Staking is often compared to mining. However, it offers less movement of assets and less attention to the ever-volatile value of cryptocurrencies.
The TL;DR of staking is that it requires you to hold your funds inside your wallet. This ensures that a blockchain is supported by a security and operations standpoint. Stakeholders are usually rewarded accordingly, depending on the application protocols.
Staking varies in terms of how funds are held. Some protocols require that you hold your coins in an exchange, while others let you keep them in a wallet.
To better understand, let’s look into the concept of Proof of Stake (PoS) and learn how this mechanism makes it easy for blockchains to maximize operations while maintaining a decentralized platform.
What’s Proof of Stake (PoS) and how does it work?
Remember Proof of Work (PoW) for Bitcoin? If not, here’s a refresher.
PoW is a mechanism that turns your transactions into blocks linked together to form a blockchain. Miners try to solve a complex mathematical problem, and the first person to do so is rewarded with the ability to add the next block into the PoW blockchain.
PoW allows for decentralization. The only problem is the amount of math involved. The math problems exist to keep the network secure. The hardship involved in solving them is exchanged for everyone’s safety. But math isn’t the most attractive thing to get more people involved, so some people have tried to think of other ways to provide security while maintaining decentralization. This is where Proof of Stake (PoS) comes into play.
PoS allows patrons to lock in coins. These values are segregated and compartmentalized at different values, with each interval working like a raffle ticket. The more coins a person has locked in, the more raffle entries they get, and the winner gets to validate the next block added to the chain.
It’s pretty ingenious. So, we’ve moved from doing math into creating a non-biased raffle system, turning the situation into a battle of riches rather than a battle of processing power. Furthermore, PoS shows high potential for scalability, which is why it’s compelled Ethereum to switch over from PoW.
By the way, we recently published an article on this new Ethereum system. Check it out below!
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Why was Proof of Stake created?
A 2012 paper on Peercoin by Scott Nadal and Sunny King is attributed to the creation of PoS, as Peercoin was launched with a hybrid PoW/PoS system.
The paper cites Peercoin as a “peer-to-peer cryptocurrency design derived from Satoshi Nakamoto’s Bitcoin,” but with PoW used to mint the oncoming assets. At some point, the developers found that PoW was unsustainable in the long run, so they decided to reduce its use until the entire system was successfully migrated to PoS.
What’s Delegated Proof of Stake (DPoS)?
Delegated Proof of Stake (DPoS) was a 2014 alternative by Daniel Larimer in which coin balances are considered as votes. This makes the raffle system more democratic, as the votes are used to elect several delegates to manage the blockchain for all the voters in the system.
Rewards from staking are distributed equally to the delegates. The elected delegates then re-distribute the staking rewards to the people who’ve voted. The distributed reward is in proportion to the number of votes a person pledged to the delegate.
This system was first used by BitShares and was adapted by EOS and Steem (also created by Daniel Larimer). Basically, DPoS was created to allow for better network performance since there are less validating nodes involved.
The only problem it posed was a decline in decentralization. With only a certain amount of people being involved and most people with money working outside of the system, it didn’t give off a greater decentralization sense since only some people could call the shots. These key people we call “validating nodes” work to fix key governance parameters, pushing decentralization to be further decreased. Hence, it can’t beat PoS.
How does staking work?
To reiterate, PoW makes use of mining while PoS makes use of staking. To proceed with the latter, validators are required to lock up their coins as “raffle entries” to be randomly selected in creating a new block. Intervals are used to cut large amounts of money into smaller votes, serving as multiple entries so that the validator with a high amount locked in has more chances of winning.
Blocks are easily produced without the need for mining and specialized mining hardware (such as ASIC). The need for hash computation is thrown out the window, allowing the number of coins you’re locking in to be the defining factor in whether you win the chance to add the next block. This staking process is what pushes validators to maintain network security. Technically, the stake is in their hands, and if they mess up, they put the stake at risk.
Every PoS blockchain has a different currency for staking. Some use a two-token system in which rewards are given out in the form of a different token than that which was put in. The entire system suggests that staking is a way to lock and keep funds in a wallet that’s perfect for it.
Anyone can easily do several network functions to earn staking rewards. Alternatively, they can opt to add to staking pools instead.
What are staking pools?
Staking pools refer to several coin holders who combine their power by merging their assets, giving them more chances of validating blocks, and reaping the rewards.
Staking power and rewards are distributed in proportion to a coin holder’s contribution to a given pool. Truth be told, it’s a tricky process that requires a lot of expertise and time.
It’s a “high risk, high reward” kind of deal. People are looking to this type of system more and more, so entering a pool usually requires a fee that is deducted from the staking reward a participant might receive.
Pools usually offer flexibility by offering low minimum balances and no fixed withdrawal times. Staking on your own means, there’s a minimum amount of assets that you need to lock for some time. You can only get it back or “unbind” on it after the protocol lets you, which could be a hassle. However, for new crypto users and people looking to try it out, participating in a pool is definitely an attractive option.
How are staking rewards calculated?
The way staking rewards are calculated differs by blockchain. Some factors worth considering are:
- Inflation rates
- The total amount of coins staked in the network
- The length of active staking by the validator
- The number of coins being staked by a validator
Other networks have fixed percentages when it comes to rewards. This percentage is given to validators as inflation compensation since inflation pushes people to use coins instead of holding.
With the latter model, validators calculate the staking reward they might receive. This reward system offers a predictable amount of cashback and is therefore attractive to investors. With the data being public, it grabs people’s attention and opens more doors for others to get involved.
What is cold staking?
This is staking done without the need to connect to the internet. It requires a stakeholder to have either an air-gapped software wallet or a hardware wallet. Some networks allow for this, as funds are secure, offline, and immovable for the time being.
When the stakeholder decides to pull their assets out of cold storage, the rewards dissipate. This process is perfect when stakeholders who put in large amounts want to keep the protection at a maximum while also supporting the network they have locked the assets in.
Staking offers a different perspective in moving your assets around in the world of cryptocurrency. With the PoS model, you’re sure that your locked assets are safe, and there’s no need to mine or do heavy math to add a new block. With certain exploits and new systems in place in the act of staking, you’re in good hands.
To check out more on the potential of staking, you can look at the Historical Yield tab of the staking pages of the following assets that support PoS: