involved in with crypto staking also offer the promise of higher potential rewards. The returns on staked crypto are higher than those on a traditional savings account, and volatility works both ways, so there’s also a chance that staked coins could increase in value over time.

Pros and Cons of a Traditional Savings Account

The advantages of a traditional savings account are its liquidity and downside protection. The principal in a savings account will remain intact, and account owners can access them any time they want.

That said, the biggest disadvantage of a traditional savings account are extremely low interest rates. Even on high-yield accounts, the return is typically less than 1%, meaning that money in a savings account is losing value over time.

What Have the Returns on Crypto Staking Looked Like?

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The returns for crypto staking vary by both platform and the coin staked, and many increase the value of rewards for crypto stakers who are willing to lock up more assets. A report by Staked and Kraken in late 2021 pegged average annual yield at 14% — a 9% increase from a year earlier.

What Cryptocurrencies Are Available for Staking?

Any cryptocurrency that uses a proof-of-stake mechanism is potentially available for staking. The biggest of these is Ether, which had an annual yield of 5.2% at the end of 2021, according to the report from Staked and Kraken. Solana yielded 5.6%, Cardano 4.6% and Terra 7.7%. Of the top 35 staking chains by market capitalization, according to the report, Osmosis was the highest yielding at 93%.

Cryptocurrency Staking and Taxes

The IRS treats money earned through staking as ordinary income. That means that clients must report earnings from staking and pay taxes on them, based on the value of that coin when they received it.

Key Takeaways for Advisors

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Having a solid understanding of crypto staking can help you guide clients showing interest in the space. Keep the following in mind:

  • As with any crypto transactions, crypto staking is subject to the asset’s volatility, and the value of staked assets could decrease (or increase) substantially in a short period of time.
  • Earnings received through crypto staking count as regular income for tax purposes, so those who stake coins may need a strategy in place to handle potentially higher tax bills.
  • Most staking platforms have a lock-up period, so make sure your clients understand liquidity restraints and avoid staking assets that they might need in the short term.

(Cover image: Chris Nicholls/ALM; Adobe Stock)