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How Does Staking on CEXs Work?

Jon Ganor
Jon Ganor
How Does Staking on CEXs Work?
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tl;dr

  • Staking on an exchange involves pooling funds to launch nodes, while liquid staking allows the use of ETH in DeFi without sacrificing staking rewards.

  • Staking on an exchange and liquid staking differ in terms of operator reliance and risk levels.

  • Staking on an exchange is convenient for users with funds on that exchange, but it comes with the risk of exchange malfunctions or hacking incidents.

  • Despite the risks, staking on an exchange fosters Ethereum's decentralization, promoting the broader adoption of staking.

An Introduction to Staking Methods

Since Ethereum's transition to Proof-of-Stake, staking has become an increasingly popular way to earn rewards for holding ETH. With staking, users can earn rewards in the form of ETH for helping secure the network by holding and validating transactions. However, solo staking requires a minimum of 32 ETH and technical expertise, which can be a barrier to entry for many users.

Multiple staking options have emerged to overcome this barrier, including liquid staking and staking on a centralized exchange or CEX. Both options allow stakers to stake smaller amounts of ETH, making it accessible to a wider range of users.

Liquid staking is allows users to stake their ETH while still being able to use it for other purposes. Essentially, users can deposit their ETH into a smart contract that mints an ERC-20 token representing their staked ETH. These tokens can then be traded or used in DeFi protocols while still earning staking rewards.

Staking on a centralized exchange or CEX is another option for individuals who want to stake smaller amounts of ETH and institutional clients with large amounts. With this option, users can deposit their ETH into an exchange that supports staking and earn rewards without having to worry about the technical aspects of staking.

How Does Staking on an Exchange Work?

Staking on an exchange allows users to earn rewards for holding and securing cryptocurrencies without having to worry about the technical aspects of staking. Typically, staking on an exchange works by pooling all stakers' ETH funds together to launch nodes, which generate rewards by verifying transactions on the blockchain.

When staking on an exchange, users simply deposit their ETH into the exchange's staking pool and start earning rewards. The exchange takes care of the technical aspects of staking, such as running the nodes, and distributes the rewards among stakers based on their contribution to the pool.

Staking on an exchange can be very convenient for users who already have funds on the exchange. They can simply move their funds to the staking pool and start earning rewards without having to worry about setting up their own staking nodes or running any software.

However, it's important to note that not all exchanges offer staking services, and some major exchanges, such as Bitstamp, do not permit staking on their platform for all users. Users should always do their own research and choose a reputable exchange that offers staking services if they want to stake their ETH on an exchange.

How is Staking on an Exchange Different from Liquid Staking?

Staking on an exchange and liquid staking is very similar on a technical level. Some exchanges, including Binance and Coinbase, even offer liquid tokens to stakers now, such as cETH and bETH. However, it is important to note that there is one key distinction between the two options.

The key difference between staking on an exchange and liquid staking is the platform operator. With staking on an exchange, users are relying on the exchange to manage their staked funds and distribute rewards. This introduces additional risks, as users' staked funds may be at risk of loss or theft if the exchange is hacked or goes bankrupt.

The Pros and Cons of Staking on an Exchange

Staking on an exchange can be an attractive option for users who want to earn rewards for holding and securing cryptocurrencies without having to worry about the technical aspects of staking. However, there are both pros and cons to this approach.

On the positive side, staking on an exchange is convenient for users who already have funds on the exchange. They can simply move their funds to the staking pool and start earning rewards without having to worry about setting up their own staking nodes or running any software. Additionally, staking on an exchange allows users to stake smaller amounts of ETH than solo staking, making it accessible to a wider range of users.

However, it's important to note that staking on an exchange comes with its own risks. Users are relying on the exchange to manage their staked funds and distribute rewards, which introduces additional risks in case of an exchange collapse or hacking incident. Furthermore, not all exchanges offer staking services, and some major exchanges, such as Kraken, do not permit staking on their platform for US-based clients.

Conclusion

Staking on an exchange is an attractive option for many users who want to earn rewards for holding and securing cryptocurrencies without having to worry about the technical aspects of staking. It is convenient for users who already have funds on the exchange and allows users to stake smaller amounts of ETH than solo staking. This accessibility is expected to contribute to the growth of staking on exchanges.

While staking on an exchange comes with its own risks, it helps to decentralize the Ethereum staking ecosystem. By allowing users to stake their funds on a centralized exchange, the network becomes more decentralized, which is one of the key goals of Proof-of-Stake consensus.