The Power of Compounding Staking Rewards

“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it,” - Albert Einstein Finding ways to generate extra returns in the crypto landscape can be challenging. You can leverage trade, yield farm, or receive airdrops, which require additional time and knowledge.  Fortunately, you can passively earn additional rewards by compounding your staked balance.  You can achieve these results without taking on more risk. In this article, you’ll learn about:

• Compound interest
• Compounded staking returns versus traditional interest
• How to compound staking rewards
• How to take advantage

Read on to increase your knowledge of staking!

What is Compound Interest?

Compound interest is interest earned on an investment that is reinvested. Essentially, it's "interest on interest."  The power of compounding lies in its exponential growth potential, making it a powerful tool for long-term investments. Let’s say you have $1,000, which you invest in a bank’s high-yield savings account (HISA) with a net annual interest rate of 5%:

• You earn $50 in interest in the first year. 
• In total, your balance has grown to $1,050. 
• Assume you do not withdraw the interest earned.
• In the second year, the interest is calculated on the new total of $1,050, leading to $52.50 in interest earnings, and so on. 

Over time, the growth of your investment accelerates.

How Does Staking Compound?

In the crypto market, staking involves locking up your assets in a network to help maintain its operations in return for rewards. Staking is the consensus mechanism for Proof-of-Stake (PoS) and Delegated-Proof-of-Stake (DPoS) networks such as Ethereum and Solana. Staking compounding refers to reinvesting those staking rewards to earn additional yield over time.  Let’s pretend you have 10 ETH, the native token of Ethereum, which has a staking reward rate of 3% per year:

• You’ll earn 0.3 ETH at the end of the first year. 
• Your total ETH balance is now 10.3 ETH.
• Assume you restake the rewards earned.
• Next year's rewards are computed on the 10.3 ETH, leading to 0.309 ETH in returns, and so on.

You may have noticed this sounds precisely like traditional finance’s compound interest terminology. However, there are some key differences, which we’ll explain in the next section.

How Staking Differs from Traditional Finance

While the mathematical principle of compounding remains the same in traditional finance and staking, the mechanisms differ significantly.

Compound Frequency

Traditional investments typically compound annually, quarterly, or monthly. Ideally, you get a daily interest payout as the more frequently you compound, the higher the annual return.  Here’s a table to show the difference, given a $100 investment at a 5% annual interest rate: For crypto staking, rewards may compound, but the payouts can fall on odd-numbered days due to the processes of each network. Depending on the platform you’re staking on, rewards may be paid differently. Lido Finance, the highly popular liquid staking and decentralized finance (DeFi) platform, offers daily rewards for ETH staking. Meanwhile, Coinbase staking hands out ETH staking rewards every 3 days.  The difference in annual returns, however, would be minuscule.  

Interest Rate Volatility

Cryptocurrencies move more wildly than traditional assets, not just in terms of asset prices but also with their stated returns. If you invest in a bank time deposit or savings account, you are promised an annual interest rate. The financial institution cannot change this stated rate. If you’re investing in equities, the company is more likely to maintain a stable dividend policy to satisfy shareholders. Crypto staking rewards decline as the network gets bigger and more stakers join the system. Ethereum, the largest and most stable blockchain to stake on, has offered fewer rewards. Staking rewards fell from over 4% last October 2023 to just above 3% as of writing.

How to Compound Staking Rewards 

Depending on which network, staking method, and platform you’re using, staking rewards can compound in a few ways:

Manual Compounding

This applies to instances where there is a maximum amount that you can stake in a single account. To become a solo staker on Ethereum, you need 32 ETH. This is also the maximum you can stake per validator. Thus, the staking rewards will arrive in another account. To begin compounding, you must transfer your staking rewards to a DeFi platform. You can consider platforms like Lido Finance, which don’t require minimum staking amounts. The Ethereum compounding process may improve with Ethereum Pectra. The upcoming network upgrade removes the 32 ETH cap and allows solo stakers to compound staking rewards.

Automatic Compounding

Some staking platforms or wallets automatically reinvest your rewards. For example, if a platform offers daily rewards, those rewards are automatically added to your staked amount, and future rewards are calculated based on the new total. Lido Finance gives out ETH liquid staking rewards daily and compounds at the same rate.

How to Leverage Staking Compounding

You can leverage staking compounding in several ways to maximize earnings.

Choose Platforms with Automatic Compounding

Opt for staking platforms that offer automatic rewards compounding. This ensures that your rewards are consistently reinvested without requiring manual intervention. Some wallets also come with auto-compounding features.  Wallets like MetaMask offer staking through their staking pool. This pooled staking method allows you to stake any amount of ETH. Rewards are sent to your staking wallet, where you can easily stake for compounding.

Regularly Reinvest Rewards

If automatic compounding is unavailable, make it a habit to claim and restake your rewards regularly. This can help you maximize the compounding effect. You can even take advantage of restaking platforms. This innovation empowers you to stake and earn rewards using your original staked crypto.

Take Advantage of the Eighth World Wonder

Understanding the power of compounding staking rewards can significantly enhance your earnings in the crypto market. By choosing the right platforms and strategies, investors can maximize their returns and leverage the exponential growth potential of compounded staking rewards.  

Editor’s Note: This article was originally published in June 2024 but has been updated with new information.

 

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