A good way to earn while you ‘hodl’ onto your cryptocurrency during a bear market is by staking your cryptocurrency to earn more cryptocurrency. Staking is a type of way to earn for individuals who have chosen not to sell their cryptocurrency holdings for the foreseeable future. It’s like investing in an FGN Savings Bond or Commercial Paper, but in this case, you are investing a crypto asset in the hope to get more cryptocurrencies.
Staking is the way many cryptocurrencies verify their transactions, and it allows participants to earn rewards on their crypto holdings while contributing to the general integrity of the blockchain in question. Staking cryptocurrencies is a process that involves committing your crypto assets to support a blockchain network and confirm transactions.
The opportunity to stake your crypto is available with cryptocurrencies that use the proof-of-stake (PoS) model to process payments. Due to climate activities pointing out how mining cryptocurrencies are harmful to the environment, the PoS has become a more energy-efficient alternative to the original proof-of-work (PoS) model that Bitcoin operates on.
Why APR is important
When staking cryptocurrency assets, APR (Annual Percentage Rate) is one of the most crucial factors to consider for optimal efficiency. Staking reward comprehensively includes income from inflation and transaction fee distribution.
In staking cryptocurrency and with everything else in life, users always tend to go for the one that is the most secure, efficient, highest-income-guaranteed investment route. APR, Annual Percentage Rate, is the most intuitive, important key element in staking because it presents how much interest a user would receive for the bonded asset in one year.
APR should not be confused with Annual Percentage Yield (APY). Annual Percentage Yield is the amount or the percentage rate of interest including the compound interest on an amount. Since APY calculates all the compound interest and the frequency of it, this is also called the absolute interest rate. Basically, APY tells you exactly how much you receive in a year while APR does not.
How APR is calculated
As previously mentioned, the APR does not necessarily mean that is the return you will get at the end of a year. This is because of how the APR is calculated. Simply put, your staking APR is calculated as: [Inflation * (1-Community Tax)] / Bonded Tokens Ratio. let’s look into the details.
To fully understand the calculation of APR, we first need to understand what annual provision and inflation are. Simply put, annual provision is the number of blocks increased on a blockchain in one year. Its formula is: Annual Provision = (Current Total Supply) * (Inflation Rate)
Annual inflation rate is the ratio of the amount of blocks increased in one year compared to the year before. The inflation rate reacts to the status of bonded tokens ratio, which means that the inflation rate is constantly changing without being noticed. Some chains do not directly show you the annual inflation rate through on-chain parameters, however, if we have the total supply and annual provision, we can derive the inflation rate with a simple division calculation.
According to how the inflation rate works, the number of blocks to be provided in one year is decided with an annual provision. For example, let’s say the current supply of a token is 1000 and the inflation rate is 10%, this means the annual provision would be 100 tokens. These 100 tokens will now then be distributed to the staking users as reward, accordingly to the bonded tokens ratio of the network. Basically, in staking APR, the inflation-driven interest is distributed from the annual block provision to staking users.
Asides from inflation & annual provision, there are other factors to consider like community tax and bonded tokens ratio. Community tax, in most cases, is relatively small, for example, 2%. Then we have to take the bonded tokens ratio into our consideration since the reward is only given to those who actively staked their assets, and not to those who did not. The bonded tokens ratio can be simply calculated: bonded tokens divided by total supply.
So far, what we have discussed above is how the nominal APR is calculated, theoretically. On the other hand, there are a couple more things behind the scenes that we have to take into consideration for the calculation of actual APR: Actual Staking APR = (Nominal APR) * [(Actual Annual Provision) / (Annual Provision)].
The first thing to consider is the block-minting speed. The actual observed speed of blocks being minted can be slower than the estimated/predicted value (annual provision) due to the uncertainty of the network’s operability. Another thing to consider is the validator’s commission. Whichever APR you have, nominal or actual, multiply (1-validator’s commission) for the final actual staking APR. Validators offer a variety of commission rates, so users are able to select their preferred validators for an optimized portfolio.
- In conclusion, the APR briefly gives you an idea of how much the interest will be in staking. The actual APR is slightly lower than the nominal APR shown, since there are other factors to be considered as discussed above. Due to these ever-changing factors, the APR rate will constantly change and might differ for different investors.
- During this, what many are calling, crypto winter, as a result of the market downturn we have seen through our 2022 so far, investors who are strong believers and holders who are down bad on their portfolio are advised to stake their cryptocurrencies so as they can earn passive income against the next big price jump.
- Those who are new to the fold must keep in mind that Bitcoin and other cryptocurrencies are extremely volatile. As a result, the amount of interest you earn may be variable. Crypto lending programs are appealing for those investors who want to keep their coins for a long term, hence passive income will add value to their portfolio. However, any changes in the price of the cryptocurrency would have an impact on their revenue.