What is Staking?

Staking is a consensus algorithm on some blockchains through which transaction validators get the right to create blocks on the network. As opposed to mining, the staker is not required to solve complex mathematical calculations, as is the case in the proof-of-work (PoW) consensus mechanism.

Popular blockchains employing the staking model include EOS, Tezos, and Cardano. Bitcoin is an excellent example of a PoW-powered decentralized protocol.

The stakers commit funds to a crypto wallet to receive the right to provide the services of verifying and securing transactions on proof-of-stake (PoS) blockchains. In the process, they get rewards for their input in enabling the blockchain to achieve consensus and strengthened the network. The amount of cryptocurrency locked up determines the size of privilege given to create new blocks.

Profit-minded crypto holders stake their coins for passive income from the rewards given instead of letting their crypto deposits stay idle.

Overview of Crypto Lending / Staking platforms

How does staking work?

Before delving into the staking process, it’s essential to shed light on the “agreement” between the validators and the blockchain.

Different blockchains frame their rules differently. However, the staker must follow some standard block-creation ethics for the staker to retain the stake ownership and qualify for the network incentives.

For instance, the blockchain only expects the validator to confirm valid transactions and avoid a single transaction’s fraudulent replication. On the other hand, the blockchain should meet the bargain’s end by rewarding the validator for approving the valid entries.

The validators could face the forfeiture of part or their entire stake if they indulge in activities that violate the staker-blockchain agreement. These are things like malicious access to the network and confirming double-spend transactions.

The initial step of staking is committing your cryptocurrency to a smart contract.

However, it’s important to note that the amount locked up should reach or surpass the minimum stake threshold set up for the particular network. When the user meets the staking requirement, a node transfers the crypto amount into the PoS blockchain.

The stake’s size determines the probability of a node being selected to create the subsequent block. The more significant the stake, the higher the chance of selection.

The network protocol randomly selects the validator. When the chosen node successfully makes a new block, it receives its incentive.

Staking Pool

We have seen that the more significant the stake, the higher the probability of selection as a validator. That means that higher stakes magnify the staking power.

In the older generation PoW mechanism, the probability of creating a new block depended on the validator’s computational resources to solve the hash puzzles. In the more convenient PoS system, the number of coins committed is a determining factor in who gets the privilege of creating a block.

Sometimes individual stakers may combine their resources to form a more robust unit and double or triple their chances of creating blocks.

In such a case, the group shares it’s collective earning on a ratio decided by the size of each individual’s stake.

What are the rewards of staking?

Different coins earn different rewards-some with higher percentage returns than others.

To get a glimpse of how staking is rewarded, let’s briefly analyze the famous Ethereum blockchain’s staking process. Ethereum is migrating from using a PoW mechanism to the proof-of-stake mechanism, and validators are required to lock at least 32 ETH for a right to create a block.

The validators whose nodes successfully validate a transaction block onto the blockchain earn a reward in ETH, which comes as a certain percentage of the amount staked. The network also favorably rewards the validators who stay online for longer, creating new blocks.

Computing Staking Rewards

The computation may vary from one blockchain network to the other. Some networks use a fixed percentage to calculate the rewards. In this model, it is easy for validators to project their expected earnings.

Other networks set the variable rates that change from one block to the next dictated by several factors like:

1. The total value of cryptocurrency staked by the validator.
2. The total value of the crypto cumulatively staked on the network.
3. The total time the validator spent in active staking.
4. Rate of inflation.

Advantages of staking

Staking provides a cheaper alternative to mining. The latter consumes too much energy and involves costly technical equipment. Moreover, the ASICs used in the PoW mining method requires the intervention of professionals to set up.

A newbie can become a validator in the PoS environment since there is no need for the expensive GPU/CPU computer hardware and electricity needed by miners in the PoW environment. In the former, the user needs to invest in crypto only.

Further, PoW mining creates a loophole for centralization and monopoly. A small group of privileged miners with the requisite computer power could gang up as the exclusive makers of new blocks and exclude less-endowed miners from validation and thus rewards.

PoS is different. It mitigates this risk by removing the restrictive barriers to entry for small-scale validators.

Ultimately, some proof-of-stake blockchains allow stakeholders with massive deposits to keep them on a “cold wallet” to mitigate the risk of losing their funds to online hackers.

Disadvantages of Staking

One of the main downsides of staking crypto is that you cannot use them during the fixed freeze period.

If the digital currency market is bearish, then the staking exercise rewards may not cover the value-deficit caused by the dropping crypto prices.

In such cases, the staker incurs a loss instead of earning.

Ultimately, staking is a matter of juggling with risk. The platform you use could be hacked, leading to loss of your stake. That’s why making an informed choice on the staking platform to use is vital.

Conclusion

Unlike the limited proof-of-work consensus mechanism, staking has reduced the hurdles in joining the blockchain ecosystem. It’s now easier to take part in a given network’s consensus and control by staking with it.

The proof of stake mechanism is set to overtake the PoW due to its less expensive investment and relatively lucrative rewards.

However, due diligence is vital in staking. Holding and freezing your funds on smart contracts is prone to hacking. Users need to make use of safe top-notch wallets.

It’s advisable to get into staking when you’ve understood all the inherent risks and provided insulation against them.