Staking vs. Lending

Since savings interest rates at banks have dropped so low, people have started looking for new ways to earn returns on the money they have. One of the ways you can do that is through staking and lending. We'll explain what this is in this article and go into the difference between staking and lending.

What is staking?

Blockchain technology makes staking possible. However, this can only be done at the point when a blockchain uses the Proof of Stake (PoS) consensus algorithm. This algorithm works with several validators that take care of transaction processing and block creation.

When someone makes a transaction, it is sent to the network. Then, a validator will be selected that is allowed to check all transactions created within a certain time frame. After performing the check, the transactions are merged and added to the blockchain as a block.

A validator is chosen based on the number of cryptocurrencies he stakes, what is called the ‘stake‘. The stake always consists of a certain number of crypto coins. In most cases, it is the native cryptocurrency of the project.

The more cryptocurrencies a validator stakes, the greater the chance that the validator will be chosen by the network to be allowed to add a new block to the blockchain. In doing so, the stake also ensures the security of the blockchain.

The other nodes in the blockchain network check the work of each validator. When a majority of the network (at least 51%) sees that a validator is wrongfully approving and adding transactions to the blockchain, that validator will be punished. In most cases this is a fine, which is paid from the stake that the validator has placed. With the stake, the validator shows that he has enough cryptocurrencies to pay a possible fine. The higher the stake, the higher the risk of losing a large amount of money. Hence, validators with a high stake are more likely to be chosen than validators with a low stake. After all, they are the safest choice because they have more to lose.

Validators receive a reward for the work they perform. After all, they have to provide a lot of energy and hardware to process transactions. So, by setting up a validator, people can earn a passive income.

Outsourcing your stake

It is not necessary to set up a validator yourself. In fact, you can also outsource the staking to another validator. In that case, you send your cryptocurrencies to a validator you trust, increasing his stake. The reward the validator receives is distributed among all users who have staked in this validator.

What is lending?

Lending is another way people can generate passive income using the blockchain and cryptocurrencies. However, the way it is done differs from staking.

There are several crypto projects where users can lend cryptocurrencies to other users. Thus, these projects always need a lender and borrower to operate. The lender lends its cryptocurrencies to the borrower.

The platform on which this happens ensures that these two users are linked together

As a user, you can't just borrow cryptocurrencies. This is because the platform wants to make sure that a user can pay off their debt. This can be compared to staking, where the network wants to be sure that a validator would be able to pay his fine.

A borrower must therefore put up collateral in the form of cryptocurrency, to be able to borrow other cryptocurrencies. But what is the point of borrowing when you have to put up the same number of cryptocurrencies as collateral?

Suppose a user owns Bitcoin (BTC). He sees opportunities in Ethereum (ETH) and would like to invest in Ether. To do so, however, he will have to sell his Bitcoin, which means he will lose his position in Bitcoin, and will not be able to make an additional profit on Bitcoin. In this case, he could use his Bitcoin as collateral to borrow Ether. In this way, he maintains his position in Bitcoin, while also taking a position on Ethereum at the same time.

After a certain time, the debt will have to be repaid. If the user has made a positive return on Ethereum, he can use this to pay off his debt, and receive his Bitcoin back. If the value of Bitcoin has also increased in the meantime, the user has thus also made an unrealized positive return on Bitcoin.

Not only the borrower can benefit from this. This is because he will have to pay interest on the cryptocurrencies he has borrowed. This interest will go to the lender. So, in this way, the lender can earn a passive income on the cryptocurrencies he lends to other users.

What is the difference between staking and lending?

The main difference between staking and lending is the way users can generate a passive income from their cryptocurrencies.

Staking requires the user to set up a validator. This means purchasing hardware, which can be very expensive. Next, a large amount of money will need to be deployed in the form of cryptocurrencies. It is difficult to get started as a validator when you have few cryptocurrencies.

Lending, on the other hand, is a lot easier to earn returns on cryptocurrencies. You do need to be able to lend a minimum number of cryptocurrencies in most cases, only this number is much lower than with staking. You also don't need to purchase any hardware in this case to be able to earn a passive income from the cryptocurrencies you want to lend.

What are the advantages and disadvantages of staking and lending?

The biggest advantage of staking and lending is that it allows users to generate a passive income over cryptocurrencies that could otherwise only increase in value through a price increase.

By staking or lending cryptocurrencies, you receive more cryptocurrencies. This is especially beneficial for users who were already planning to hold their cryptocurrencies for the long term.

The disadvantage is that with both staking and lending, users risk losing their money. Even though there is a high return to be made, there is always a risk that you will not make a return and the entire stake will be lost. Therefore, it is important to always do proper research on a crypto project where you can stake or lend.

Conclusion

Staking and lending are both ways users can earn a return on the cryptocurrencies they hold. It's how this is done that makes the big difference. Another difference is the risk difference, which is higher for lending because of the third parties involved.

With staking, users will have to run a validator in a blockchain network or outsource their stake to another validator. The validator checks transactions and adds blocks to the network. As a thank you for his work, he receives a reward for doing so.

Users can also lend their cryptocurrencies to other users, so that they can make other investments with them, for example. For the cryptocurrencies they lend, they receive an interest rate that is paid by the borrower.